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%
Understanding costs deducted from gross realisation value (GRV):
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 Cordell Construction Cost Index or Rawlinsons), 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.
Neglecting to account for GST and/or margin scheme calculations: Ensuring are correctly factored into project planning and budgets is crucial to maintain profitability, manage risk, and support cash flow.
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.
