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CONSTRUCTION FINANCE

DEFINITIONS OF CONSTRUCTION

Construction includes the following: 1. New buildings and structures. 2. Additions, alterations, conversions, expansions, reconstruction, renovations, rehabilitations, and major replacements (such as the complete replacement of a roof or heating system). 3. Mechanical and electrical installations such as plumbing, heating, electrical work, elevators,escalators, central air-conditioning, and other similar building services. 4. Site preparation and outside construction of fixed structures or facilities such as sidewalks,highways and streets, parking lots, utility connections, outdoor lighting, railroad tracks, airfields, piers, wharves and docks, telephone lines, radio and television towers, water supply lines, sewers, water and signal towers, electric light and power distribution and transmission lines, petroleum and gas pipelines, and similar facilities that are built into or fixed to the land. 5. Installation of the following types of equipment: boilers, overhead hoists and cranes, and blast furnaces. 6. Fixed, largely site-fabricated equipment not housed in a building, primarily for petroleum refineries and chemical plants, but also including storage tanks, refrigeration systems, etc. 7. Cost and installation of construction materials placed inside a building and used to support production machinery; for example, concrete platforms, overhead steel girders, and pipes to carry paint, etc. from storage tanks. The following are excluded from construction: 1. Maintenance and repairs to existing structures or service facilities. 2. Cost and installation of production machinery and equipment items not specifically covered above, such as heavy industrial machinery, printing presses, stamping machines, bottling machines, and packaging machines; special purpose equipment designed to prepare the structure for a specific use, such as steam tables in restaurants, pews in churches, lockers in school buildings, beds or Xray machines in hospitals, and display cases and shelving in stores.

3. Land acquisition. VALUATION Defined as the technique of estimating or determining the fair price or value of the property such as building a factory , other structures of various types and land etc. Depends on selling price or the income or rent it may fetch. Value of the property depends on o Its structural condition o Architectural content o Life o Maintenance o Location o Bank interest o Legal control etc. Need for valuation Buying and selling property Taxation Rent fixing Security of loans or mortgage Compulsory acquisition Insurance betterment charges (Parts that wear out and need replacement with time and use ) VALUATION OF BUILDING Valuation of a building depends on the type of the building, its structure and durability, on the situation, size, shape, frontage, width of roadways, the quality of materials used in the construction and present day prices of materials. Valuation also depends on the height of the building, height of the plinth, thickness of the wall, nature of the floor, roof, doors, windows etc. The valuation of a building is determined on working out its cost of construction at present day rate and allowing a suitable depreciation. Six Methods of Valuation 1. Rental Method of Valuation 2. Direct Comparisons of the capital value

3. Valuation based on the profit 4. Valuation based on the cost 5. Development method of Valuation 6. Depreciation method of Valuation 1.Rental Method of Valuation In this method, the net income by way of rent is found out by deducting all outgoing from the gross rent. A suitable rate of interest as prevailing in the market is assumed and Years purchase is calculated. This net income multiplied by Years Purchase gives the capitalized value or valuation of the property. This method is applicable only when the rent is known or probable rent is determined by enquiries. 2.Direct comparison with the capital Value This method may be adopted when the rental value is not available from the property concerned, but there are evidences of sale price of properties as a whole. In such cases, the capitalized value of the property is fixed by direct comparison with capitalized value of similar property in the locality. 3.Valuation based on profit This method of Valuation is suitable for buildings like hotels, cinemas, theatres etc for which the capitalized value depends on the profit. In such cases, the net income is worked out after deducting gross income; all possible working expense, outgoings, interest on the capital invested etc. The net profit is multiplied by Years Purchase to get the capitalized value. In such cases, the valuation may work out to be high in comparison with the cost of construction. 4.Valuation based on cost In this method, the actual cost incurred in constructing the building or in possessing the property

is taken as basis to determine the value of property. In such cases, necessary depreciation should be allowed and the points of obsolescence should also be considered. 5.Development Method of Valuation This method of Valuation is used for the properties which are in the underdeveloped stage or partly developed and partly underdeveloped stage. If a large place of land is required to be divided into plots after providing for roads, parks etc, this method of valuation is to be adopted. In such cases, the probable selling price of the divided plots, the area required for roads, parks etc and other expenditures for development should be known. If a building is required to be renovated by making additional changes, alterations or improvements, the development method of Valuation may be used. 6.Depreciation Method of Valuation According to this method of Valuation, the building should be divided into four parts: 1. Walls 2. Roofs 3. Floors 4. Doors and Windows And the cost of each part should first be worked out on the present day rates by detailed measurements. VALUE OF CONSTRUCTION PUT IN PLACE The value of construction put in place is a measure of the value of construction installed or erected at the site during a given period. For an individual project, this includes 1. Cost of materials installed or erected. 2. Cost of labor (both by contractors and force account) and a proportionate share of the cost of Construction equipment rental. 3. Contractors profit.

