Two ratios for the same developer's profit, the exact conversion, and what the denominator does to a residual land bid.
Profit on cost divides the developer's profit by total development cost; profit on GDV divides the same profit by the gross development value. They convert exactly: profit on GDV = profit on cost / (1 + profit on cost), so 20 per cent on cost is 16.67 per cent on GDV, and 20 per cent on GDV is 25 per cent on cost. On an illustrative £30,000,000 scheme, confusing the two moves the land bid by £934,579.
Worked in full in The Real Estate Development Manager by Julian R. Sterling, with every figure reproduced in a free workbook.See the book on Amazon →
A residential scheme with a gross development value of £30,000,000, net of sales costs. Every cost other than land, from construction and fees to contingency and all finance, totals £19,000,000; for simplicity it is held fixed as the land price changes below. Land and its 7 per cent acquisition costs bring total cost to £25,000,000. All figures are illustrative.
| Line | £ |
|---|---|
| Gross development value (net of sales costs) | 30,000,000 |
| Costs excluding land (build, fees, contingency, finance) | 19,000,000 |
| Land, including 7% acquisition costs | 6,000,000 |
| Total development cost | 25,000,000 |
| Developer's profit | 5,000,000 |
Profit on cost = profit / total cost = 5,000,000 / 25,000,000 = 20.0%
Profit on GDV = profit / GDV = 5,000,000 / 30,000,000 = 16.67%
Converting: PoGDV = PoC / (1 + PoC) = 0.2 / 1.2 = 16.67%; PoC = PoGDV / (1 − PoGDV)
Excel: =PoC/(1+PoC) and =PoGDV/(1-PoGDV)
The two always differ because GDV is larger than cost by exactly the profit. Profit on cost answers the investor's question, what return does the money at risk earn. Profit on GDV, the margin, answers the seller's question, how much of each pound of sales is kept, and it is the basis many residential developers and their lenders quote. Neither carries time; for that, see what IRR a 20 per cent profit on cost gives.
| Profit on cost | = Profit on GDV | Profit on GDV | = Profit on cost |
|---|---|---|---|
| 15.0% | 13.04% | 15.0% | 17.65% |
| 17.5% | 14.89% | 17.5% | 21.21% |
| 20.0% | 16.67% | 20.0% | 25.00% |
| 25.0% | 20.00% | 25.0% | 33.33% |
The gap widens as the target rises: at 15 per cent on cost it is under two points, at 25 per cent on GDV it is more than eight.
The residual appraisal works backwards from a profit target, so the basis of the target decides the land price.
Target 20 per cent on cost. Total cost can be no more than GDV / 1.2 = £25,000,000, leaving profit of £5,000,000. After the £19,000,000 of other costs, £6,000,000 is left for land and its on-costs, and divided by 1.07 the land price is £5,607,477.
Target 20 per cent on GDV. Profit must be 0.2 × £30,000,000 = £6,000,000, so total cost can be £24,000,000. That leaves £5,000,000 for land and on-costs, a land price of £4,672,897.
The same words, "a 20 per cent profit", produce bids £934,579 apart. The cost-basis bid is 20.0 per cent higher than the GDV-basis bid; put the other way, the GDV-basis bid is 16.7 per cent lower. Two developers using the same appraisal and the same target, with a different denominator in their heads, will not recognise that they disagree about the margin rather than the site.
| Target | On cost | On GDV | Gap |
|---|---|---|---|
| 15.0% | 6,623,324 | 6,074,766 | 548,557 |
| 17.5% | 6,104,593 | 5,373,832 | 730,762 |
| 20.0% | 5,607,477 | 4,672,897 | 934,579 |
| 25.0% | 4,672,897 | 3,271,028 | 1,401,869 |
Note the diagonal: 25 per cent on cost and 20 per cent on GDV give the same land price, £4,672,897, because they are the same profit. One point of margin on GDV is worth £280,374 of land price here; one point of profit on cost is worth £196,340. A negotiation over "a point" should state which.
The error is rarely in the arithmetic; it is in the hand-off. A board approves a hurdle of 20 per cent, meaning on GDV. The acquisitions team runs its residual at 20 per cent on cost because that is how the template is set up, bids £5,607,477, wins the site and delivers a 16.67 per cent margin that the board then calls a miss. Or the reverse: a lender's term sheet asks for a 20 per cent margin, the developer shows 20 per cent on cost, and the loan is sized on a scheme that does not meet the covenant. Every appraisal summary should print both ratios, side by side, and every target should name its denominator. Check also how GDV itself is defined: net or gross of sales costs and of any affordable element sold to a housing association at a discount.
The book works the residual appraisal and its stress tests on an illustrative scheme, and the free workbook for this case runs it live, including the cost overrun and value fall that would each eliminate the profit.
No. 20 per cent on cost is 16.67 per cent on GDV, and 20 per cent on GDV is 25 per cent on cost. On a £30,000,000 GDV scheme the first means £5,000,000 of profit and the second £6,000,000, a difference of £934,579 in the land price the residual supports once land on-costs of 7 per cent are allowed for.
Divide the margin on GDV by one minus that margin. 15.0 per cent on GDV is 17.65 per cent on cost, 17.5 per cent is 21.21 per cent and 20.0 per cent is 25.00 per cent. The reverse conversion divides profit on cost by one plus profit on cost.
Practice varies by lender and market, so read the term sheet's definition rather than assuming. Residential development finance often refers to margin on GDV, while investors comparing returns on capital tend to use profit on cost. On the illustrative scheme a 16.67 per cent margin and a 20.0 per cent profit on cost describe the same £5,000,000.
This article is one calculation from The Real Estate Development Manager. The book takes the same case from first principles to the decision, chapter by chapter, and every figure it prints is a live formula in the free companion workbooks.
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