Required Return on a Development Project: How to Set It

The required return is the dial that decides everything else in the calculation. It is not a figure you add at the very end as a tidy rounding-off — it is the first lever, the one that sets the frame for what you can even afford to pay for the site. Set it too low, and you overpay for the land and eat through your own buffer before a spade is in the ground. Set it too high, and you systematically price yourself out of every deal, while a competitor with a sharper — but not reckless — requirement walks away with the site.

The problem is that the required return is often treated as a gut feeling or an industry convention (“we always reckon on 20 %”). That doesn’t hold up when projects differ. A required return has to reflect the specific risk in the specific project — and that means knowing precisely what the requirement is, and what it actually covers.

Required return, profit margin, and return on invested capital are not the same thing

The most common source of confusion is that three different quantities get lumped together as one. Before you set a figure, you need to know which one you are talking about.

• The developer’s profit margin (developer’s profit). The profit that must be left for the developer, typically expressed as a percentage of the finished project’s value or of total project costs. This is the quantity that goes directly into the residual calculation as a cost item, before you arrive at the residual amount available for the land.
• The investor’s yield requirement. The return a capital provider expects on the equity invested — often measured as IRR or return on equity over the project’s lifetime. This is a financial view of the money, not of the building itself.
• The yield on the finished property. The operating yield (net rental income relative to value) that a buyer of the finished asset uses as a basis. This is an exit consideration and belongs with how you set the exit value — not with the profit margin.

The three are connected, but they are not interchangeable. When a client’s adviser says “required return,” they usually mean the developer’s profit in the residual calculation. When an investor says it, they mean the return on their equity. Whoever has to qualify the figures needs to know which hat is being worn.

Rule of thumb: use the profit margin when you need to find the maximum price for the site (the residual method), and use return on equity / IRR when you need to assess whether the financing can close. They answer two different questions.

Why the required return drives the residual calculation

The whole logic of a development project is turned on its head compared with an ordinary purchase: you know (or estimate) the finished project’s value, you know the construction budget, and you work backwards to what the site can cost. That exercise is the heart of the residual method, which determines what the site can actually cost.

Simplified, the calculation looks like this:

Exit value − construction costs − soft costs − financing − profit margin = maximum site price.

The profit margin sits right before the bottom line. That means every percentage point you add to the required return is subtracted, krone for krone, from what you can bid for the site. On a project with an exit value of DKK 40 million, the difference between a 15 % and a 20 % profit margin shifts the site price by DKK 2 million. That is rarely marginal — it is often the difference between winning and losing a site.

That is why the required return is not an isolated assumption. It speaks directly to the exit value and the construction budget, and an error in one place propagates through the entire calculation. If you want the full picture of how the items hang together, the walkthrough of feasibility with residual value, construction budget, and profitability is the right place to start.

How to build the required return from the ground up

A defensible required return is not a single figure — it is the sum of identifiable risks. Build it up in layers rather than guessing at one overall percentage:

1. A base level that reflects the developer’s basic expected compensation for running the project — with no particular risk.
2. A risk premium for whatever makes this specific project uncertain. The more that is unresolved, the higher the premium.

The factors that genuinely move the risk premium in a Danish development project are usually:

• Planning status. Does the project require a new local plan, or are the building rights already in place? A project that presupposes a planning process carries an entirely different uncertainty than one within a local plan that grants building rights. You can check current frameworks and local plans in Plandata.dk (the national planning data portal) — and understand what they actually bind you to, in the guide to how to read a local plan.
• Sales risk. Are you selling on the existing market at known price levels for comparable sales, or are you betting on a segment with thin demand? Note: this is an assessment of the current market, not a forecast of where prices will be in two years.
• Construction complexity. A new build on a greenfield site is more predictable than converting an existing commercial property with unknown structures, environmental conditions, or contamination.
• Time and financing. The longer the lifetime and the greater the interest-rate sensitivity, the more risk the requirement has to cover.
• Easements and title. Unresolved burdens in tingbogen (the Land Registry) can change the assumptions significantly. They belong in the initial groundwork — see the checklist for site due diligence.

The upshot is that two projects with the same exit value can easily deserve wildly different required returns. A detached-housing project with building rights already in place, in an area with thick sales data, carries a lower requirement than a commercial conversion that presupposes a dispensation under section 19 of the Planning Act and a market you don’t know.

Common levels — and why you shouldn’t copy them blindly

In practice, profit margins for new construction are often seen across a wide range, with low-risk residential projects at the low end and complex conversions at the high end. But a figure lifted from a neighbouring project is only a bearing. Use industry figures to sanity-check the requirement you’ve built yourself — not to replace it. If your bottom-up requirement lands far from what you usually see, it is either a signal that the project is unusual, or that you’ve overlooked something in the build-up. Both are worth finding out before you bid.

Where the required return typically goes wrong

The mistakes that cost the most are rarely arithmetic errors — they are errors of assumption:

• Putting one fixed figure on everything. “We always reckon on 20 %” ignores that risk varies from project to project. A fixed requirement means you overprice low-risk sites and underprice the dangerous ones.
• Double-counting or omitting risk. If you have already built a conservative buffer into the construction budget and a cautious exit value, and then add a high risk premium on top, you penalise the project three times over. Risk should be placed in one place, deliberately.
• Confusing profit margin with exit yield. If you mix a buyer’s operating yield in with your own profit, you end up with a figure that answers no useful question.
• Leaving the required return untouched while the assumptions change. When a planning process falls into place, or sales are confirmed, the risk has fallen — and the requirement should come down with it. A required return is a living quantity throughout the project’s phases.

The required return is only as solid as the figures it rests on. A sharp requirement on a skewed exit value gives a skewed result — so it is worth making sure the exit consideration is defensible. That is exactly what the walkthrough of exit value: what the project is worth if it stood finished today is about.

From gut feeling to a substantiated figure

The manual work of building a defensible required return — gathering planning status from Plandata.dk, assessing sales against comparable transactions on the existing market, qualifying the construction budget, and letting all the items interact in a single residual calculation — takes hours and demands that you keep your concentration through every dependency.

That is the exercise that Projektvurdering (Project valuation) in Arcili automates. You enter the cadastral parcel and the project’s frame, and the model runs the residual value through with exit value, construction budget, and profit margin on the existing market — so you can adjust the required return and see the consequence for the maximum site price right away. It does not replace your professional judgement of the risk; it gives you a fast, transparent starting point to qualify it from, instead of starting from a blank spreadsheet.

If you’d like to see how this looks on a real project, drop by Arcili or book a walkthrough.