Save money – your project could cost 20% below market value
Make money – you could make large development profits
Get better rental returns – which helps pay the mortgage
Obtain easier finance – on completion giving you better leverage
Achieve great tax benefits – from new property
Becoming a property developer allows you to acquire high performance properties “at wholesale” (with built in capital growth) and ones that are cheap to own.
This helps you build your property portfolio faster and safer than the average investor.
What is Property Development?
Property Development involves a wide range of activities and processes from purchasing land to building and developing facilities.
One definition of property development is “the continual reconfiguration of the built environment to meet society’s needs.”
While this can be anywhere from roads to high-rise office buildings, this article will discuss a specific segment – the “average” investor working on small to medium-sized residential development projects.
What’s required of a Property Developer and why get into Property Development?
In order for a Property Developer to be successful, need to have the ambition and patience that the process requires.
They also need more knowledge than they may think – there’s things the already know, things they know they don’t know, but as soon as you get into your first project you’ll also stumble on lot’s you didn’t even know you didn’t know!
As a developer, you’re an investor committing your equity, expertise and talents to convert land from its current use to a higher and better use.
So you’ll need to educate yourself on property, the markets, economics, finance, town planning, the construction processes and the marketing of real estate projects.
Some of this you can learn by doing your homework and other lessons you’ll learn along the way.
In order to be successful, you need to start small and work your way up.
Most of your mistakes will be made with your first few projects so it is important to start small so you don’t ruin your property investment career before it has even begun.
GETTING STARTED – WHO TO TALK TO
Who should you be talking to now
O.K.- you’ve decided that Property Development is a smart choice for you and you’re ready to start discovering your options.
So who should you be getting in contact with?
Who will tell you everything you need to know and offer direction?
Depending on the complexity of the project, you may need only some or all of the following team members:
Real estate agents
Finance strategists to get you development finance – this is very different to investment finance
Accountants – to help you set up the right ownership structures
This is one of the most important aspects to consider before you invest in developing property.
The crucial question to ask is – can I afford it and will I be making a worthwhile profit?
Before you commence any development project, it is obviously crucial to first establish how much you can borrow and how you will be able to manage all associated costs of the development.
That’s why always recommend you have finance pre-approval in place before you get started.
This way you know your limits are and how much you can actually put towards developing a property.
Financing a property development is more difficult than obtaining finance for a simple investment purchase.
When approaching banks and lenders you have to remember that they have their own safety to consider when deciding whether or not to finance your development venture.
They will want to establish the track record of both you and the people on your team.
It is also important to understand that any project involving the construction of four or more dwellings on the one site will be considered a commercial endeavour by the banks and can therefore be more complex to fund.
Lenders will usually allow developers to borrow up to 70-80% of the total cost of the “hard costs” of the development project – not the end value of the project.
And they often won’t lend money for the “soft costs” – things like architect’s fees, Council fees, other consultants and purchase costs.
What this means is that your loan to value ratio for a development is significantly less is than that for a buy and hold investment property.
The bottom line is that you need quite a bit of money saved up to start off with.
By the way…development loans are offered in staged payments finalised at the end of each building stage. These include the deposit, base stage, frame stage, lock up stage, fixing stage, balance of development funds supplied on completion of the project.
Creating a Concept and Determining Feasibility
As different councils have different, and usually strict, guidelines in terms of what can be developed in their municipality – it’s important to understand the principles of town planning and how each Council interprets the overall development code for your State to suit their own local neighbourhood character.
This means it’s important to do your research before buying land.
Don’t fall into the trap of looking at existing developments in the area and thinking that you could built something similar today – they may have been approved under old town planning regulations.
So some of the important questions to ask are:
What can I put on this property – what is its highest and best use?
How many units?
How big will they be?
What restrictions are there?
Are there overlays, easements or covenants on the title restricting its development potential?
Securing the “right property” is critical for the success of any investment property.
Acquiring a piece of real estate that ticks all of the right boxes according to your investment strategy and long term goals is of paramount importance.
Of course when it comes to property development, site selection is even more critical as a large portion of your profit margin will be determined when you buy the property.
Sourcing good development sites is all about knowing your market and I don’t simply mean having an understanding of the many property markets out there, but the bigger economic picture as well.
Because a development project has a life of at least one year, and more frequently two to four years, if you want to be a successful developer you need to inform yourself about not only the property markets, but economics in general.
Then you will need to make an educated decision about where you think the markets are heading over the next few years.
As always…location is critical when it comes to selecting the best site.
Properties in prime locations will sell and lease far better than secondary locations, even in bad times when the market is doing it tough.
