Let’s face it, development is sexy. Everyone loves property and the idea of making ‘fast money’ is appealing to most. Unfortunately, often the proverbial lure has a jagged hook on the end of it if you are not careful! Before embarking on any project, it is important to have a thorough plan and accurately calculate the time, cost and importantly, the return, each with a contingency allowed for a blow-out. You don’t need to be a developer to know that building rarely goes according to plan.
A 10% blow out in cost, or a 10% reduction in the return could turn the project from a winner to a loser quite quickly!
If you are interested in taking on a development project, below are 12 considerations you should carefully think through before taking the plunge:
- Buying well is critical to success – Buying a quality piece of land at fair value or below market price that is suited to a successful development is arguably the most critical component of any successful development.
- Stamp duty: how will stamp duty add to your base costs?
- Holding costs: if you have borrowed money to purchase the property, what is the cost of paying interest and other bank fees during the development period; what is the additional cost if the project runs over time; what is the cost if you cannot sell prior to or immediately after completion?
- Tax. Do you understand the tax implications upfront? Tax is often riddled with complexity:
- Capital gains tax must be considered. Rates vary based on how long the asset is held. In addition, rates can be significantly higher if you are deemed to have undertaken a development to return a profit.
- GST may be payable if renovating or developing for a profit on the sale of properties that have not been sold as residential premises before, have been created through substantial renovations, or new buildings that replace demolished buildings on the same land.
- Things not going to plan: include anything from project overruns, mistakes, tradesmen who don’t turn up for work, late deliveries to bad weather. A contingency for these costs should be factored in.
- The cost of your time: if you plan to take time off from your normal dollar producing work, you need to count this hourly rate and pay yourself. Even if you decide not to take time off, there is still a cost. Could you have spent that time increasing the income you earn from your profession? What is the cost in lost time with loved ones?
- Agents’ selling costs: Anticipate fees between 1.1 and 2.5% in addition to marketing fees.
- Increased asset value and income V increased debt (if holding): Consider whether you will get a positive cash flow from the development if you keep some or all the property(s). You do this by calculating the rent less interest and other holding costs. Then determine the total debt you will take on board and calculate how many years it will take for you to achieve positive cash flow from the investment to pay off the debt accumulated.
- The land appreciates: If you already own the land, is there a benefit from sub-dividing and building when you weigh up the above. Could you be better off placing your capital and borrowing power into another investment that could provide a greater return than the small time sub-division and development? Could you purchase another quality asset sooner?
- Council/town planning: Do you know what is involved, the likely timeframe and cost to obtain sub-division and construction approval? Understand the councils control plan ‘before’ the purchase and discuss your ideas with the planner at the council. History is littered with examples of small time developers purchasing with a view to build three or four properties, only for the council to reject the plans ultimately limiting the financial return.
- Granny Flat tenant quality: If you are building a Granny Flat, consider: what type or tenant will live in the Flat? What impact will the Flat have on the type of tenant and rental income for the existing dwelling? What happens if the tenants from each property do not get along? How clearly separated will you have the boundaries of each property?
- What is your ‘buffer’ or ‘wriggle room’: You should always plan to succeed, but equally understand what your downside looks like. If your development fails, what does the worst-case scenario look like, do you ‘lose your shirt’ or will you be educated and empowered to take the learnings onto your next development and be better for the experience, despite a reduced return or financial loss.
As you can see there is much to think about and the considerations outlined above are only the tip of iceberg!
Let’s face it, if you hope to do multiple developments, it is likely your first one will include the most mistakes and be your least successful. Common sense tells us that most things we do in life for the first time, we do not do well. Be a realist going in and you are more likely to appreciate the journey.
Attempting to make ‘fast money’ usually ends in tears. Going into the project viewing it as a learning experience which could yield some dollars is the right mindset.
There are not too many ‘short cuts’ to success in life. Speak to anyone you view as successful, you will not hear them tell you the journey to success was filled with ‘short cuts’, unless of course they are trying to sell you something.
As the world’s pre-eminent investor and billionaire Warren Buffet famously said, ‘Wealth is the transfer of money from the impatient to the patient’.
We all have an inbuilt desire to build things, especially shelter. Combine this with the highly emotional charged desire to make money, and this can be a heady mix. As with all financial endeavours, it pays to go forth with open eyes and a strong mind. Without it, you may end up with failure knocking at the door – pun intended!