Property development is no easy business, and its all too simple for newcomers to mess things up. We finds out everything you need to know, from the amount of money required to the best locations to invest in…
Where you start out as a developer will be dependent on how much capital and experience you have, according to Michael Ta, director – Viva Properties. “A beginner may want to start off doing joint ventures with a property developer,” he says. “This enables them to learn the process in an environment where they are still making quite a substantial profit but where they are exposed to a lot less risk.”
Ta adds that investors need to make sure that they are dealing with reputable and stable developers, and when it comes to finding the best location, he has one word of advice: research, research and more research.
Research does not necessarily have to be in the property market exclusively either. For example, hints of growth potential can also be found by looking at where big successful retailers are investing (eg. by building new outlets or shopping centres).
The amount of capital needed depends on what kind of development is being considered and where it’s located. “Typically, financial institutions will finance 70% of the cost of the land and 70% of construction costs or 65% of the project’s end value,” says Ta. “However, smarter structures may allow a developer to reduce their capital requirements to about 12.5% of the project cost.”
Sheales agrees that the amount can vary, saying that you will usually require a minimum of 20% of the completed project cost and that is “cutting it thin”.
He adds that you also need funds for holding costs such as the interest payments over the time of construction and until sale of the property. Also most contracts don’t include driveways or landscaping so this needs to be allowed for. “You need either good old cash or equity in another property,” he says. “You also want to have a reserve, because you can always guarantee nothing goes to plan.”
If you are building up to three units on one title then most banks and non bank lenders will fund the project, says Sheales. “If it is a multi-unit project or commercial development then this can be more complicated. The golden rule is do not over commit yourself and always, always, get your approval first, before you sign.”
When it comes to choosing a mortgage, construction loans are the way to go.
Most lenders offer them (see our top 5 on page xx), and Sheales recommends that developers opt for a package that allows for future flexibility.
“Obviously you need to have something with no ongoing fees, the ability to fix, the ability to redraw and you also need to have the ability to make the loan portable, particularly if you’re investing,” he says.
“You might want to buy a house, renovate it, sell it and do it again. If your product’s portable you don’t have to pay all the application fees and everything again; they’re the things that you should look for.”
Sheales believes that commercial property offers the best returns on an investment, but he stresses that it must be a prime commercial property on a high exposure site. The fact that the tenant pays for all the outgoings including rates and repairs on top of the rent is the main draw. “For everyday mum and dad developers, small unit developments are probably the best”, however.
Sheales also recommends buying and selling your owner occupied property because of the tax breaks involved. “If you buy and renovate in a suburb that has a good track record of sustainable growth, then without going overboard with costs, you should be able to make a tidy tax free profit if you sell after one year and one day. Then just replicate the process every year or so.
“I have a lot of friends that use the profits from this to allow one partner to stay at home rather than working so they can raise young children. It has a lot of merit for all sorts of different reasons.”
Older style strip shopping centres which are now being converted into unit developments are another option, with councils openly promoting these conversions with incentives like reduced parking restrictions, easier and quicker approval times [Before, After and Corner Development photo – 037507-09].
“They are excellent investments and are seen to be trendy and as such have high rental returns,” says Sheales. “They come in all sorts of mixes such as all residential projects or a shop downstairs and one or two smaller units above [Shop and Unit photo – 037510].”
Selecting a site team
Choosing the dream team to make it all happen can be one of the most overwhelming prospects for a new developer, and Sheales recommends the use of a fixed price contract with a registered builder, which covers everything including insurance.
“Spend as much time as you can onsite,” he says. “As you get more experience and have more equity in the projects, you can possibly build to lock up and then subcontract the finishing of the construction. You save on bathrooms and kitchens and maybe you can even do the painting and landscaping yourself.”
Traps to avoid
Starting out as a developer is an undeniably steep learning curve, and there are many mistakes to be made along the way. The most common amongst them include underestimating the cost of building and the time required to get plans and permits, and not paying enough attention to project management. “These are all areas that new developers do not give sufficient attention to and result in many first time developers going broke or having to sell the project at a loss,” says Ta.
The worst mistake you can make is “trying to do too much, too big, too fast”, according to Mangioni. Paying – for example – $2m for a house and then spending $1m on it is another error – “cost does not equal value, always remember that”, he warns. “You can over-capitalise very quickly if you don’t keep everything consistent with the market.”
