Software Helps Builders Produce Comprehensive Financial Analysis and "What If" Scenarios for Acquiring Land.

Guesstimating is often the science of the brave or foolhardy. This is what often happens when one tries to acess the true value of land during a land purchase bid.

Take the example of a builder looking at a tract that he knows can be broken up into a marketable lot development. Everything seems fine during the evaluation and bidding process. The land is purchased and building begins. Suddenly the builder is faced with unexpected costs appearing early in the job. How did this happen and why? It happened because he didn’t ask a key question or failed to assess his cash flow properly. There would appear to be little doubt that builders and developers can either make hefty profits or "lose their shirts" on land acquisition.

What can help separate the winners from the losers in this process is the use of rigorous cost-accounting methods using integrated software. Unfortunately, many builders rely on guesswork, faulty models, or inappropriate software that is force-fitted into land analysis.

Land acquisition software provides historic references and templates to create automated checklists that can be applied to every development proposal. Developing a standard financial model that allows you to effectively bid on land can best be done with software fitted for the purpose. Using user-defined library costs and cost curves to control cost/time relationships, even the most infrequent computer user can do quick analysis.

From the land buyers and estimators to the CEO, everyone needs to be able to see and understand the true and accurate impact of cost and revenue on margin, both gross and net of interest. A builder can be much more successful in this process when he can accurately calculate "all-in" costs, assessing market revenues for land sales or lot build-outs, and properly determine "cash flowing" for all costs and revenues.

This requires dynamic, integrated software designed specifically for the task. Until recently, the "digital toolkit" for land acquisition was limited to older software programs and, more commonly, Excel spreadsheets. Though popular, Excel can be a time-consuming and complex application to use, since an independent analysis has to be built for each subdivision or community acquisition. Without a cost-category checklist and the ability to engage in "dynamic residual analysis", independent models can omit crucial cost factors. This can result in an over-bid or under-bid on the land purchase.

Information and analysis not only must be clearly visible, the user must be confident in the rules and models he is using. Using standard feasibilities reflecting the usual company scenarios, i.e., single- or multifamily dwellings or mixed uses, the user can quickly call up similar projects and use them with minor modification. As more information becomes available, the information should be able to be quickly updated and allow near-instant reporting. Having this information iterated back into the business will enhance both the product and the knowledge base.

Affordable, highly sophisticated land acquisition software written exclusively for residential builders is available today. These software packages not only standardize the cost libraries and land-cost/land-yield modeling, they also enforce the standardization of reports and "user ownership" of land proposals submitted for the builder’s internal approval.

The adage "You get what you pay for" is true in software as well as life. While there are several solutions available, companies will want to purchase software that is robust and functionally rich, but that can also grow with the company. Off-the-shelf packages exist today, that allow simple, but complete user configuration. Applying this configuration will allow builders from the smallest local contractor up to the largest national homebuilder to reflect their requirements in the software, without the need for constant reviews with the vendor, requesting modification or change. When the time is right, they also need to be able to integrate into larger systems, creating a true integration with the business, without changes or modification to the working package.

Automated Cash-Flow Modeling

All land acquisition software must be able to build and execute fully dynamic, integrated, automated cash-flow modeling (CFM). CFM is the analysis of the cost and revenue in relation to time, spreading both in accordance with a standard company model resulting in the reporting of key performance indicators. It also allows the impact of modification to both streams to be seen and reported instantly to reflect circumstantial change, i.e., inflation or cost increases.

The key to cash-flow modeling is speed and accuracy. The model must be flexible enough to calculate the implications of all costs on the project, and allow automatic cash flow for lot servicing or building, and other associated costs, e.g., enablement costs, roads and sewers, staffing costs, etc.

To speed the process, the builder needs to be able to prepare templates that will hold typical scenarios and allow users to copy these scenarios, in template form, between developments, further speeding the preparation process. The cash flow must generate Internal Rate of Return (IRR) and Net Present Value (NPV). The NPV is the actual worth of your margin after an estimated deflationary discounting has been applied over time. This then allows an IRR to be calculated based on the NPV, which represents the percent by which costs can increase before the NPV becomes zero. Since an investment with a higher IRR is typically favored over an alternative investment with a lower IRR, it means similar developments may quickly and easily be compared to see which is best.

Return On Capital Employed (ROCE) is an alternative measure that allows the assessment of the effectiveness of the development in utilizing the capital invested.

Since there are a number of different ways IRR and ROCE can be calculated, systems should be able to cope with them all, presenting the builder with the key performance indicators that will tell him how projects should perform.

Multiple Residual Analysis

The "residual" is the cash figure a builder has remaining when fixed costs, revenues, and profit are all considered, as calculated in an interactive cash-flow model. Confidence in the variables is key. But let’s say that the builder doesn’t know the cost of the land he is looking at. He can still run his cash-flow model, put in his desired profit, and the model will kick out the most he can pay for that land and still make his numbers.

On the other hand, the cost of the land may be known. In that case, the builder can insert the land cost in the cash-flow model and see if the resulting profit is within his acceptable range. As the builder adjusts the model, he is able to change and adapt the residuals in order to meet the needs of his development and the expectations of his company. It is essential in the preparation of bids that the builder quickly see the result of changes he makes in the cost/revenue modeling—another reason Excel spreadsheets are not ideal.

Consolidation

When you are dealing with many developments, it is all too easy to lose sight of the bigger picture: "Is my company actually making money overall?" or "How are my larger schemes going to perform over time?"

Take for example the situation of a builder constructing apartments on the same scheme as single-family. The scheme may at first seem to show a poor net profit overall. But by breaking the schemes into separate cash flows, each may be viewed on its own merit and then consolidated into a single cash flow. The upfront cost of capital lock-up in apartments can be assessed and managed by balancing the costs of the faster return development of single-family to manage the cash flow. If this principle is developed, consolidation of land, if integrated with other business tools such as budgeting and sales, can allow a builder to keep a constant view of his financial outlay, profitability not just on one development but many. Ultimately this can help assure the survival of one of the most capital-intensive investment processes.

Whether you are a single- or multi-region builder, you must buy land to survive and grow. The acquisition of this land is not the "black art" it might seem. It is a science that adept practitioners have learned by realizing the importance of knowing and controlling the variables associated with any development. This can only be done with industry-specific software that provides the framework of a rational, disciplined approach to land purchase and homebuilding.

Doug Openshaw is director of implementations and Jim DesLaurier is general manager at SiteStream, a provider of integrated homebuilding software to the residential homebuilding industry. To learn more about SiteStream, visit www.SiteStream.biz.