The Complete Guide To Property Development
5 Reasons for why property development
1. You want to take advantage of growing markets
In big cities, with land shortages in desirable areas and land values high, medium- to high-density housing is the stock in most demand as populations continue to grow. Some 725,000 new homes are needed to house 1.7 million extra people in Sydney by 2036. Melbourne is forecast to overtake Sydney as Australia's biggest city around 2048, when both cities will be approaching eight million residents. By then the populations of Perth and Brisbane will each exceed four million. This means a continuous demand for new homes (which will mostly be apartments) and supporting infrastructure.
One of the strong growth areas in the near future is predicted to be 'co-living' accommodation, where people choose to live in supportive communities, rather than as isolated individuals. Think student accommodation, or even separated parents. Who will make this type of housing happen? Smart developers will.
There are also thousands of brokers and real estate agents advocating the qualities of property as an investment, providing a continuous flow of buyers and improving property prices over time and market cycles.
2. When you become a property developer, you are your own boss
Property development is not a passive investment like buying shares. Instead, you become a creator and an entrepreneur. You are in control of your own destiny and that can be satisfying. Through your own research, actions and capital, your own vision can come to fruition by improving or renovating existing buildings or rezoning and subdividing land and building on it. Many property millionaires started with small-scale, residential developments, forging a new, fulfilling path for themselves.
3. You want to make your money work harder
Low-interest rates mean low returns on your cash investments. The stock market continues to be volatile due to global uncertainty. Meanwhile at a local level, residential property remains a safer and stronger investment.
You can learn how to leverage a small amount of equity to raise the full funding of a development, earning a significant return when the property is sold. Property development offers several cash flow strategies, such as funding projects by selling 'off the plan'. It is also possible to increase your profit using innovative financing and negotiation techniques.
4. You want to take advantage of government incentives for property developers
Some states offer government incentives to boost residential development. Depending on the location of your project, you may be able to take advantage of these financial incentives. There are a number of tax incentives for private investors to invest in property development. These allow deductions for associated expenses connected to property development.
5. You want to fund future investments
If you decide to retain your development as a long-term investment, its value will continue to increase. It can then be used to fund future projects. This strategy also offers a level of insurance in case the market changes ' you can always retain properties and rent them out for cash flow.
How to get started in property development
First and foremost the most important thing you can do before you get into property development is educating yourself.
Educating yourself
This is really important. And don't think that just because you've watched a few series of 'The Block' that you understand all the 'ins' and 'outs' of property development.
You need to do research on the basics of property development which include:
- Types of properties
- Property markets
- Economic factors that affect property demand and supply
- Property financing options
- Council regulations
- Town planning information
- Building processes
- Real estate buying, selling and marketing
Property development is quite a broad-ranging topic and there are many definitions of what property development is.
For the most part, we can look at property development improving or changing the use of land.
Property development is quite often something as simple as a land subdivision, which is just purchasing a large block of land and cutting it up into smaller parcels.
Or it is even buying an old home, demolishing it and then building a new home.
However, the real opportunity in property development occurs when you are combining both of those strategies together.
For smaller property developers, that might mean buying an old home, subdividing the land into multiple blocks of land (2-3), then demolishing the house and building three new dwellings.
The same process applies when we move into larger developments, such as apartment buildings or even commercial or mixed-use properties.
While the process becomes more complicated and more expensive to undertake, the principle remains the same. We're trying to take some land and ultimately improve it and get the best possible use out of it.
In property development circles this is often referred to as getting the highest best use or the land.
In many cases, what the highest best use is, is generally determined by the State Government with their planning policies and the local Government and their respective planning schemes.
We can see that when we look around at our major cities. There are certain areas that continually see high rise development and new buildings. These are the types of areas that the State Government and local councils have earmarked for development.
While there are other areas that generally feature large older style homes that have been largely untouched for decades.
Your job as a developer is to work within these constraints to try and identify where there is both an opportunity and a need for a development to take place.
Your role as a developer is to also coordinate with a range of professionals to put your project together.
The types of people to build a professional network will include:
- Sales Agents
- Designer, draftsman or architect
- Town Planners
- Surveyors
- Lawyers
- Accountants
- Builders
- Quantity Surveyors
- Finance Brokers
- Engineers
This is just to name a few and the people you need on your team will largely depend on the size and scope of the property development project you're undertaking.
Your success as a developer is not in knowing every single detail and how to do every aspect of the development. Rather it is about assembling the very best possible team and leveraging their skill to bring the project together.