This could mean you’ll need to invest 15-20% more for land, but ultimately you’ll receive greater profit margins.
You also need to do your research and determine the type of property use people in that area want.
For example, if a suburb consists of an older demographic, single story townhouse may be more suitable than double story dwellings.
If the area is popular among families, you might consider building more bedrooms and choosing a location close to schools.
Another critical piece of research prior to purchasing a property is undertaking a detailed feasibility study to determine how much profit (if any) your project will make.
Just to make things clear… Just because you can develop the site doesn’t mean it is financially feasible to do so.
One of the reasons so many property developers go broke is that they buy with their heart (their emotions) and don’t complete a property comprehensive development feasibility.
Just like any new business venture you need a business plan, weigh up the pros and cons and crunch the numbers to ensure there will be a profit.
Sure your initial feasibility study will be rough and have many assumptions, but it should give you a reasonable guideline if you include:
The purchase price, purchase date and settlement. Stamp duty on the purchase.
Your equity in the project which will then determine the size of the borrowings required and interest payable.
Conveyancing and legal costs.
Consultant’s costs, such as architects, town planners, engineers, project managers and surveyors.
Rates and taxes are self-populating based on the properties values.
A contingency amount (many inexperienced developers unfortunately leave this out.)
Income from sales and rentals.
1. PRE PURCHASE STAGE
This stage is where the developer investigates properties based on their finance pre approval.
This is also the stage where you develop the concept for the site you’re considering as well is conducting a feasibility study.
During this time the developer should be consulting some of their expert team.
Generally, the following services will be required in order to accurately assess the feasibility of the site:
A Solicitor to check the contract of sale
A Town planning consultant to determine the site’s development potential
An Architect or draftsperson to design a concept
An arborist – trees on surrounding sites can restrict what you can develop on your site
Your project manager or builder or possibly a Quantity Surveyor (if it is a larger project) to determine build costs
It’s also a good idea to touch base with the planning department at the local council.
This department can provide you with an overview of any future planning or zoning changes in the area, which could limit your development in the future.
What you consider a relatively straightforward application, can sometimes be held up in council for over a year due to seemingly minor issues.
A good town planner working in conjunction with your architect, should forewarn you of any possible points of objection from neighbours. With this insight, the town planner and architect will coordinate a design that has greater potential for faster council assessment.
Above all, once you’ve found that perfect block and carefully researched any restrictions, act fast.
If it really is the perfect site for developing, the chances are another developer has their eyes on it too. Don’t allow procrastination to get in the way of a good deal and a great opportunity
2. NEGOTIATING CONTRACTS AND PURCHASING
This is the stage where land is bought at a price that allows the developer to make a commercial profit.
You should be thinking about how much you’re willing to pay and the end value of the dwellings at the end of development project.
Negotiating a price is best left up to the expertise of a buyer’s agent (one who understands the development process well.) Don’t take a shortcut here as the fee a property buyer charges is often covered by the savings you’ll make with the better negotiated price.
3. TOWN PLANNING AND DEVELOPMENT APPROVAL
At this stage your architect draws up plans to fit in with planning regulations according to council development guidelines. This stage can be complex so this may also require the input of a Town Planner.
The role of a Town Planner includes offering feedback during the design process, writing the development application, handling further requests, objections, cases in the appeals court.
You’ll also require the services of a Land Surveyor who will establish the title boundaries of your property, conduct a survey of the neighbourhood properties and how they will impact on your proposed development, consolidate a number of titles into one title for you if you have bought more than one block and draw up a plan of subdivision.
4. WORKING DRAWING AND DOCUMENTATION
Once you obtain a development approval your plans stage is where plans for the build are finalised and will require the involvement of a number of consultants including an Architect and an Engineer.
Architects are the creative designers of your project but they can also do a lot more your development process.
The three essential parts to the architect’s role are:
Preparing working detailed drawings which also requires coordinating necessary consultants such as geotechnical, structural and civil engineers. And…
Administrating the building contract. Preparing The architect may also assume responsibility of administrating the building contract and supervising of the construction.
Behind a building but they also have to work closely with engineers in order for your build to be structurally sound. Depending on the complexity of the build you may require more than one type of engineer.
At this stage you may need a consult different types of Engineers including:
Geotechnical or Soil Engineers – who test the soil to establish the conditions necessary for a structural engineer to design the footings or foundations of the building.
Structural Engineers – who work above the ground to develop a structural design that is both functional and cost effective. They work with the architect considering the weight of materials (eg. concrete and steel), furniture, windows, cars and many other factors.