4. Cost of architectural and engineering work. 5. Miscellaneous overhead and office costs chargeable to the project on the owners books. 6. Interest and taxes paid during construction (except for state and locally owned projects). The total value-in-place for a given period is the sum of the value of work done on all projects underway during this period, regardless of when work on each individual project was started or when payment was made to the contractors. For some categories, published estimates represent payments made during a period rather than the value of work actually done during that period. For other categories, estimates are derived by distributing the total construction cost of the project by means of historic construction progress patterns.

FINANCING OF PROJECTS | ECONOMICS RELATED TO BUILDING INDUSTRY Financing of Projects is the most important factor determining the success of the project. Various factors influence the success of a project. THE FOUR FACTORS: A. Sources B. Total Cost Estimation of the Project C. Utility in Financing D. Agencies and Institutions directly and indirectly influencing the economic aspects of a project A.Sources Loans are available for both purchasers and Builders from: All Nationalized Banks, Co-operative Banks, Private Banks,

LIC HFL, Finance Companies, Insurance Companies like General Insurance Co (GIC), United India Insurance Co Ltd, National Insurance Co Ltd, Oriental Insurance Co Ltd, New India Assurance Co Ltd (for the employees), Foreign Direct Investment FDI, 20 Nationalised Banks along with Regional Rural Banks come under Public sector. Commercial Banks, Cooperative Banks operate under provisions of Cooperative societies Law of states for credit and non-credit purpose. National Bank of Agriculture (NABARD) help Farming sector. and Rural Development

B.Total Cost Estimation of the Project Price to be paid for a project include : The cost of construction General level of prices The cost of price of the material an article Cost of production Cost of housing the property for habitation A building should be built based on an estimated cost. If the building cost increases, it will be a loss and if it can be reduced, it will be a saving for the individual as well as for the company as a whole. C.Utility in Financing Proper utility of the available financial resources in a planned manner will result in the success of the projects. Any improper planning, lack of technical expertise, under utility of technology and expertise will result in the losses of the project as well as loss to the resources of the Nation as a whole. D.Agencies and Institutions directly and indirectly influencing the economic aspects of a project

Interest rates by banks, availability of materials (products, producers of materials), Governmental agencies, both central and state policies in making finances available for loans, personal savings, demand and supply, Population (Growing in India and decrease in some western countries). Economic stability of the country, Global Economy, Location of the projects, Inflation or Deflation. All the agencies those advance Housing loans like Specialised Financing agencies like HUDCO, HDFC, National Housing Bank (NHB). More than 90% of the dwelling units are financed by Housing and Urban Development Corporation (HUDCO) for economically weaker sections and Low Income Group.

CONSTRUCTION FINANCE One of the major problems facing any business enterprise is that of obtaining finance. This is a problem not merely of quantity but also of type. The situation is further compounded by legislation, the dynamism of the economy, but fundamentally by the requirement to minimize costs. The construction industry comprises a wide variety of firms from the single person enterprise to the large multinational public company. The sources of capital available to any firm are quite numerous but public companies have the great variety of sources available for their use and the single person enterprise, the least variety. Construction Loans.can be classified into short term and long term borrowings. Long term Finance. It is that capital required for five to ten years, either to start a business or to carry out expansion programs. Broadly the capital is used to purchase buildings, plant and equipment. The risks to the lender are high because of the time scale involved, consequently only established firms are generally considered by the lending institutions. Short term Finance The firm when established often needs short term capital to overcome immediate cash flow problems. Materials have to be purchased, plant hired, labor and sub-contractors paid and so on before payment is received from the Employer. The common types of Finance are the following:

Shares Shares may be of several types, each with different rights. Ordinary shares which are called equity of the company represent the major ownership and risk bearing element of the entrepreneurship. The shareholder is entitles to the residual profits in the company after all other commitments have been met. Ordinary shares usually entitle the holder to voting rights. Preference shares are also common, entitling the shareholder to a dividend up to a prescribed level prior to any distributions being made to holder of ordinary shares. Cumulative preference shares are less common and carry a right for any unpaid to be carried forward for payment out of the profits of future trading periods. A new issue of shares for sale raise capital for the company Debentures These are loans made to the company. They differ from conventional loans insofar as they are offered to the market at a fixed interest rate and are repayable at a set time. The loan is either secured by mortgage on the firm's property or simply on the basis of the firm's reputation. Debenture holders rank ahead of almost any other creditors in the case of liquidation of the firm's assets. Like other loans, Debentures represent a cost to the company and as such the interest payment made is deducted from profits before allowance is made for tax income. In addition, the payments rank ahead of any dividend declared to shareholders. Bank Loans Loans are not easy to obtain. Most institutions are reluctant to lend long term, particularly to construction firms. They often request the borrower to provide a proportion of the finance from internal resources. Merchant banks tend to demand higher rate of interest than the clearing banks since they are normally dealing with a large loan. Retained earnings Retained earnings is profit retained within the firm instead of being distributed to the owners Bank overdrafts A bank overdraft is a process whereby a customer of a commercial bank is permitted to overdraw on that account up to an agreed limit for a prescribed period. This is rather similar to a bank loan except that interest is payable for the amount overdrawn only for the period it remains overdrawn and the account is usually repayable on demand or upon the termination of the overdraft period.

