To examine economic aspects of the construction industry at the project level, this Part examines how a private property developer might conceive a project price and some of the theoretical and actual outcomes which arise.
The model
Property developers build for selling or renting on the open market, and, therefore, have to consider completed property values, and affordability by buyers. A model is used below in which the developer sees a business opportunity to develop and sell houses on an estate, complete with roads and utilities. Potential sites are available for sale, either from private owners or from state agencies like Central Housing & Planning Authority (CH&PA) and the next step is to determine an offer price at which a development plan at one of the sites can be successful. An effective plan would demand that the sale price of the completed houses be factored into the site purchase price, and this will be done through an appraisal. In his textbook, ‘Property Development’, A. F. Millington, professor of land economics, postulates that the objective of the appraisal is “…to reveal whether there is latent value in a site or property which can be released by …. expenditure of money on construction work”. Millington is referring to the realisation of the potential of land through construction activity. This search for “latent value” includes competing with other developers for a suitable site location (this encourages buyers); assuming certain site risks (flooding, for example, could impact construction); and managing a long term land deal contract with a state agency or a private land owner. The developer also needs a profit margin on expenditure, and might embark on a process in the following stages.
Appraisal: An offer price for a site is guided by a subjective valuation, which calculates the residue available for purchase after deducting the construction costs from the sale price. The offer price should be below this ‘residual value’. If necessary, the appraisal will be done with reiterative calculations, and different assumptions. Drawings are not yet started and it is appropriate to involve a quantity surveyor, a cost specialist in construction works, who can estimate the probable completed cost; here this will be termed, Price 1#. Even more important is a valuation surveyor, to advise the developer on prices of completed properties, and affordability on the market segment targeted.
Making ends meet
Site purchase: Site value is now known, so pricing will be re-calculated with this given value. The ‘residual item’ will now be the obviously important item of profit. If first results are acceptable, the developer can proceed without a headache. Architect and engineer are engaged, and so drawings are available as a basis for the quantity surveyor’s estimate, which will now represent the maximum cost for the profit margin desired: Price 2#.
Construction: First, tender interaction between the developer and bidders occurs, as previously outlined: (SN 04/08/2019). Price 2# must align with the eventual accepted bid price: this is an acid test. (If not met, the quantity surveyor may be liable for professional negligence). The bid price plus any modifications post-award, must periodically be reviewed by the quantity surveyor during construction, working with other consultants, to help keep final cost within budget: Price 3#.
Hence the price varies over the project cycle. Also, increased costs can arise at any time—from inaccuracies in projection of prices, or from true flood conditions, or in construction pricing itself, as examples. Inevitably, the developer will repeatedly be brought under pressure to effect changes that meet the preferences of house buyers and keep the business plan viable. Other private construction owners – domestic and commercial – will similarly have to make ends meet, except that this is done largely to their own preferences.
The model confounded
Recently in Guyana, private property developers have mainly failed to realise housing potential from land. An IDB sponsored study over the period 2000 to 2015, noted the low occupancy rate by beneficiaries of house lots distributed by CH&PA, due partly to inadequate infrastructure. This may well have been the starting point for government grants of blocks of land to private developers for development of housing estates. From media reports in 2015, in the previous four years some 600 acres of “prime housing lands” along the East Bank Demerara were sold to a total of 18 private developers. Unlike our model developer, as the media further reports, one would-be developer, Sunset Lakes, allegedly sold its 100-acre block to another, Baishanlin. The latter acquired a mortgage secured on the said block. Following mortgage default, the bank repossessed the block, selling it to a fresh owner to recover payments. The future of this block is unknown. CH&PA has reportedly signalled that it is to repossess lands from other errant developers, but it is unreported who these are, thus leaving it unclear if or how those lands also will be developed into housing. These experiences have confounded our model, and would lead some to believe that the private developer is merely speculative or, worse, untrustworthy, rather than a pennywise businesswoman.
After 2015, the new government declared a new model of development based on formal partnerships with developers, and invited expressions of interest for same in 2016. New proposals included multi-storey flats, which generally increase the efficiency coverage of associated infrastructure. No publicised results are available on the outcome of the invitations, but by April 2017, government diverted its approach to construction of exhibited-types of model houses, supervised by CH&PA, built by private contractors, then sold to house owners. This is a welcomed change to the housing supply environment, but it noticeably avoids developers. Also, just last May, supplementary finance for development of new house-lots sought by the Minister responsible, signalled a full-scale return to house-lot distribution, with the original problematic of infrastructure.
The search continues
Fallout from this fiasco has undoubtedly dented the credibility of developers, in housing at least, in the public eye. This is a reaction shared by government judging by its new avoidance path. At the same time, there has been much better private developer experiences in other areas, delinked from government, like commercial malls, associated offices and linking infrastructure. If the search for latent value involving the private housing developer is to continue, as per Millington (and his ideas on the role of the developer are applied in public-private partnership schools) then some ideas should be ventured for Guyana:
Government should urgently address collection and analysis of housing affordability data. Such would form the basis of any housing subsidies on the property market (which is quite separate from the construction market).
State entities should publicise land deal contracts for housing, which must specify affordable housing categories to be developed. Developers to complete on the basis of the affordability mix and numbers offered. Transaction completed after the last housing unit is sold or rented.
▪ Government to address wider governance issues and its relations with the
private sector.
▪ Entities to put counter-corruption measures in place.
▪ The next Part will examine conceptual pricing by a contractor.
