Property Development 101 – Part 6

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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

Research

How to find development sites

Choosing the best site

Drawings

Feasibility studies

Working with council

Selecting a builder

Finance

Project management

Real estate agent/property manager

Tax

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.

In the fourth instalment I looked at one of the most critical components of property development; the feasibility study.

In the fifth instalment, I outlined what to do when working with your local council or shire so as to obtain approval for your development.

In Part 6 of the Property Development 101 series, I address a number of issues you need to consider when selecting a builder for your project.

Overview

Building your development will probably be the most expensive component of your project. You could save money by sub-contracting the building work but if you are not experienced in building, construction or development, I would strongly advise against this. Your best option is to find an appropriate builder. By this I mean finding a licensed builder who has experience in building investment properties in the local area that are similar to what you wish to build and is recommended by others who have used their services.

The Right Builder

If you do a search on the internet, you will find countless builders that operate in your area. These will include builders who may do just a few projects a year to multi-national companies that construct hundreds of homes a year. So, which builder is best for your project? There are a number of strategies that you can use to help select the right builder for your project.

Ask others who have built for their recommendations. In my opinion, referrals are the most important indicator in the builder selection process. If you don’t know many people that have built, drive around the area that you wish to develop in and take note of the builders who are active in that area.

Once you have the names of four or five builders, contact them and ask if you can inspect some of their projects. The larger builders will probably have display homes that you can check out whereas smaller builders should at least give you the addresses of completed projects or projects under construction that you can drive past.

Your final decision as to which builder you select will be based on referrals, experience in building similar developments in your area and a “gut feel”. If a builder doesn’t seem right because they don’t return your calls promptly, don’t take you seriously, they are not helpful or you just don’t feel comfortable with them, look for another builder.

The Right Building Contract

Most residential building contracts are ready-made documents but in some cases, the builder has their own contract. Whichever contract you have, make sure you READ IT VERY CAREFULLY before you sign as “the devil is in the detail”.

When it comes to residential building, there are generally three different types of contracts:

  • Cost Plus
  • Construction Management
  • Fixed Price

Cost Plus Contract

In a cost plus contract, the client (you), will pay for all the costs of construction plus a margin on top of the construction cost. This margin is the builder’s payment for their management of the project and is usually 10% to 15% of the total construction cost. I personally don’t like this type of contract as it places all the risk with the client. Let me explain using an example. Assume that you are building four townhouses and you agree with the builder that their margin is 10%. If the construction cost of the four townhouses is forecast to be $1,000,000, the builder will charge you an extra $100,000 for managing the project. However, if costs blow out, the builder’s margin also increases as it is based on the increased cost, not the original $1,000,000. If the cost of construction increases to say $1,200,000, the builder’s margin is $120,000 (10% of $1,200,000). Not only do you have to find an extra $200,000 for increased construction costs but you also have to pay the builder an extra $20,000!

Construction Management Contract

This is similar to a cost plus contract but the builder’s margin is fixed. If we use the example above, the builder’s margin on the forecast construction cost of $1,000,000 is $100,000. If construction costs blow out to $1,200,000, the builder’s margin remains fixed at $100,000. I think this is a better type of contract than the cost plus contract because at least the builder’s margin is fixed. However, I think the best type of building contract is a fixed price contract.

Fixed Price Contract

As the name suggests, the price is fixed. If the forecast build cost (including the cost of construction and the builder’s margin) is $1,000,000, that is all you will pay. Even if costs blow out to $1,200,000, all you will pay is $1,000,000.

This is a much safer option for you as the risk is with the builder.

Some builders also offer a fixed price/fixed time contract. In this type of contract, the price AND construction period is fixed. This is great for the client because time is money in property development and any overruns in time will cost you extra in bank interest if you have borrowed money for the project.

No matter which contract you opt for, READ IT VERY CAREFULLY. If you don’t know how to read a building contract, ask a property/construction lawyer to read it for you, especially the fine print.

Property development can be a very risky business. You can minimise your risk by selecting the right builder and signing the right type of contract.

 

Written by Peter Koulizos – lecturer and author – www.thepropertyprofessor.com.au

 

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