The Market Seen From The Street: "Development of a Residential Project in the Príncipe Real Neighborhood"
Today I bring you a real case.
It is a Residential Building, composed by 8 units, featuring architectural details, high ceilings exceeding three meters in height, a garden with enormous potential, and a superb location.
The state of conservation is "Reasonable.". Upon visual inspection, there are no significant structural damages, although its original construction likely took place in the early 20th century.
As "age doesn't lie," we are fully aware of the need for Renovation/Rehabilitation to provide the asset with the necessary features for maximizing its value.
And this is where the first doubts arise about which path to follow:
Renovation of the existing property without changing its "structural" characteristics, eliminating the need for a licensing project and potentially allowing for a shorter development cycle (12 to 15 months).
2. Development and Licensing of a Residential Project that allows for a better distribution of living spaces and their relation to the exterior garden, a slight increase in private area by optimizing the current building height, and the incorporation of an elevator. Due to the Licensing Period circumstances, the development cycle will be longer (35 to 38 months).
TIME will indeed be the key variable in determining which option maximizes the value of the asset.
Before we define the "path to follow," let's briefly describe the Principe Real Neighborhood:
It is one of the most elegant and prestigious areas in Lisbon, known for its architectural charm and cosmopolitan atmosphere.
One of the distinctive features of this magnificent location is the Principe Real Garden, a charming and lush park with old trees, flower beds, and a picturesque kiosk. The buildings in its vicinity have a "Majestic" and distinctive character compared to other areas in the neighborhood.
It is an area that combines the authenticity of Lisbon with a modern and sophisticated atmosphere, evolving significantly!
And from a real estate perspective:
It is undoubtedly one of the most valued locations in Lisbon, with the ability to attract new residents from various nationalities and lifestyles.
Property values have been consistently rising across all asset classes in the area, where demand significantly outweighs supply.
Despite the current economic conditions, with high inflation levels and increasing interest rates (with no significant forecast of slowing down), it remains one of the safest locations to invest in Residential Development Projects.
With all the attributes of a true PRIME LOCATION, sales prices for new homes can reach up to €10,000/sqm, and rental prices can reach €25/sqm.
Taking into account the considerations described, let's move on to the practical part. The development of a Business Plan that validates the development of a Residential Project with the objective of selling housing units.
The building's conservation conditions allow for "minor renovations" that can make the building profitable in the rental market while developing and licensing a Residential Project that maximizes the value of the asset.
Thus, the development decision may involve a "mix" between the paths 1) and 2) described above.
Existing Building Characteristics:
Land Area: 345 sqm
Footprint Area: 187 sqm
Gross Construction Area: 783 sqm
Terraces, Gardens, and Balconies Area: 168 sqm
Number of Above-Ground Floors: 4
Number of Units: 8
Unit Mix: 4 two-bedroom (T2) and 4 two-bedroom plus one (T2 + 1)
Use: Residential
Conservation Status: Reasonable ("Habitable")
Potential Project Characteristics:
Being a building located in a historical area of Lisbon, there are a set of constraints that we will always have to consider.
In this particular case, let's assume that there is no possibility of incorporating parking spaces.
Since no preliminary architectural study has been conducted to define the development project more precisely, I will share with you a hypothetical development option that seems suitable for the building's circumstances and the future users' needs.
One of the "most sensitive" point is how we can create more outdoor spaces with a possible change to the rear facade. Nowadays, it is extremely important to include outdoor spaces in residential buildings.
The incorporation of an elevator also seems essential. This situation requires us to redefine the building's layout, including the loss of some private areas due to the existing stairwell's characteristics.
Lastly, we have the issue of a slight increase in the Gross Construction Area of the property by optimizing its building height. In fact, it mainly involves utilizing the attic space, which already appears to have sufficient height to become a "habitable space."
