So, you want to be a property developer!
This can be a great way to make money, if you know what you are doing. The property development process can be a long and complex one, from finding a site and selecting the builder to financing the deal and building and selling. Property development can lead to significant profits but it can also lead to significant losses so the more you have planned and thought about your project, the more likely you are to succeed. Remember the old saying, “A failure to plan is just a plan to fail”.
This “Property Development 101” series won’t be able to teach you everything there is to know about property development. However, if you read each instalment, you will learn about the fundamentals of property development and it will make you aware of what questions you need to ask so that you can make educated and informed decisions.
In this “Property Development 101 series”, I will be outlining the major steps involved in property development. These include:
Setting your goals
How to find development sites
Choosing the best site
Working with council
Selecting a builder
Real estate agent/property manager
In the first instalment I outlined some strategies in relation to goal setting and research.
In the second instalment I detailed some methods on searching for development sites and then some considerations when selecting the best site to develop.
In the third instalment I provided an insight in to the design and drawings for a development.
This month, we look at one of the most critical components of property development; crunching the numbers.
It is your feasibility study that will largely determine whether your venture is a success or failure.
I have detailed a few tips on how to go about your feasibility study.
Include All Costs
So far as property development is concerned, tax is commonly overlooked Tax is something we are so accustomed to these days that when it isn’t automatically included in a price, we can easily forget about it. Consider the price of a property or development site and the amount of tax it would incur. It won’t be a small number, so don’t forget to factor it into your feasibility.
The other commonly forgotten cost is holding costs. It’s not simply adding the cost of the land to the cost of construction to determine your total cost. If the project is going to cost a total of $800,000, most people will need to borrow the majority of the money. Development finance is more expensive than typical home loan finance so you might find that a development that has land costs at $400,000 and construction costs at $400,000 might have an additional $50,000 in bank interest.
Use Present Costs and Values
Once you have accounted for all costs, you need to work out what the sale price will be of the newly created allotments/dwellings. You can’t guess what you think they are going to be worth on completion. Your feasibility study should be based on comparable sales of properties that have already sold. Far too many part-time investors assume property prices will rise by 10% during the 12 months it will take to complete the project and are bitterly disappointed (and out of pocket) if it doesn’t happen.
If you calculate the sale price of your development based on present day sales, any uplift in property prices is a bonus.
Conduct a Scenario Analysis
To minimise your risk, you should have three separate feasibility studies. These should be based on most probable, best case and worst case scenarios.
The most probable scenario is the one that will probably eventuate, assuming everything goes to plan. However, it is rare that everything goes according to plan.
The worst case scenario should include such items as:
- Increase in holding costs due to the construction taking longer than expected.
- Increase in construction costs based on issues such as the footings costing you more than you anticipated or variations that you request during the building process.
- A decrease in the anticipated sale price(s) is the most important figure to calculate in your worst case scenario. If your properties sell for 5% less than you expected because of a down turn in the market or an oversupply of new dwellings, what do your profit (or loss) figures look like?
One of the rules of thumb I use is the gross profit margin you should aim for in a development. Residential property investors might be happy with a 5% return on their rental property. A commercial property investor might be seeking 10% return due to the increased risk involved in owning commercial property. If you are developing residential property, you should aim for a 20% gross profit as this is one of the riskiest property investment ventures. Gross profit in this context means the profit you make before you have to pay tax.
If you are looking for ways to calculate your feasibility study, there are many options. From free apps to complex software, it is all available. However, a visit to a good property accountant is the first step in developing your feasibility study.
Written by Peter Koulizos – lecturer and author – www.thepropertyprofessor.com.au