In that sense, a property developer is a bit like the conductor of an orchestra, rather than a musician.
Project costs + profitability ' is it worth it?
Now that we understand, what it means to be a property developer and what the process is, it's important to understand what the financial aspects of a property development deal look like.
As we've established, if you can buy some land and build for less than the costs of buying an established property, you are likely to have a profitable property development deal on your hands.
Looking at the actual numbers, property developers generally look to make a 20% profit margin. This is known as the development margin and it acts as a safety barrier for the property developer.
That's because property development projects take time to complete. They take time to get the necessary council and state Government approvals and it takes time to physically build.
That's time the developer is exposed to the property market and a 20% margin means that they will be protected should the market fall during that time. The margin will also protect the developer in the event that their projections for the end sale value or costs are not accurate.
On paper, a property development deal might look like this:
| Costs of Development (Land, Construction, Approvals/Interest etc) | $2,000,0000 |
| End Sale Value | $2,400,000 |
| Profit | $400,000 |
|---|---|
| Development/Profit Margin | 20% |
Looking at the costs, we can breakdown property development into two categories, hard and soft costs.
The cost of land and construction are the hard costs.
Things like stamp duty, approvals, or the costs of hiring contractors or professionals are known as soft costs.
Understanding the breakdown of costs is important when we look at how lenders will finance a property development.
Generally speaking, a lender or bank will finance around 70-80% of the hard costs of the project. That means a developer will still be forced to pay out of pocket for a number of the initial expenses and soft costs as well as contributing equity to the project.
On top of that, the developer will also need to have sufficient borrowing capacity to purchase the land and also be able to fund the construction costs.
There are a range of different funding options that you need to consider and they will vary depending on your personal circumstances and also the nature of the project you're looking to undertake.
As a general rule, if you are looking at the construction of three dwellings or less, this is considered a 'residential' project and you can access standard residential funding from a lender. The advantage of this will be that the costs are lower along with the rate of interest. You will also be able to achieve a higher LVR on the project.
The downside is that your personal borrowing capacity will be taken into account and that can severely limit your ability to complete a property development project.
If you're looking to build four or more dwellings, that is often moved into the realm of commercial financing. The advantages of commercial financing, is that funding is given to the project itself, more so than the borrower.
A lender will want to see that there is sufficient margin in the project to counteract any risk.
The downside is that commercial LVRs are lower to compensate for that while interest and costs are going to be higher. Many lenders will also look closely at your experience as a developer or at the very least, the team around you.
Most new property developers start by doing smaller projects that will fall into the residential funding realm so it is important to have your financials in order, much like if you were going to be applying for a loan for a standard investment property.
When looking at the numbers, again it all comes down to the profitability of the project. The higher the profit percentage, the more likely lenders will look favourably on the project and the safer it will be for you as a developer.
Barriers to property development
While most people think success in property development is all about money, the reality is that it is a skill like any other profession.
The skill of the property developer is about being able to identify what the end buyer ultimately wants and then being able to create that product within the constraints of both the project costs and the limitations of the local planning authorities.
Property developers also have to be able to assemble a team of highly skilled professionals while being able to manage them effectively.
While money isn't the most important thing, it is helpful if you do have some equity and cash to get started as well as some ability to borrow money. However, those elements are similar in any type of property investment strategy.
Property development, unlike buy and hold investing, is also likely to incur things likes capital gains taxes taxes and even GST, so this needs to be factored in an accounted for.
There are risks to undertaking a property development and for that reason, there is the associated reward that is often far greater than a buy and hold investment. But with careful planning and due diligence, these risks can be greatly mitigated.
For new developers, there are also a range of strategies, such as simple subdivisions, that you can implement, that will have significantly lower costs and are a great place to start.
However, building the skills that you need to be able to execute a property development are ultimately the most important part of the process.
Property development vs property flipping
It's important to understand the difference between property development and property flipping. While both involve strategically buying, renovating/building and selling properties, property development usually involves holding on to properties for longer periods of time.
Property flipping, on the other hand, involves buying, renovating/building and selling properties as quickly as possible. It can be difficult to make enough profit on a short-term property flipping project to make the investment worthwhile, once you factor in all your costs. Those costs can include:
- buying costs like stamp duty and conveyancing fees,
- renovation costs (including both building costs and council fees), and
- selling costs like real estate agent commissions and legal fees.
While you also have property development holding costs like rates if you hold on to a project for any length of time, all of these costs can be offset via your property growing in value, as well as by it generating rental income.