I will now describe the potential characteristics of the building, taking into account the desired changes:
Land Area: 345 sqm
Footprint Area: 187 sqm
Gross Construction Area: 813 sqm
Gross Private Area: 654 sqm
Terraces, Gardens, and Balconies Area: 221 sqm
Common Areas: 159 sqm
Number of Above-Ground Floors: 4 + 1
Number of Units: 6
Use: Residential
Therefore, we have an increase in the common areas to incorporate an elevator, resulting in a loss of private area, which can be compensated by utilizing the attic space. Simultaneously, we reduce the number of units and opt for "different" typologies to balance the "Interior Space vs Exterior Space" ratio.
Assuming the purpose is to sell the units, if we consider an average price of €9,000/m2 based on the property's characteristics and the type of rehabilitation to be carried out, the Overall Sales Volume could reach €6,548,924.55.
Tipology MIX Number Of Units Gross Private Area Balconies, Terraces & Garden Selling Price per Tipology
T3+1 Duplex 2 145 83 1 553 149,50 €
T2 2 75 11 706 179,60 €
T2+1 Duplex 2 107 16 1 015 133,18 €
Total 6 654 221 6 548 924,55 €
A breakdown of the development costs is as follows:
Project Costs, including VAT: €62,408
Preliminary Studies
Licensing Projects (Architecture and Engineering)
Execution Projects (Architecture and Engineering)
Energy Certification
Acoustic Certification
Other Certifications
2. Municipal Fees: €27,529
TRIU (Infrastructure Realization, Maintenance, and Reinforcement Fee)
Occupations of Public Spaces
Submission Fees for Projects and Requests
IMI (Municipal Property Tax) and AIMI (Additional Municipal Property Tax)
3. Construction Costs, including VAT: €1,753,875
Civil Construction and Materials Contracts
Infrastructure (Water, Electricity, Sanitation, Gas, Telecommunications Connections)
Supervision
Insurance
Contingencies
Policing/Security
4. Project Management and Administration Costs, including Taxes: €123,235
Management Costs
Outsourcing Costs
5. Financing Costs, assuming all development costs are financed and land is acquired with equity: €164,128.61
Procedural Fees
Stamp Duty on Utilized Capital
Interest
6. Marketing and Sales Costs: €402,758.86
Marketing Materials
Real Estate Agency Fees
In summary, if we exclude the Marketing & Sales Costs and Financing Costs from the Development Costs, considering that they are generally not financed, the Development Cost amounts to approximately €1,969,543.32. This represents about 30% of the Overall Sales Volume.
Now, we move on to the more complex question of determining the value of the land, taking into account the following factors:
1.There are not many properties with similar characteristics, and the comparative sample shows some dispersion that is difficult to perceive.
2. It is challenging to define the Development Cycle considering the uncertainty of Licensing Time and obtaining usage permits.
3. The variable "Civil Construction and Materials Contracts," which represents about 25% of the Overall Sales Volume, is difficult to assess due to fluctuating material costs and a shortage of labor (which may worsen given the upcoming Public Works Pipeline). The time between creating the Business Plan and starting construction should not be less than 18 months, considering the time required for licensing. Therefore, we are predicting a cost that will occur in the not-too-near future.
4. In times of uncertainty, investors tend to increase their Cost of Capital due to higher perceived risks.
Currently, there is significant divergence in opinions among different market players.
"Land prices will rise."
"Land prices will fall."
"Construction costs will rise."
"Construction costs will fall."
One of the most challenging tasks in the market at the moment is property appraisal. It is difficult to establish assumptions in a climate of uncertainty.
I have observed differences of 10% to 20% in the valuations of development assets. This is a considerable deviation.
Furthermore, it is important to note that the Appraisal Value may differ from the Transaction Value that the market is currently willing to pay (upwards or downwards).
Returning to the case study, if we assume a Development Cycle of 38 months, a Project IRR above 20%, and all sales occurring before the completion of construction, the value to be attributed to the land would be around €2,400,000. This is based on the assumption that it will be possible to develop a project with the stated characteristics.
Therefore, the Land Cost category would represent approximately 37% of the Overall Sales Volume in the presented case study.
The big question is, "Is the market willing to pay this price considering the risks involved?"
See you soon,
André Casaca
