Construction Finance Management Assignment

Hi

I am taking up the subject of Construction Finance Management in my first blog. This is because I have received email from my batch mates to help with this. I am going to explain the approach that a person can take towards solving the particular problem presented in the Construction Finance Management Assignment.

Let us start by listing the problem.


An offer has been given by a Charitable Trust to develop and build a facility on a 10,000 sq.m of plot in a prime locality of Pune where 5,000 sq.m of area will be used by the trust for housing, health facilities for senior citizens. 5,000 sq.m. will be given free to the developers as a cost of development
Cost of Land is Rs. 10,000/- sq.m
Flooring specifications for flooring:
- 10% Granite
- 40% Kota stone
- 50% Mosaic cement tiles
Developers would like to have minimum 18% net profit on their investment. Developer can invest only Rs. 10 lakhs as his own funds and can raise not more than Rs. 50 lakhs as bank loan.


Understanding project and project requirement


The trust wants to build a facility for public welfare. Due to probable lack of resources the trust is willing to pay the developer in kind i.e. through giving 50% of total land.
By making a preliminary survey of land prices of prime locations, it is estimated that the cost of Rs 8,000/- per sq m to Rs 12,000/- per sq m is prevalent. Therefore the given Rs 10,000/- per sq m rate be safely taken to calculate the land price. Thus 10,000 sq m of land will be of Rs 10,00,00,000/- worth .
Therefore in principle the trust is paying Rs 5,00,00,000/- in kind to the developer as development cost.
The objective for this complex:
• To utilize the space provided by charitable trust for a social & noble cause.
• To provide a better place for senior citizens.
• To make the society aware about the responsibly towards our elders.

With the said objective and given ‘A’ Class construction the 5 crore worth of construction would be around 5000 sq m of built area. 
Thus the charitable trust will get what they need through this arrangement.

Developer’s perspective:

This offer gives the developer an opportunity to make profit from the parcel of land given to him by the trust. The challenge here is to generate capital and cash flow during the construction period, in which there will be no revenue generation.

Since the present capacity is restricted to Rs 60,00,000/-, the developer has to look into other sources to finance the project.

Alternatives for Method of financing:

The developer will have to build either housing or a commercial healthcare facility on his parcel of land which can be then sold at a profit. It is assumed here that both housing and healthcare are the approved land-use since the charitable trust is making these facilities on the same parcel of land.

Of the two, housing is more preferable as these can be marketed before the construction starts and sold before the start of project, during the construction phase and at the completion of project. Hence this method will generate cash flow during all stages of the project.

However for making a healthcare facility developer will have to find a financer or go into an alliance with established healthcare leaders in the industry which will finance the project. It is both difficult to find such a financer and it will also reduce profit margin as the developer will be acting as a builder for two clients.

Requirements of funds for the housing developed for commercial purpose by the developer will depend on the amount of permissible FAR (floor area ratio) for such purpose.

By looking again at the proposal of the trust, a preliminary estimate can be made for calculating the area of housing. It is as follows:

Total project cost of 5 crore can be split into 3.5crore for housing for the aged and 1.5 crore for the healthcare facility.

Since the housing is a multi level development and health care will be limited to 2 -3 floors we can estimate that housing and healthcare uses an equal amount of site area, i.e. 

- 2500 sq m of area is used in housing which costs 3.5 crore, and

- 2500 sq m of area is used in healthcare which costs 1.5 crore.

Thus if we require to make housing on 5000 sq m of land, it will cost Rs 7 crore (this we assume includes the marketing cost for the project).

CALCULATING CAPITAL REQUIREMENT:

For trust’s requirement : Rs 5 crore – profit of 10 % i.e. 4.5 crore.

Development  : Rs 7 crore – profit of 10 % i.e. 6.3 crore

Total capital requirement: 10.8 crore. (This is Net Present Value)

The capital requirement would be as follows:

1st year – 2.3 Crore approx

2nd year – 6 crore approx (which will be 6.54 crore based on current inflation)

3rd year – 2.5 crore approx (which will be 2.97 crore based on current inflation)

Therefore at the end of 3 years total of 11.81 crore would have been spent.

On this the developer wants to make a profit of 18% on his investment.

CALCULATING PROFIT:

Typical project of this nature would need 3 years to get finished. At the end of 3 years total of 11.81 crore would have been spent. The profit on this amount would be 2.215 crores.

This profit will be generated from the sales of the housing units and will be generated continually throughout the 3 years.  

 

PROPOSED PROJECT FINANCING

The developer has Rs 10L to invest and can take a loan from bank for Rs 50 L. Therefore based on our initial estimate of capital requirement for First year this is nearly 30 % of total capital needed for year 1.

Also the sale of the proposed housing can be done through CLP (construction Linked plans) but that revenue generation will only happen after some period of time, especially after the first quarter. Therefore the developer will have to look for some other source of long range debt capital.

This he can raise through the mortgage of the land given by trust to him. Since the value of the land is 5 crore, he can easily have a loan against property for around 50-60% of property value. i.e 3 crore.

SUMMARIZING:

Year 1:  

Total capital available        = 3.6 crore

Source of capital:

1.  3 crore long term capital, 

2. 50L short term capital and   [needed for the first quarter]

3. 10L his own investment. [needed immediately for starting of work]

Total requirement for expenditure  = 2.3 crore 

Requirement of revenue from sales = 0.0

Surplus will have to be invested in short term investments.

Year 2:  

Total capital available  = 1.3 crore

Source of capital:

1.  1.3 crore surplus from the “3 crore long term capital loan”, 

2. From booking/sales of housing units.

Total requirement for expenditure  = 6.54 crore 

Payback of loan from bank and personal investment = 0.672 crore

Minimum Requirement of revenue from sales = 7.212 crore

Surplus will have to be invested in short term investments and used to pay back the short term loan raised from bank worth Rs 50L. The payback in this year would be 56L. Also developers own capital investment will be paid back, which will amount to 11.2 L.

Year 3:  

Total capital available  = 0.0

Source of capital:

1. From booking/sales of housing units.

Total requirement for expenditure  = 2.97 crore 

Payback of loan taken against property = 3.36 crore

Minimum Requirement of revenue from sales = 6.33 crore

This is minimum revenue will provide the breakeven for the project. 

Remainder of 2.215 crores can be generated after this period also.

Disclaimer:

This is just one way of looking at the problem. This example is given to provide clarity to the problem. In no way the given solution given here can be substituted for a formal submission. It is advised to all students to make independent effort to solve this problem.