Developing a property can be one of the most rewarding exercises you can do, but if you get it wrong it could also be one of the most gruelling.
For many, the thought of developing property conjures a lifestyle of convertible sports cars, beachfront homes and bottles of Moet. As a novice, the reality is usually far from this. Lengthy delays, piling interest bills and a host of other factors out of your control can all take their toll.
I first decided to invest in property when I was 20. None of my family had done this so I didn’t have guidance or a basic understanding of how it worked. All I knew is that I wanted to do it. I set out searching for opportunities in Melbourne, where I grew up, but the prices were so high that entering that market unnerved me.
I only really got started by talking to people and getting advice. I started researching markets that suited my criteria until I heard about Emerald in central Queensland. I also happened to have friends there who were builders.
Deciding Emerald was a good place to kickstart my investment portfolio, I didn’t just buy there, I moved there. I wanted to know as much as possible about the process and be hands on. I saw this as pivotal for my future.
I started with one duplex development that I turned it into five. Now I’m seeing a complex of eight townhouses come to fruition. From my experience, here are the key points you need to understand to get a development project right.
Know your position
It is important to know and understand your position to develop, from a time and financial perspective. Developing a small project can require a considerably larger amount of funds than a standard investment. Initial costs that your bank usually won’t provide assistance with include plan preparation, development application fees and headwork charges – depending on when they are needed to be paid. Some ask for it prior to construction and some after construction.
There are also a considerable amount of miniscule costs that can add up. Your bank may not cover them in the earlier stages of your development and you need to identify where these funds will come from and have a contingency in place.
Too often I talk to people that want to start developing a small complex when they haven’t even grasped or experienced the basics of property investing. If this is you, the best step you can take is to start investing in something, ideally a new house construction to at least give you the fundamental understanding of a basic construction process without too many hurdles.
Knowing your position will indicate what type of small development you can take on, but also whether it’s a good idea for you in the first place.
Once you know your position, the next step is finance. There’s no point even looking for a site if you simply don’t have the financial capability to fulfil the requirements of a development. A mortgage broker who has experience in small developments is your best port of call. Many bank lending managers and even many mortgage brokers do not understand the concept of developing a duplex or triplex, yet they may still provide advice to you. This is where many can go wrong – they take the advice of someone who is not familiar with the process.
Financing any sort of development outside of a house is its own ball game. Lending criteria changes according to the amount of dwellings you are going to construct and your intention for those dwellings. For most lenders, a duplex will always fall under residential. You lose a lot of residential lenders when constructing a triplex (three units) but there are ways to get around this under residential terms.
When you start building four or more, you are categorised under commercial lending criteria. This is where it can get difficult for some. A 20% deposit is usually required, sometimes leading to 30% depending on market conditions. If your plan is to sell them immediately pre sales may also be required, quite often at the ratio of 50%, or enough to cover the bank’s debt for the project.
Should your intention be to hold the properties and rent them out, you will quite often be required to reduce your LVR (loan to value ratio) to 65%.
i) Understanding value
The term LVR can get misconstrued here for many investors. Some think the “value” in the banks terms will be the value of the end development with individual titles. It rarely is. The banks usually only take value from the contract prices for your development.
Needless to say, even if you’re set to make a motza from your development, you will generally still be required to put in the nominated percentage of funds. I find this disappoints many people as they want to make money from nothing.
Based on your available deposit (be it cash or equity) you will need to show the ability to service the debt. Most lending institutions will assume maximum drawdown of your loan for approximately 12 months and ensure that your current cash flow can sustain that.
Having access to the funds to complete the purchase of the land and other associated costs is vital. If the property you want to buy is good, chances are you are not the only person wanting to buy it. You need to ensure you are in a position to make an offer and act on it within a reasonable time frame.
For a more simple duplex, lending is easy and you can do this with a 90% LVR at least.
ii) Create a risk mitigation strategy
A risk mitigation strategy will help you set out on paper what a number of worst case scenarios would look like to you.
You can do this by identifying your budget and working out your annual interest. Many people look at a draw down timeline and calculate interest on this. This can be accurate, but it is not the safest option. Make sure you can pay the full amount of interest when the property is complete. Other aspects like cost blow-outs need to be factored into this and how you will accommodate them.
Depending on the size and intention of your proposed development, you may want to assess potential market changes. What if values go down during your construction or the rental market slows? What are your exit strategies?
It is recommended you have at least two worst case exit strategies and ensure you can afford to implement them if need be. Having a risk mitigation strategy in place before you start your research is a good idea as it will help you understand what you need to identify in a market.
Researching your market
Too often we don’t look past our own postcode for development opportunities. We rely on the performance of our suburb to dictate to us what the entire Australian property market is doing. This is when there are hundreds of property markets throughout Australia.
The internet is a great tool to start researching other markets. Assuming your finances and risk strategy have been prepared, you should now be in a position to start looking at various markets.
The first two aspects to focus on are price points and end saleability. Novices often want to develop in prestige suburbs. These places have high buy in prices and their councils can often be hard to deal with.
Personally, I prefer suburbs that have a median sale price similar to their state average. In Queensland, I always like to keep under $500,000. More people can afford that market, and if you’re developing a unit where the median house price is below $500,000 your end product will most likely be around $400,000. This attracts not only owner occupiers but investors too. Increasing your end buyer pool is good as it exposes you to two different markets when you sell.
