Followup Query from
Start Dates & Investor Equity Explained
"We had to pay a $50k deposit when we cleared our 45-day Due Diligence phase. We’ve also paid the stamp duty on the property as well as all the costs for our DA (which was granted in December).
As we’ll need to account for these outgoings in the Development Costs tab, wouldn’t we need to keep the project start as September 2024 not March 2025?
Explanation
In the current version, it is assumed that your project officially starts with land acquisition, which is standard practice, as technically, you do not own the land until settlement.
Therefore, the project timeline starts from the date of land settlement, as there is no way to account for how pre-settlement expenses are funded in the pre-development phase.
All expenses incurred before settlement, such as due diligence, stamp duty, and DA costs, are rolled into the same month as land acquisition. This approach is common practice in financial modelling and ensures that these costs are captured appropriately.
I’ve debated this with veteran financial modelling experts and faced similar scenarios in real-life projects. From a feasibility and financial modelling perspective, allocating pre-settlement expenses to the same month as settlement has minimal impact on the project’s overall feasibility metrics, including IRR and NPV.
While current holding costs or other pre-settlement expenses could technically be spread over earlier months, doing so would unnecessarily complicate the model and distort the project’s IRR and NPV calculations.
By incorporating these costs into the month of settlement, the model remains clean, accurate, and a true representation of the project.
Introducing a pre-development phase before land acquisition can often make the financial metrics, particularly IRR and NPV, misleading, as they wouldn’t align with the actual project timeline where ownership and funding responsibility begin with settlement.
Impact on IRR and NPV
- IRR (Internal Rate of Return):
- Pre-acquisition costs lower the IRR because they are cash outflows that occur earlier in the timeline, increasing the time over which the investment needs to generate returns.
- Early outflows also create a longer gap before positive cash inflows (e.g., revenue from sales or rentals) occur, which reduces the project’s IRR.
- NPV (Net Present Value):
- These costs directly reduce NPV, as they are included in the total cash outflows. Since they occur early in the timeline, they have a significant impact due to the discounting effect.
- The earlier the cost, the higher its present value (in absolute terms), leading to a lower NPV.
Important
- Project Viability: High pre-acquisition costs can make marginal projects unviable by significantly reducing IRR and NPV. Developers often assess these costs against expected returns before committing to further phases.
- Contingencies: Pre-acquisition costs are often treated as sunk costs if the project does not proceed. In feasibility models, these costs are sometimes highlighted separately to assess the break-even point or contingency requirements.