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IRR Guidelines

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One of the most common queries at the Estate Master Support Desk is ‘what kind of IRR should my project aim for?’ This will, of course, differ from project to project and is a subjective decision to be made separately for each project’s risk profile. 

The IRR target, in theory is set by the CAPM (Capital Asset Pricing Model) which is a summation of Cost of Funds + Inflation + Beta ( or risk allowance of the project). Property development in terms of risk profile sits higher in risk than equities and property investment. In practice however, the IRR is often set by the  market forces such as whether property development is in high demand (peak market) or suppressed (low market). In addition to the IRR targets set by developers for project feasibility, financial institutions also set prerequisites for funding which needs to be viewed in conjunction with IRR target. For example, the percentage of sales off the plan or percentage of floor space leased.

As a cursory view as to what to expect, Estate Master CEO, Martin Hill, has compiled the following guidelines based on his own experience in the property development industry.

Project Type Project IRR Comment
Land Subdivision small to medium size – minimal planning risk 20% Allow a minimum 6 months to project start
Land Subdivision small to medium size – some planning risk – masterplan and DA required 22% Allow minimum of 2 years for planning approvals before start
Land Subdivision – Higher degree of planning risk. Such as a rezoning and unknown levies 25% Be conservative as to time to get approval. If expected to be 3 years – Do modelling on 5 years
Land Subdivision – Large Size (staged over 10-15 years) A degree planning risk is expected 18% The large size of the project can reduce market risk and planning risk by the fact such risks can be spread over the entire project life.
Larger Apartment Development with Pre Sales 17-18% Pre sales at 50% of floor plan
Apartment Development Speculative 22-25% No presales but good demand
Smaller Medium Density (Townhouse) 12-17% Less than 10 units closer to 12% IRR. Greater than 20 units IRR target over 15%
Integrated Housing (excluding subdivision profit) on super-lots 12-15% Assuming a controlled builder’s margin
Speculative Office Development 20-22% Few examples. Most have a 50% pre-commitment to lease.
Office Development with End Take Out 12-15% Over 10 to 20 year hold period post project completion. Development margin also around 12%
Retail Develop & Hold 12-15% Over 10 to 20 year hold period post project completion. Development margin in some cases are negative.

Disclaimer: These guidelines are only an opinion and are a result of the author’s personal experience. They do not taken into account your objectives, financial situations or needs and should not be relied upon. Any person considering an investment or financial commitment should seek independent financial, legal, accounting or other professional advice.

Date Published: 29 Mar 2012
Category: White Papers

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