21 Jul Feasibility Studies
Let’s discuss feasibility studies. As someone who sources a significant amount of construction debt and equity, frequently for hospitality, I deal with this issue regularly. It is not uncommon for sponsors to request funding for their projects, often sizeable ($15M +) who have not commissioned a feasibility study. Look, I understand that for a project that will cost one or two million dollars a feasibility study may be a bit of overkill however when one thinks about it, even at that level it may be a good idea. Here are some arguments supporting this position.
First, while the cost of these studies is not insignificant, if one takes a “big picture” approach to their development, the cost is a decimal point and is likely to be less costly than a move in the interest rate, or a mistake by a sub, or perhaps a change order. In other words, looking at the overall cost of the project, the cost is marginal.
Probably the biggest reason sponsors do not commission these studies is they are convinced their project will be successful. They do not need a third party telling them what they already know. In many cases the sponsors are correct, but occasionally they may be mistaken. A marginal or bad investment can wipe out the gains or equity of multiple good investments. While not infallible, soliciting the opinion of a dispassionate third party does have its merits. Think of this study as inexpensive insurance. If the study supports the sponsor’s assumptions, it is one more positive factor supporting the investment. If the study indicates the sponsor may want to reconsider, or change the nature of the asset class, it may be one of the highest return on investment decisions they have made.
Finally, as a practical matter, many lenders or equity investors require these studies. If the sponsor gets in front of the process and has one in hand, it will expedite the capital raise. It also enlarges the universe of lenders or investors likely to review their deal. Many underwriters ask up front if one is available and to have it sent with the OM. It also demonstrates a level of professionalism and thoroughness on the part of the sponsor.
As a postscript, some feasibility studies fail to include an opinion of value as completed and stabilized. It is a good idea to request that the study provider include this information.
In conclusion, there are many good reasons to commission and pay for a feasibility study. The two negative issues are time and cost. With some planning time should not be a problem and if the lender or investors insist on one in fact time has been saved. Given the cost benefit ratio, if the price of the study is truly an issue, the sponsor should perhaps reconsider developing the project.