An eager and ambitious property developer walks into a brightly lit room. Calm and professional. Confident but grounded. An air of charisma exuding from their open smile and jazzy outfit. More importantly, their golden ticket is in hand: a thorough and well-formed investment pack. They’re ready. Ready to present ‘the project.’ Sat in the room opposite them waiting will be five chances to make this dream a reality.
They launch into the pitch with clarity and precision. The deal? An attractive prospect in a number of ways. A private development in a charming location in East Anglia. The numbers are solid; nothing extraordinary but a decent 20% on GDV with about 25% return on costs, as I recall. They are clearly hard-working, dedicated and thorough. Furthermore, the entire presentation is memorable and motivating. They paint a picture of peaceful calm, as residents of this quality build enjoy their view of the Fens river. To all appearances, this is an investable project. And with several investors to pitch to, they will surely walk away with more than one offer.
All five investors say no. And I’m one of them. Why? My decision not to fund this deal was based on my perception of risk and more importantly here, relative value. In an investment context, the risks to this particular project were all on the downside. With a bit of investigation, it was obvious that the projected profit was really the maximum that was likely to be achieved if all the stars aligned and everything went smoothly. I don’t know about you but in over 30 projects, I have not had one of those yet. So factoring in the ‘unexpected’ for example time delays and cost overruns (even with contingency), my conclusion was that the projected profit, relative to the risk, was not of enough value. I could get a much more straightforward, and by that I mean lower risk, deal elsewhere that would provide similar returns. The relative value in this project was not appealing enough for me. Simply put, it wasn’t worth it.
Relative value (RV) is an investment method of determining an asset's worth that takes into account the value of similar assets. Basically, it lets you compare apples with apples. The most basic way of measuring this in resi property is the £/square foot calculation. Let’s say we have two virtually identical properties. If Property A costs £1,000 sq ft and Property B costs £1,200 sq ft, then Property A represents better value ceteris paribus. Now Property B may have a large garden that justifies the premium. It also gets people excited by the possibility of desire and therefore profit (again projected upside).