Civil Engineers – design the roads and bridges. For a residential property this role may not be necessary but civil engineers will design systems to help cope with heavy periods of rain and retain water onsite slowly allowing it to seep through into the council’s assets.
Hydraulic & Fire Engineers – work on high rise apartments or commercial buildings that will require design for pipes for water, gas, waste as well as fire hydrants, hose reels and sprinkler systems.
The role of the Quantity Surveyor, while the architect and engineers make your building look good and make sure it will actually stand up, they have little consideration for the cost of your build.
During the Design phase the Quantity Surveyor or QS – not to be confused with a Land Surveyor – will ensure the design remains on budget through cost management and suggest alternative ideas to other approaches in the construction to save money. A QS isn’t usually required for small developments, but for construction costs that exceed $2 million lenders often require a report from a QS.
Once everyone on the team is happy with the plans (the developer included) obtaining a Building Permit is your next step. This process can take a month or two.
5. PRE CONSTRUCTION
Now it’s time to obtain quotes from builders and finance for your project.
Finding the right builder can be daunting.
There are so many options out there making it difficult to know who is best for your project.
One of the best ways to find reputable builders for your development is through recommendations.
These recommendations may be from friends, family, colleagues, or even your architect or development manager (who may know best because they work on developments all the time).
Only employ a registered building practitioner and be sure to request a copy of all the builder’s insurance certificates prior to hiring them for the job – this includes public liability insurance that notes you and your job as being covered for an amount of $10,000,000, WorkCare insurance and completion guarantee insurance.
Above all, look for evidence that the builder you are considering is able to deal with the type of project you are proposing. Determine this by visiting previous projects completed by them and speak with their previous clients to make sure they can deliver on promises.
Builder’s Contract and Specifications
The contract should include overall terms agreed to by you and the builder, including the price and payment arrangements; outline the scope of the project, who is involved and what each party is expected to do to support the other (providing access to the site, providing accurate working drawings, etc).
It should explain what will happen in the event of a dispute between the developer and builder and incorporate a time line that has been agreed to by both parties into the contract.
It will also state that work is to be done in compliance with specifications, drawings and calculations to comply with the relevant building regulations.
Building has now commenced and you’re well on your way to completion.
Do bear in mind that the construction phase can take anywhere from six to twelve months depending on size and complexity. You should also account for poor weather and other disruptions to building time.
Paying builders throughout construction and the specifics of this will have been included in the contract.
Payments are usually broken down into six instalments:
An initial deposit to confirm acceptance of the contract and commence construction
A payment at the end of the base stage
A payment at the end of the frame stage
A payment at the end of the lock up stage
A payment at the end of the fixing stage
Final balance on completion of the project
If a Quantity Surveyor has been involved in the project, they will oversee these progress payments at regular intervals. During construction the QS will also value changes or variations or additional works required and if disputes arise, the QS is called on as an expert witness or as an arbitrator.
At various stages of the building project a building surveyor will need to certify that works have been completed in accordance with regulations and to specified building standards.
Now you almost done, the building is finished and your project almost complete.
This is the time to submit the plan of subdivision to obtain separate titles for each dwelling and to either refinance and lease your completed project and hold in the long term (my preferred strategy) also your project for a profit.
WHAT TO DO WITH YOUR COMPLETED DEVELOPMENT PROPERTY
Essentially, you have two main options:
Selling your newly built development for a profit or
Holding on to it as an investment property.
But which is the right option? There isn’t really any right or wrong answer. It is dependent on the developer and their circumstances.
Selling the Development
Most developers have a “trading mentality” – developing for short-term profits rather than long-term asset growth.
The advantages of selling your completed development is that you’ll make a profit straight away, pay off the development loan quickly and be able to move onto your next project with a bit more experience and money up your sleeve.
The disadvantage to this method is that there is no potential to make more from the property – it’s a short-term gain.
Apart from paying tax on your development profit you will also be required to pay GST (Goods and Services Tax), selling agents commission and stamp duty on your next purchase, significantly eroding your profit margin.
Retaining your project as a long-term investment.
The advantage of holding onto a completed development is that it becomes a long-term investment.
You also benefit from:
Higher rental yields as the tenant pays you retail rents (not knowing that you your investment property wholesale.)
Great financing options – on completion of your project the bank should refinance your property based on its market value (which should be considerably more than what you paid for it) allowing you to withdraw a substantial amount of your funds used for the development.
Substantial depreciation allowances – meeting your property should the tax effective.
Strong capital growth – because you bought in a great location – didn’t you?
Putting this together means you have a high growth high yield investment property that is cheap to hold on to.
Who could ask for more?
Source: Bryce Yardney, “How to get started in property development”, Property Update, March 9 2018.