Funnelling your cash into an investment property and hoping it will reap wealth over the long-term is an entirely different strategy to manufacturing value by creating it yourself.
When managing director of Develop Capital, Adam Barry, signed the sales contract for a 1970s home in Parkwood, Perth, he had plans to do a cosmetic reno and make a 10% profit on the purchase price.
That was, until he realised that there was more opportunity to be realised within the simple brick house on a concrete slab.
“In the past, the house had been extended so that it had an extra-large living area,” he says.
“I didn’t change the external walls, but in that living area, there was enough room to take some of it and turn it into a new main bedroom and an ensuite.”
Manufacturing a bedroom by reconfiguring the internal space under the existing roof didn’t require planning approval – but it did result in a significant value boost to the home.
Barry reaped a profit of $50,000 from the project, and in doing so, took his first step towards becoming a professional renovator and developer. Today, he manages up to four projects at any one given time, with a current focus on 3 to 4-unit sites with single level houses.
“I wanted to start with a renovation before taking on a development because it felt less complicated, and it also required me to put less money in. So, for a starting-off project, it ticked a lot of boxes, as I didn’t have to take as much risk,” Barry says.
“I was really encouraged by the result and it proved to me that my strategy worked, and that it was a profitable thing to do. Next, I did another renovation and after that, I did a sub-division – and then I moved into building and construction, and building developments from there.”
After the completion of two profitable renovation projects within a year, Barry purchased a property in Bayswater, Perth, on which he planned to execute his first sub-division.
“There was an existing house that was kept and renovated. I also subdivided the land, so I had the existing house on one title and a new vacant block on another title,” he shares.
A mighty $136,000 was reaped from the project – an 18% profit on total cost.
A little over a decade on from his first renovation at Parkwood, and having left his full-time job to devote his nine-to-five to developing residential properties, Barry shows how big profits don’t always mean having to take on larger-scale projects – especially when first starting out.
Mastering the essentials
Getting an understanding of construction is essential for those who want to take on a development project, explains Bryce Yardney, project manager at Metropole Projects.
“You need to understand what you can do on the site before you buy it, and you need to understand what it’s going to cost, because otherwise you can’t crunch the numbers, you can’t do a feasibility study and you don’t know what you can pay for the site – or know if you’re going to make money out of it,” Yardney explains.
A renovation project is a good entry point for a beginner, he adds, as it allows them to become familiar with the vital components of a build and how a project ultimately comes together.
“It’s much lower risk, less money to lose, but you can still make some good profits with it,” he says.
Meanwhile, Barry’s advice for new developers is to carefully study other projects in the area and take note of what property types are most sought after.
“Start with developments that are in the middle part of the market, where there is a common formula for the type of housing in demand,” he says.
“Beginners should focus on researching what buyers want and which previous developments have sold well, and then aim to produce a similar product. This will remove the risk of over-capitalising, as they are building what has worked in the area before.”
Progressing from a fixer-upper
If you’re keen to get started with a substantial renovation or development project, what is your next step?
In comparison to doing a sub-division, or two or three builds on an established property, purchasing a bare stretch of land that can accommodate a single new build may sound like a straightforward approach.
However, according to Yardney, it can be restrictive to the profit that you make.
“There isn’t going to be enough margin in a single land and one-house build to make it worth your money, so you have to be doing something a little more challenging, something that everybody else can’t do, and that the market is going to pay a margin for,” Yardney explains.
“Buying an old house that is close to land value, so that you are pretty much only paying for the land value, and then… building at least two townhouses is going to be more profitable.”
Barry advises that it’s important to work out a project’s potential profit margin, first and foremost – and to be realistic when you’re crunching the numbers.
For his development strategy, he aims to buy in an area where he can achieve a 15% to 20% profit margin after costs. When approaching a renovation, it boils down to him being able to buy in an area that will allow him to sell the renovated property for about 30% to 35% more than what he bought it for.
Second to margin, Barry looks for an appropriate house that will fit the purpose of his build, and this generally takes the form of a property that he says is “a bit run down to be able to get it for a good price”.
“You want to be able to spend the money on cosmetic things that you can see and improve,” he says.
“Things like, say, internal plumbing and wiring – if a house had bad plumbing and wiring and it all needed replacing, well, you would need to get a discount on the purchase price because by fixing those, you’re not really adding value, you’re just restoring it to what people expect any habitable house.”
Aim for big ROI renovations, like updating kitchens and bathrooms, painting walls and replacing flooring, and you’re likely to see the biggest uplift in value.
“Education is critical when starting out,” he adds, “to ensure that you minimise the chance of catastrophic failure. But the only way to continue learning is to start doing.
How much does developing cost?
If you’re wondering how much cash is needed to dive into a development, Yardney says this ultimately depends on the project itself, but advises that at least 25% of the total project costs is required in equity.
“If it is a $1m project, you will need $250k – and that’s a very significant sum,” he says.
If you have the funds at hand to proceed and you’ve found the ideal site, then the next step involves running a development project to schedule, which heavily relies on the builders at work. Sourcing trades that supply a quality build can very much prove to be a skill in itself.
“For the Parkwood renovation, I project managed it, so I got the individual trades in. I got quotes and referrals, so I got three plumbers in for example, and just by doing that I could tell who seemed competent and reliable and who didn’t,” Barry shares.
“I already had an electrician who I knew was good, so when you have one good trade, usually they know other trades that are good. They’ve got high standards.”
In this way, Barry has roped together a reliable network of builders from the very start.
“That electrician I still work with on projects 10 years later,” he adds.
Yardney adds that referrals and word of mouth are a “gold for builders”.
“Do your own due diligence as well. If you’re going to go out and meet the builder, don’t do it in your own office, don’t do it in a café,” he explains. “Do it on one of their construction sites so you can see some of their work.”
The realities of developing
- Not all developments make money. “People assume that just because someone is building, they are going to make money out of it. It’s not always the case,” says Bryce Yardney from Metropole.
- You need an exit strategy at the outset. This includes working out whether you want to sell or whether to hold – and be prepared for the worst-case scenario before they show up at your newly-paved doorstep.
- Financial ‘buffers’ are essential. “You should aim for a low loan to value ratio, and secondly, have a big enough buffer so that you don’t get into a ‘fire sale’ situation where you need to get rid of it now, no matter what the market is [doing] around you,” Yardney says.
- Over-confidence is a big risk. “When people reap a profit on their first project, they might then skip on some expert advice and guidance on their next one,” Yardney adds.
You’re a-list development team
Beginner developers need to surround themselves with the right team of experienced professionals from the start: these are people who have been involved in development projects in the past, and know how to help you navigate the potential pitfalls and red flags along the way. They include:
- An accountant
- A solicitor
- An architect
- A project manager
- A town planner
- A mortgage broker
- Connections with local real estate agents