Architect As Developer Series: 02

02: The Project Budget

This is Part:02 of the AAD Series. Check out Part:01 if you haven’t already.

EQUATION: Profit = Revenue - Cost

In simple terms, a development is profitable when the Revenue exceeds the Cost. The revenue side is fairly easy because you base it on comps in your market and that’s about all you can do. You make as best of an educated guess as to how much you will make. The cost side is much more detailed. It is in fact, the heart of your budget. Making sure you have a comprehensive Cost budget is key to a successful development.

Why your budget doesn’t have to be accurate. Sort of.

Yes, you read that right. Your budget doesn’t have to be accurate. By that I mean, if at the end of the project, it turns out it cost you $247/SF to build this thing, and you budgeted, $225/SF, you’d say your budget estimate was inaccurate.

What I would do is actually ask you, “Was it comprehensive?” More precisely, “Did you include everything you were supposed to include?”

This question alone is what I would say caused us more problems than anything else when we first started out. Here’s why.

As Architects, we’re used to dealing with general contractors and we’re pretty good (ok, kinda-sorta good) at knowing how much things cost to build. Drywall is this much. Framing is this much. And on and on. In other words, we are very familiar, and most comfortable with, developing the Hard Costs for a project.

What we don’t have much knowledge of, and what I was horrific at when I started, was the Soft Costs.

We don’t really deal with Soft Costs.

You know why? The Developer, or your client, does. That’s their responsibility, not ours. Many of the soft costs that are incurred by a development project we never deal with. When we give development a try the one mistake we make first, and often, is forgetting to include all of the costs in our project budget. Then, one day when we have to actually pay for that soft cost we say, “Damn, I didn’t account for that in my budget.”

Here are some examples:

1. Legal Fees. By this I mean lawyers. You’re going to forming LLCs, or partnerships, or whatever you choose. You’re going to want to minimize risk from litigation if you’re doing For-Sale development. You may need CC&Rs. A buyer may bring his own PSA (Purchase and Sale Agreement) which your lawyer will have to review. Legal fees start to pile up quick and you may think it’s not much, and maybe it isn’t. But, all the nickels start to add up. Keep track of the nickels.
2. Insurance. If you’re going to develop, you’re going to need insurance. Depending on how you set up your organization’s structure, that will dictate how much insurance you need. If you develop/design/build/gc/ and market the whole thing, you’re going to need lots of insurance. What kind of development are you doing? For Sale projects usually carry higher risk, i.e. more insurance. Find out how much Course of Construction insurance is where you are. Find out how much Wrap policies cost if they’re used and offered where you live. What about Project Specific policies? If you don’t know what these are, you need to find out. Again, I can’t go into everything here, but be aware of this cost.
3. Financing Costs. Every dollar you get comes with strings. Loans, private equity, etc…they all come with a cost. Find out what they are and make sure your project budget accounts for them. You may think you have a slam dunk project and then you realize the construction loan you got is not as awesome as you thought. The interest may begin to accrue earlier than you thought. Points and extensions may cost twice as much as you thought.
4. Broker fees. These hurt a lot. You do all this work, and some broker swoops in at the end and gets 5% of your revenue. I won’t go into much on this here, but you have to be really creative and try to get these fees down. Be your own broker. Get a lower rate in return for exclusive listings of your projects.
5. Entitlement Costs. Many times, when a developer-client shows up at an architecture firm, their project may be entitled already. They have spent tens of thousands of dollars on getting variances, on zoning adjustments, consultant fees, filing fees, and a million other things. If your project will require getting Entitlement, you’d best find out what those costs are. Ignore them at your own peril.
6. Holding Costs. You may acquire the land or parcel today and not start or complete your project for a long time to come. You may have to pay property tax during that time. You may have to pay some utility costs, or who knows what. Make sure to include this as well.
7. Permits. As Architects we may know what a building permit costs, but how many of you know what every single permit a development project needs costs? I still don’t. And guess what, this one is another biggie. For example, when we did our first project we did not know what “School Fees” were or that they even existed. Here in Los Angeles, if your project is over 500 SF (new or renovation) they charge you about $4/SF in school fees. The money goes to the local school district. Oh yeah, and this is calculated on GROSS SF. So, our first project was 4 homes at roughly 2,000 SF each. 8,000 SF X $4=$32,000! We had this nowhere in our budget. The only place to take it from is the profit. It’s embarrassing to admit this here, but I don’t want you to make the same mistake. You may think you know, but you don’t.

Aim for comprehensiveness first, then accuracy.

For all of the reasons pointed out above, I think you should not get hung up on whether the hard flooring you want will cost $4/SF or $4.25/SF. That is nothing if you leave out tens of thousands of dollars in fees you didn’t even know existed. Here are some tips.

Talk to Land Use Consultants. If you’re going to do anything that you think may require any jurisdictional approvals, etc, these folks may be able to not only help you with the process, but also with the costs.

Talk to Expediters. Expediters definitely know what the costs are when doing any kind of project. They spend their days going from agency to agency getting clearances and approvals for projects.

Talk to Developers. This may be a little tougher since so many people in this business hate sharing, but you never know. You lose nothing with asking someone in your neck of the woods to review your project budget to see if it passes the smell test.

Good Project Budget = Better Proforma

If you set up a detailed and comprehensive project budget, you are 90% done with your proforma without you even know it yet. The proforma builds on the project budget. To see how, we will start to discuss that in the next few posts. In the meantime, start researching, start asking questions, and make sure you’ve identified as many of the soft costs for your particular project as you can.

Next Week:

03:Proforma Lingo. Key terms and ratios you should know.

Do you have questions?

I want to answer everyone’s questions as best I can given my other responsibilities (don’t forget, I have a firm and office to run). Please post your questions below and I’ll try and answer them as best I can.

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