Sheales says that most problems can be overcome unless the property cannot be used for a development and a planning permit is rejected. “Land size and setback are very important,” he says. “Always double check the relevant rules before you sign anything. Remember when it comes to developing there is rarely a bargain.”
As for making it as a developer, timing is key – in fact some experts say it has the edge on location. “Timing is certainly more important than the location in some respects,” says Mangioni. “You could be caught in the midst of a huge jump in interest rates where the market might slide to billyo.”
Your success will therefore depend on many factors, but ultimately, according to Mangioni, “It’s either in you or it’s not in you to do this sort of thing. You can lose lots of sleep and you can lose your peace of mind. Basically everyone thinks that they can be a developer and everyone thinks that they can be a builder…” But not everyone’s right.
6 rules for starting out
Rule 1 – Know your area. Pick a suburb that you like and put yourself on the email alerts from domain.com.au and realestate.com.au then go and look at as many properties as you can. You need to know what land is worth, what old homes are selling for and what completed units are selling for. Rule 2 – Visit the local council and speak to town planning. Tell them what you want to do and let them know you haven’t done it before. Ask as many questions as you can about building units or dual occupancy and never be afraid to go back on a number of occasions. Rule 3 – Find a good architect and discuss what you want to do. He will tell you what the council won’t approve. Rule 4 – Speak to an accountant to determine the right structure from the start to maximise your tax savings. Rule 5 – Get your finances in order and be prepared as this project may go on for a lot longer than you originally planned. Rule 6 – Have a plan B, what will you do if you cannot get a planning permit?
Gaining development approval – stages
While development approval varies from one project to the next, this is a good example of the time scales involved with a simple case
Consultations with architect/town planner, pre development meeting with council 1-2 weeks
Prepare development applications. Consult with all professionals 2-3 weeks
Submissions to local council for processing – at least 40 days 4-6 weeks
Period for objections and local council advertising 2-3 weeks
Planning departments approve with conditions 1-2 weeks
Preparation of building plans 2-4 weeks
Approval of building plans 2-3 weeks
Development approval – provided by the council, it contains conditions, fees and contributions
Construction certificate – permits you to start construction
Building plans/strata draft – the plans approved by council stamped in conjunction with the Development approval. A draft strata is prior to the registered plan
Copy of inclusions – generally found in a specification i.e. prime cost items , fittings and fixtures
Copy of QS report or construction costs – compiled by a Quantity Survey to estimate the construction costs, or a building tender is mainly sought by developers
Proposal asking price if available – what the end value might be, generally a real estate agent, but a valuer is generally used by a lender
Lending pre-commitment information – are their any pre-sales?
If land held at July 2000 – copy of GST valuation – this is to establish the GST guideline for payment of GST
Development approval – repeated
Construction certificate – repeated
Building plans/strata draft – repeated
Copy of inclusions – repeated
Property development risks
The risk attached to the initial purchase – the acquisition – is significant; mess this up, and the development is unlikely to succeed. If it already has development consent, this will significantly reduce the time frame involved – though pre-existing development approval may come at a premium, thus impacting on the overall finance risk.
Once the site has been chosen, the risk centres on the development itself. To manage this, the developer needs to consider the realistic timeframe required to obtain the necessary development approvals including the Construction Certificate. “The developer needs perseverance and patience in dealing with the consent authority to achieve approval for its development,” says Bradley.
Obviously, making money is the ultimate objective with any development, meaning financial risk the greatest cause of concern. The development risk can have a knock on effect here as the time required to obtain the development approval may result in a delay in sourcing development finance. “It is prudent to achieve a reasonable level of pre-sales off the plan to underpin the finance risk and ensure a quick exit of the primary loan from these sales,” says Bradley. “These sales may be at a discount thereby impacting on the finance risk associated with the development.”
There is considerable risk attached to the building works, and this can be reduced and better managed by considering various methods of undertaking the development. Reduce risk by carefully examining the terms and conditions of the development approval, the conditions attached to the consent and the inherent site conditions; these could be restricted easements, building site availability or essential services or access to the site.
Marketing the finished product will depend on a number of factors, the most obvious of which is the quality of the built development. Location and future investment potential of the property in the long term also feature.