When you find a suburb with a low buy-in price and active sales or rental market, you need to research the needs and wants of buyers. This to me is the most important aspect.
I find many novice developers who don’t know a market and live in a different state propose to build something they’d build in their own suburb. This simply doesn’t work.
In Mackay, for example, people have proposed three bedroom units covering 200sqm each. The build cost for this is simply too high. In reality, an optimal floor area of 165sqm will net you a similar sales price with a much cheaper construction price. This is a large reason that a lot of small developments never get off the ground – they don’t work with their builders or the end market through the design phase. Eight months later they obtain build quotes and sales appraisals only to realise there’s no difference between the two.
Identify your target market and cater to it. Many investors are return driven. Find what will provide them the best return to make your product superior to your competitors.
Investors also want to ensure capital growth will occur; which is where you need to ask: “could I live in these”? You need to do this very carefully. You won’t be living in them, but you need to ensure that you could live in them.
Finding the right site
Having the right site is an important aspect of your development. Your first port of call here is the local councils “planning” section on their website.
A town plan should be relatively simple to understand and will help you identify what is acceptable according to the town planning code for any given site. Flood overlay maps and zoning maps will also be required. If you are proposing to do something outside of the town code, any development application becomes “impact assessable” and is then opened up to the public and surrounding properties to make comments about the proposal. This is where delays can occur. If you don’t understand what the community wants and accepts you will suffer lengthy delays and consultancy fees.
While you may find an allotment big enough for your budget, you need to ensure that there will be saleability aspects from day one. Assessing proximity to services becomes ever so important the smaller the unit sizes are. People who buy or rent 1-bed units with only a terrace are often doing so for lifestyle choices. They want to be able to walk to cafes, shops, parks and recreational facilities more so than people in larger houses.
Again, identifying your target market is vital. If a site doesn’t have at least three saleability points, move on.
Presenting an offer
Once you identify a site that fits your budget and ticks the initial due-diligence boxes you may be in a position to present an offer. If there are unknown aspects you still need to clear up, presenting an offer with a simple due-diligence clause will allow you time to do so while having the site secured.
When presenting an offer, remember to be fair. Money talks. If you’re serious about a site and you’re a seasoned investor you can make cash offers with no abnormal exit clauses and save yourself thousands.
If you’re 80% of the way there, money can buy you time too. If you’re after generous terms and time you may have to pay more. When I know a site I want, I put in my offer with fair money, longer settlement terms and permission to lodge a Development Application at my cost prior to settlement. This has saved me a lot of hassle and tells the sellers I’m serious.
Of course, I need a mutually beneficial outcome. If the site is too good to be true and you want to make sure it really is worth it, sometimes a non-refundable deposit is a great bargaining tool. This can be anything from $5,000 for several months of terms favourable to the buyer.
Design & Development Application process
I have touched on this a little bit when finding the right site. You really should have a good idea what you are going to put on a site before purchasing it. Researching your target market is key when designing. You may choose to engage the services of an architect or be confident that you can bring the development to life with a draftsman. Either way, your knowledge of the market needs to be communicated.
In this process it is important to be in discussions with your preferred builder to make sure the design is cost effective. If not, you will need to ensure every extra cost will provide a return on investment. This is where you need to let the market dictate what you design. With many architects wanting to vie for an award using your money, you must remember to keep this a commercially beneficial process. This is where people over capitalise and lose money.
Once you design your new development, it is time to lodge your development application with the local council. I recommend using a local town planning firm who know the area and the council. Many councils will be efficient in getting approval to you within four months, but large delays often come when you haven’t lodged an application properly and the council have to request extra information. Knowledge of a local firm will save you months of waiting. I allow at least six to eight months from preparation of my design to DA approval.
Depending on what you are building, you will often have to lodge a Building Approval application. You will have to engage with engineers to provide this detailed information.
Choosing a builder can be one of the hardest parts of your development process. With different prices, quality, times, systems, procedures and experience many first time investors don’t know where to look.
Local agents, developers and planners can point you in the right direction to start talking to the right builders. It is important to tender your project out to at least two or three builders. You will need to spend time identifying what inclusions and finishes you want in your development and provide these to each builder to include in the quote. You must make them aware that it is a tender process as many don’t want to quote for a job that may only have a 30% chance of winning.
Be in control of the building process. You will find yourself having to negotiate on many aspects of the construction. Without knowledge you won’t be able to make informed and tough decisions that others may disagree with.
Your construction process should take six to eight months – again, if it is no more than two stories and on relatively flat land. Being able to go on site or having a project manager to do that for you is important. You want to make sure that your investment is being delivered as you thought and as is contracted by the builder. Many people forget the builder can make things really hard for you. It is important to work as harmoniously as possible with them – allowing them to bring their ideas to the table while standing your ground on the issues that you know are important.
Speeding it up
Builders have many out clauses with time delays – don’t give them reasons to want to use them just to make life hard for you. At the end of the construction, you will need to ensure that the home has been finished according to your contract and the quality control is where everybody wants it to be.
This final hand over is vital to ensure that all aspects have been covered. I have seen too many construction jobs where small details get overlooked and it is only the end purchaser that picks them up.
You will need to work out with the builder who looks after the community titling process. This involves a surveyor and solicitor. For me, I prefer to be in charge of this process.
Josh Atherton runs Portfolio Property Investments - a property brokerage business with a core focus on sourcing small property developments in key regions throughout Queensland.