A common theme I hit on when addressing commercial lending is more analysis is not always better analysis. Time and time again, I have stressed you shouldn’t use every tool in your toolbox just because it is there, because a one-size-fits-all approach will always result in white noise. Recently, the question has arisen whether we should be using a certain tool in our toolbox more often, that being the use of feasibility studies. Does it make sense to get a feasibility study for each construction project?
I strongly support any method that helps us understand and reduce risk. The question at hand is will a feasibility study help us assess, understand, and minimize risk? To answer that question, we need to understand what a feasibility study is. Note, “feasibility study” is not in the dictionary, so there isn’t a hard and fast definition of what one is. From context, we can assume it is a study or investigation into whether something is feasible, which is synonymous with “capable” “reasonable,” and “successful.”
Feasibility is not really a concrete idea, so it will mean something different to each person. To one person, a feasible project simply reflects the cost of accomplishing a project. Another person may view a project as feasible if it meets certain goals, which may be unrelated to profit motive. Perhaps an investor will only view a project as feasible if it meets a certain benchmark for return on equity, and lower levels of profitability will not be deemed satisfactory. Determining feasibility is truly a subjective task.
I think it is not coincidental that there are not industry standards on feasibility studies, because the concept of feasibility in itself is subjective. Feasibility studies will need to employ whatever methods and whatever data they need to meet the request of the party that commissions the study. Because of this, there will not be methods or data that will necessarily be repeated in each study.
A feasibility study for a gas station will employ entirely different methods than a study that investigates low-income housing, and for good reason. A gas station needs to be profitable; whereas, low-income housing needs to meet the needs of a specific population, and perhaps only needs to break-even or may be allowed to operate at less than break-even to meet its goals.
Note that this is unlike appraisals, which will have to conform to a cost approach, sales approach, or income approach; and there is an attempt to reconcile each method in the appraisal. Feasibility studies do not have to conform to a certain method. Like I mentioned, there simply won’t be a method that can universally conform to each feasibility study.
So, can a feasibility study help us assess risk? They may, and they may not. The feasibility study helps assess whether a goal will be met, which may or may not tell us something about risk. If we were to engage a third party to specifically assess the financial feasibility of a project, this would present a challenging obstacle. In the absence of standards, how do we determine who is qualified to undertake the task? If a report is prepared by somebody not qualified to assess the project, now the feasibility study is introducing additional risk into the decision making process, rather than mitigating risk.
To me, it is clear a feasibility study is not a tool that will regularly inform us about the risk, so to seek one out for every project would be cumbersome and pointless. It is a tool, however, that has a special purpose and is useful in sampling markets for which little is known or helping understand atypical requests. In this way, they will gather data that is not readily available and show how it could support a request. But, in this way, feasibility studies are reserved for special circumstances.
For established markets and standard requests, an appraiser will employ standard methods that show how markets are establishing the value of a project, which is far more practical for underwriting purposes. A feasibility study tries to project what will be, and trying to underwrite to a subjective projection is risky and should not be done.