Profit on Cost (POC) is a fundamental metric that measures the profitability of a property development project. It provides a clear picture of your project's financial health, the make up of which includes: construction costs, professional fees, and financing charges. By accurately calculating POC, you can manage your project’s attractiveness to lenders and increase your chances of securing funding.
In this article, we explore how to calculate POC, including the pitfalls to avoid, and will see examples of strong and weak POCs.
What is POC?
POC is a percentage representing the overall profit margin of your project compared to its total cost. It considers not just the purchase price and cost of the work but all the other fees you’ll encounter.
How to calculate your profit on cost:
- Total expenses: Add the purchase price, construction costs, professional fees, sales and marketing costs, and estimated loan costs.
- Projected sale price: Estimate the expected selling price.
- Profit calculation: Subtract total expenses from the projected sale price.
- POC calculation: Divide your profit by total costs and multiply by 100 to get a percentage.
Why is POC important for your finance application?
A strong POC demonstrates your project's profitability, making it more attractive to lenders. We rely on POC to assess risk. You may wonder what constitutes a strong POC and how it differs from one that could hinder your financing efforts.
Calculate your profit by:
- Subtracting expected revenue from estimated costs for gross profit.
- From the gross profit, deduct additional expenses (e.g loan interest) to find net profit.
- Divide net profit by the total initial investment and multiply by 100 to calculate POC.
Example:
A project anticipating £2 m in revenue, £1.6 m total estimated costs, and £50,000 in additional expenses, would generate a £400,000 gross profit and a £350,000 net profit. Dividing the profit of £350,000 by the total spend of £1,650,000 and multiplying by 100 equates to a POC of 21.2%
An example of a strong POC:
Project: Conversion of a vacant, centrally located office building into luxury apartments.
Clear market demand: High demand for luxury apartments in the city center, supported by market research and rental data.
Detailed financial model: Comprehensive budget outlining construction costs, marketing expenses, rental income, and profit margins.
Proven track record: Developer has successfully completed similar projects with strong financial returns.
Risk mitigation: Detailed risk assessment and mitigation strategies in place, such as contingency funds for unexpected costs.
Exit strategy: Clear plan for selling or refinancing the property at a profit within a specified timeframe.
An example of a POC that could stall a finance application:
Project: Conversion of a suburban office building into residential apartments.
Overreliance on local demand: Assuming strong demand for apartments in the suburban location without sufficient market research.
Inaccurate cost estimations: Underestimating renovation costs and overestimating rental income.
Lack of exit strategy: No clear plan for selling or refinancing the property in case of a market downturn.
Inadequate risk assessment: Failing to consider potential issues such as vacancy rates, property management challenges, and economic fluctuations.
Limited developer experience: No previous experience in residential property development.
Understanding costs deducted from GDV (Gross Development Value):
Several costs are factored into a development appraisal and should be used in your POC calculations:
Construction costs: These vary depending on the intended use, specification, construction type, and location. Use client-provided figures, cost databases (like BCIS), or a quantity surveyor for accurate estimates.
Professional fees: Typically 10-20% of the build cost, covering architect, quantity surveyor, structural engineer, planning consultancy and project manager.
Other costs: These cover marketing, letting, disposal, and a contingency fund (3-10% of build cost).
Finance costs: Factor in interest payments and consider the loan drawdown profile during the build.
Site-specific costs: Demolition, site clearance, and specialist surveys may be required.
Land cost (if applicable): The purchase price of the land is a fixed cost.
Common mistakes to avoid when calculating POC:
Optimistic revenue forecasts: Base forecasts on current market data and consider various scenarios, avoiding overestimated selling prices or demand.
Underestimating costs: Thorough due diligence and regular budget reviews are crucial to prevent unforeseen cost overruns.
Ignoring economic factors: Stay updated on market trends like interest rates, inflation, and consumer confidence, adjusting strategies if necessary.
Neglecting finance costs: Accurately calculate financing costs. A conversation early on in the process should help inform you of this.
Failing to plan for delays: Plan for potential delays to minimise holding costs and missed market opportunities.
A desktop appraisal is the initial step in determining a property's or land's potential value. This assessment can quickly identify whether the asking price aligns with your investment strategy, saving you valuable time. If the numbers don't add up, their may be a different strategy that creates an improved value.
Calculating and understanding POC is essential for the success of any property development project. By accurately assessing your project's profitability and presenting a compelling POC, you can increase your chances of securing financing.
Are you ready to take the next step? Apply for funding in just five minutes and get an instant Decision in Principle* today.
*Instant DIPs will not be issued for projects where the loan amount is greater than £3.5m (or £3m if bridging), the profit on cost is below 5%, the loan amount is less than £100k, the loan term is greater than 24 months, if any required data is omitted, or the loan type is portfolio acquisition, special situation, planning gain, or project refinance.
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