If you’re thinking about doing a small-scale development, there’s some essential research you’ll want to undertake before you can count on a profitable project.
These kinds of projects can be lucrative for investors, providing a return on investment of up to 20 per cent, but there are inherent risks you’ll need to manage along the way.
Should I start with the end in mind?
Property developer, educator and mentor Rob Flux runs the Developer Network in Brisbane, Sydney and Melbourne and says it’s crucial to always have the end in mind before you purchase a property.
Will you hold or sell the property on completion? Will you move in or rent it out?
“In the early days when you don’t have much cash at all, [our clients] generally cash in on their first project to realise the cash and reload very quickly,” he says.
Flux says many first-time developers start with a relatively simple sub-division, before eventually building up their borrowing capacity and experience to build something like a set of six townhouses. With the latter, one scenario may be to sell five of the townhouses and end up owning the sixth debt-free.
“As a nest egg, you want to get to the point where you’re doing projects large enough for a hybrid approach [to both sell and hold],” he says.
Andrew Crossley, director of Australian Property Advisory Group, agrees. The author of five property books, including Commercial Property and Residential Development Made Simple, helps clients decide what to buy and when to hold or flip.
He says one of the best strategies for turning a profit is to build two dwellings on one block, sell one and keep the other with a significantly lower debt than is typical when investing in a single dwelling.
“I think this is the best strategy in property,” he says. “You’re manufacturing capital growth and cash flow. This is where you can make the most money.”
How do I work out if my development is feasible?
Arguably the most important step on your way to becoming a developer is the feasibility study you’ll conduct to determine if a project is viable.
At a high level, Crossley says your analysis should include an estimate of all the key costs, from the land acquisition and building contract to the council and valuer fees.
“Engage a surveyor or town planner to educate you on the level of precedent in the suburb,” he says. “They can also do a survey to ascertain if the footprint of the proposed dwellings is appropriate for the size of your block, taking things like the width of the drive, setbacks and easements into consideration.”
Crossley says it can be worthwhile to get a market appraisal done on what the value of the land will be post sub-division.
Ideally, aim for a valuer that’s on the panel of the bank you’re considering using – your mortgage broker should be able to help here.
If you plan to hold onto the project once complete, invite several real estate agents to provide a rental appraisal for the planned development.
Flux says it’s critical to identify any likely problems with the site up-front.
“Once you’ve identified those, you can engage the appropriate consultant to give you guidance on the cost to solve those problems,” he says.
But while there are experts for each piece of the development puzzle, Flux says it’s ultimately up to you as the project manager to consider each of the pieces as a whole and work out if the development will be profitable.
To arrive at a workable price for purchasing a property, Flux says he likes to start with what he expects the property will sell for post-development, then subtract the forecast profit and all of the costs identified in the feasibility study. Whatever is leftover is the maximum price that should be paid to purchase a property.
“By doing that reverse approach, you can very quickly get to a point where you don’t even bother investigating sites because it’s very clear they’re not viable.”
Flux, who aims for the average project to deliver 15 per cent annualised profit, says 90 per cent of sites that are developable are not profitable.
How do I finance my development?
Flux says there are a number of options to finance a small-scale development and the one you choose is likely to depend on the scale of the project.
“The smaller the scale, the more likely you’ll use traditional residential lending where you service the loan every month and pay interest,” he says. Your current income stream is therefore a critical piece of the equation as lenders determine your ability to service the loan.
“For larger projects you’ll tend to use commercial loans and the lender will look at the profitability of the project rather than just you as an individual and how big a loan you can service,” Flux says.
With commercial loans there is usually the ability to capitalise the interest and tack it on to the debt that you’ll repay on completion of the project.
Flux says he also teaches his clients alternative methods to do developments without using a bank.
“With such a challenging lending environment and many people starting with limited funds, there are creative ways to overcome your lack of resources and find alternate sources of finance outside traditional lending structures.”
How do I keep my development costs under control?
Crossley says it’s critical to engage a reputable builder offering a fixed-price building contract if you want to keep your budget on track.
“Ensuring you’ve chosen the right builder is so important,” he says. Check reviews to establish a builder’s reputation, research their size, their previous work and phone their references.
Crossley says it helps to keep your emotions in check and stick to your plan.
“Don’t get carried away with adding upgrades that weren’t originally in the plan,” he says.
Flux advises his clients to hone in on one type of small-scale development and build your skillset over time.
“Choose one development strategy and get very good at it,” he says, noting that your chances of a successful and profitable project will increase as you become an expert in your chosen approach.