Subdividing – the fundamentals for success (Ep.67)

In this week’s episode, Dave, Cate and Pete take you through:

  1. The first step – planning. Ask yourself how does this step fit in with your overall property plan? Start with the big picture and work out what stage of life is the best time for you to complete this project. Is it an acceptable risk to take on now?
  2. Buying well – a critical requirement to success. Selecting the right property and the right block will either make or break your plans. Itcould be the difference between make a profit or ending up with a vacant block and a hole in your wallet.  
  3. Know your market. Is there demand for smaller blocks of land with townhouses in the location that you’re purchasing in? Who is your target buyer and how will the property cater to their desires and price point? And is the project likely to be as profitable as other, similar priced alternatives?
  4. Have an in-depth understanding of council plans. Even if your plan is to subdivide, sell and leave the building project up to the next purchaser, the council still wants to see the plans. If you want to get three townhouses onto a block, be prepared to demonstrate the feasibility of your plans. Each council has their own guidelines, so it is important to understand the sensitivities, likely steps and local town planner’s approach at every step of your process. In particular, it helps to get to know who you will be dealing with.
  5. Consider all costs. From transaction costs, holding costs, tax obligations and the value of your own time – ensure you have an accurate understanding of the true projected cost of your project. Have you modelled what your budget will look like if a few key costs vary by 5%? And will you still make a profit?
  6. Obtaining finance for developments. Development finance is not as straight forward as getting a loan for a purchase. There are many additional hoops to jump through before you get the lenders tick of approval.
  7. Common mistakes and how to avoid them. Just because your neighbourdid a subdivision 5 years ago, doesn’t mean you are bound for success. We outline the common mistakes, misconceptions and unwitting risks we see time and time again, so you can put your best foot forward on your development journey. 
  8. Getting educated. One of the most critical factors to success is to ‘know your stuff’ and learn from the experts. We provide a bonanza of resources in our show notes for you to start learning and work out if subdivision and development is the right move for you. 
  9. And of course, our ‘gold nuggets’

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Show notes:

  • Misconceptions on subdivision – just because someone did it across the road 5 years ago, you can do it.  
    • Zoning changes 
    • Size of the land 
    • Frontage – how wide is the block? 
  • Not much opportunity to over-capitalize if you’re only subdividing and not building – you’re got a few costs really – demolition, connecting water and sewerage, council costs, interest and fees.  
  • Location demand – sometimes people move to a particular suburb for the 800 square metre blocks, they’re not interested in the 400 square metre blocks – do your research, are there smaller blocks selling in that suburb? 
  • First step – Timeline for subdividing and then doing the development (if that is part of your plan). Start with the big picture and then narrow down.  
  • The next critical requirement is buying well – the right property and the right block. 
    • You want to know that you can do what you plan to do.  
    • Get something that will be desirable and saleable, that you can make a profit on. 
    • Commonly you want to get into a sought-after location where there is a market for townhouses – 2 to 4 on a block. Often they are highly speced townhouses for people to get into a location that they can’t normally get into. This interconnects with knowing your target market. 
  • The council wants to see the plans – even if you’re only going to subdivide and sell. They want to know set backs from the side, rear, private space, overlooking or over shadowing. There’s no point in building what you like, but no one else does. Check out what other developers have built and monitor the market – did they sell them before they were finished? 
  • Even if you chop one block into two without building, you’ve also got GST to pay – a lot of people don’t factor this into feasibility. You have to pay GST whether you make a profit or a loss.  
  • Pete’s tip – get approval from the council, without proceeding with the actual subdivision – because you’re not creating anything new, there is no GST applicable and you don’t have to demolish the house.  
  • Two of the main issues people have with developing which cause great risk are: 
    • Will the council allow me to do it? 
    • How long will the council take to give me a yes or a no? 
  • If you take the risk out for the developer, people will pay a premium for that. A lot of profit can be made just for getting the permission to subdivide and letting someone else do the subdivision. 
  • The costs of subdivision – if the cost blows out on two or three of the critical ones, only by 5%, it can blow out your budget significantly. 
  • Purchase costs  need to be added to your base costs. Stamp duty adds 3.5 – 5.5% to your base costs (labour, materials etc.) 
  • Agent selling costs – Anticipate fees between 1.1% and 2.5% in addition to marketing fees. 
  • Holding costs – Does your contingency calculator factor in if the project to takes 6 months, 12 months, 18 month and 24 monthsIf you have borrowed money to purchase the property, what is the cost of paying interest, other bank fees, council rates. Subdividing and developing: 
    • 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. 
  • Cost of your time and stress – If you plan to take time off from your normal dollar producing work, you need to count this hourly rate and pay yourself (or eat into savings). 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? 
  • Tax obligations: 
    • Capital gains tax – 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. If you decide to chop off some land from your principle place of residence, there will be some tax to be paid on it. 
    • 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. 
  • Accountant fees – to get your tax advice – have you factored this in? 
  • If it is a Home you already live in – what are the costs for renting during the period that you are selling. 
  • 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? 
  • Finance for constructing property is more complicated than a straight forward purchase. Larger sums of money to be borrowed to do a subdivision and development, if you haven’t got presales the lender will assume that you are holding the properties, the ‘as if complete’ valuations may be conservative to protect the lenders interests, so you may not have as much equity in the lenders eyes as in your eyes. Then you’re stuck to a program that you’ve put in place that the lender has agreed on, there may be some variations along the way which the lender will have to approve. 
  • Mistakes – inferior budget and going for an area that is too early in it’s day for subdivision, meaning that there is an abundance of affordable houses on full blocks, so why would someone purchase a little unit on a smaller block. Or going or an area which is gentrifying, but the local planning has an appetite for medium density, so there are a lot of streets that allow subdivision and because of the price point, the target buyer is a first home buyer. So you’re dealing with affordability, rather than desirability – designing a product that fits a low budget – maximize profits by cutting costs. That’s not a high-level end product by any means. If you’ve got volatility, that will compound issues. 
  • The ones who get it right are experienced developers who’ve made their mistakes and finessed their craft. Or people who have owned the property for such a long time, land-banked and it’s now worth heaps – so you don’t have to cut costs to turn a profit. 
  • Pete’s projects: 
    • Buy the land, get the approval and sell. 
    • Buy the land, subdivide the land and sell. 
    • Buy the land, build and keep. 
  • Building takes another year, the value of the real estate is in the land – you will make most of the profit by selling the land. Why would you spend an extra $300,000 per dwelling to make an extra $300,000 and then there’s holding costs on top of that. Why not find another simple project to do? 
  • The key is knowing a little bit more than everyone else – knowing that you can put 3 when everyone else thinks you can only do 2. This comes down to knowing the council’s development plan. Rather than using scatter gun approach – each council has their own development plan, become an expert in one and get to know the planners, then you can pick the holes in where you can get the advantage that most people are not aware of. 
  • There are risks – if you buy a vacant block of land and you can’t sell it, there’s no plan B, no one is paying you to rent the vacant block. 
  • Misunderstanding easements: you can have a look in the contract and see what’s on the title plan, but there could be something on the water certificate that is not on the title that can catch you out. There could be an encumbrance on the land or a defective contract. 
  • Some of the traps that the Master in Urban Planning can avoid – the most important thing is that they are guidelines. If it says minimum 10 metre frontage and yours is 9.8, you may get it through or you may not. There are a number of boxes that the town planner needs to tick, you could miss one, but if you more than meet the other requirements, then you could be lucky. 
  • Keep in touch with the people you meet – especially town planners. If you’re not sure of something, ask the town planner what they think, is it a possibility? Some plans can be privately certified – go straight to the source.  
  • Check out our show notes, plenty of resources – Ron Forley – WA architect – has written some books on property development, Pete’s articles and videos. Margaret Lomas and Pete are writing a book on small-scale residential development. The key is to try to minimise your mistakes. 
  • State’s plan v council plan – would you recommend understanding the state plan or the council plan. The state plan is like guidelines, fluffy statements, this is what we’d like. Council plan is the nitty gritty, set-backs, heights, site coverage. 

David Johnston – The Property Planner’s Golden nugget: if you would like to subdivide and develop, but you don’t want to put the whole house on the table and risk, make it part of your overall portfolio plan. Maybe it’s your fourth or fifth or sixth purchase, something you land-bank with a capital growth focus and something you look to do towards the transition to retirement when you’re in a strong financial position. If things go wrong, you can wear some of the cost at that point in time, you’re not putting the whole kit and kaboodle at risk through the development. 

Peter Koulizos – The Property Professor’s Golden nugget:If subdividing property was easy, everyone would do it. Do your research, speak to locals, other people who have developed before you embark. There is potential for higher returns, but it comes with a higher risk.

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