Trade creditors Delayed payments to creditors and prompt ones from debtors, if handled with care, ease cash flow problems. The construction industry is well suited for this sort of financial arrangement since completed work is paid for by the client in periodical stages. CFF3 Cash Flow Forecasting software is a unique construction management software for estimating the difference between cash in and cash out amounts for construction projects, and hence you can realize the construction loan or external finance required for completion of the project. Creditors are the people to whom we owe money for goods and services supplied by them to us on credit. Debtors are the people who owe us money for goods or services we have supplied to them. They are our debtors. It is quite easy to mix up the terms, and get them the wrong way around, especially as they are "relative" terms - for example, I am a debtor to my creditors! To learn these terms - start with credit. You buy on credit, therefore you are a creditor, and the credit purchases that you have yet to pay is part of your liabilities. Individuals and companies that owe you payment are in debt to you, and are your debtors, and consequently constitute part of your assets. Short Term Loans Short term loans are available from individuals, banks, and other financial institutions. They are required for the provision of working capital, carry a prescribed rate of interest upon the entire sum and can not be recalled prior to the due date. Usually short term loan are obtained from commercial banks Internal sources of capital Provision for corporation tax Payment of this tax is usually made one year in arrears. The cash therefore remains in the business during that time and acts as a valuable source of short term funds.

Depreciation is the loss in value of an asset / building over time due to wear and tear, physical deterioration and age. The cost of reproducing an income property can be recovered over the useful life of the asset which is determined by law.

Depreciation is treated as an expense and is a line item on an income statement. Depreciation can only be applied to the building and not the land, since land does not wear out over time. Residential income property must be depreciated over a 27.5 year period using straight line depreciation. Commercial income property must be depreciated over 39 years using straight line depreciation. Straight line depreciation stipulates that an asset must be depreciated by equal amounts each year over its useful life. Depreciation is a bookkeeping and costing exercise by which the initial cost of an asset is written off over its useful life. It can be regarded as a source of capital. Thus, reserves created by the process of depreciating fixed assets represent a stake in the firm by the owners, in a similar manner to retained earnings. For purposes of corporation tax, the method to be used for depreciating any asset is prescribed in the tax regulations .

ECONOMIC FEASIBLITY REPORT TYPE 1 - MARKET FEASIBILITY STUDY For public utility building project, the building project potential in an site is deciphered by inspecting the surrounding community , identify existing competition and determine primary and secondary market areas based upon drive times, competition, patterns of travel and shopping, natural or psychological barriers, and other market area influences. Geo-demographic and lifestyle cluster market area data, including fiveyear population projections, will be obtained and analyzed. (For many international locations, detailed demographic data is often not available..)If at any time during the market analysis it appears the project might not be feasible, work will be stopped and the total fee will be adjusted to only reflect work performed to that time.

A written summary of the market analysis will be provided at the conclusion of this phase, which will contain:

identification of market areas; definition and character of the market area population including demographic, lifestyle clusters and socio-economics; breakdown of the population into appropriate segments to determine potential users; estimates of the number of customers appropriate for the proposed project; identification and impact of other competitive recreation/entertainment activity; recommended strategic direction for development; and recommended project mix.

TYPE 2 - ECONOMIC FEASIBILITY CONCEPT DEVELOPMENT This is when the recommended nature of the project will be refined and an unthemed conceptual physical plan of the project developed. Included will be:

recommended mix of recreation, entertainment and other program elements; recommended facility size; conceptual floor plan; Building regulations compliance inside and out; points of purchase; cross-merchandising of program elements; conceptual plans of sufficient detail to permit preliminary construction estimates by a contractor.

FINANCIAL FEASIBILITY Based upon the market analysis, project concept plan and cost estimate, pricing recommendations and attendance projections will be made and a three or five year operating pro forma will be prepared detailing probable revenue, expenses, profits, cash flow and pre-tax return on investment. The projection will detail expenditures by revenue category. These projections will be run based upon the estimates of the project's cost and proposed financing structure (owner equity and loans). A sensitivity and breakeven analysis is also included.