As property development is becoming increasingly more popular creating more competition for good development sites and where profit margins are becoming thinner, property developers have to be smarter and more disciplined by sticking to core principles. Any mistakes made in this business can either decrease profit margins or worse in bankruptcy. Below is a list of the most important things. These general principles will guide you in the process of your development career.
1. Familiarise yourself with the local property
Astute developers make it a point to study the properties on the market. They learn all about their city, specifically the growth points and movement patterns including the depressed areas. With this increased knowledge they become more confident and will possess the ability to spot a good opportunity.
Knowledge of the local property can be gathered by talking to local real estate agents, reading the real estate classifieds and driving through the neighbourhoods looking for “For Sale” signs and asking questions. Another source would be to obtain a structure plan with the various zonings from the local council office and check with the Planning Departments if there are any future changes. Remember that a great opportunity always goes to the developer who knows how to locate the right development property and who dares to act quickly.
2. Understand where you are in the property cycle
The property market is continuously changing with peaks and troughs over, and this is in direct response to variable economic market conditions. Most developments often span over two years or more, so it is vital that you understand where your project sits in the property cycle.
The timing to buy or sell considered by a property investor is different from the timing of a property developer. With development, you will have to know when to buy a property, build and sell or rent their product. With property investors the process to purchase or sell takes less time to settle whereas with a development the developer requires time to plan and wait for several approvals before his project can be marketed. It is therefore vitally important that you have full knowledge of the property market cycle.
3. Develop properties in a good location
“Location, Location, Location”, how often have you heard this saying from real estate agents and property people? History has proven that well-located properties will still sell in bad markets and these properties escalate in value at a faster and steadier rate than properties in poorly selected areas. Look for development properties that have all the necessary infrastructure and services such as access to public transport, shopping, parks, schools, medical services, community centres and sporting facilities.
4. Develop properties that are suitable for both sale and rental
Even though your aim may be to sell your development, it is essential that when you are evaluating the feasibility of a development, make sure that you take into account what rental is achievable and the net return. Therefore, look for development properties in the right areas that will not only sell but also are easy to rent. When interest rates increase there will be fewer buyers around, but there will be more people looking for rental properties.
5. Set your minimum return on your developments
Always value your risk in a development. Work out your expected return when undertaking a project. Returns from a residential development differ to a return on a commercial building and are dependent on several variables.
When assessing a return, always take into account your return if the market falls. In residential developments, I personally aim at achieving a minimum of 15 to 20 per cent return on total development cost (TDC) after a project. This is, of course, dependent on the scale of the project, the duration of construction and the risks involved. If my set return is not achievable, then I would wait and look for a property that will fit into my profit/risk criteria.
6. Don’t purchase the first property you see
As mentioned earlier, the more you look for properties, the better you know the market and the better your judgment becomes. One should always feel comfortable after signing an offer. It would help if you did not think that you will be missing out or the boom in the property cycle will be over soon. Well-located properties purchased at the right price will always hold their value. Therefore, do your homework and take your time to find the right property that suits not only your pocket but also your development plans.
7. Do careful pre-purchase due diligence
Before you purchase a development site, it is vitally important that you undertake due diligence. It will allow you to find out everything about the property before payment is made. The process is where you and your team of advisers (if needed) undertake a comprehensive review of property such as zoning, site conditions, encumbrances s etc.
The vendor will want to cooperate in providing the due diligence material to provide the purchaser with information and help shield it from any future claims. If risks and liabilities have been adequately disclosed, the purchaser cannot make claims against the vendor in the future for not knowing.
8. Buy low, sell high
There is a saying in the development industry “you make your development profit when you buy the land. So aim to purchase a development site when the market has bottomed out. During this period, there is a lack of buyers, and motivated sellers will reduce their asking prices once they become more realistic about precisely what market values are. The time to sell your development is when the market is rising and moving toward its peak. Therefore, as explained earlier you will need to understand the property market cycle.
When you find the right development site that could be very profitable, act quickly as there could be other purchasers looking at the same property. Place a firm offer and don’t play games with the seller. Once the offer has been accepted start organising your finance, architectural plans and feasibility study. If development or planning approval is required to act quickly and submit plans early as this could be a long and drawn out process. Even if the plans are not 100 per cent correct, but the concept is workable, submit early as every month passes it will cost you money in interest or loss of profit.
9. Keep away from green fields
This does not mean that development in new sub-divisions is a bad investment; it merely means that new areas have some fundamental disadvantages that increase the risk of new developments. For example, if you are developing a few “Spec” homes, you run the risk of competing with project builders as they can build a new home for an interested party that can cost less than what you are asking for. In addition, rental demand in new areas is lower compared to established areas, as the latter has all the necessary support services and facilities such as shops, schools, transport etc. Besides, the people buying into these new areas are people building their dream homes and to suit their personal needs and taste.
10. Get a good team that you can trust
Property development is a complex subject. There are no short cuts and developers should seek the advice of a professional team that they can trust. To save money, some developers have not sought such professional guidance and have subsequently made bad decisions, which in turn have costed them more in the end.
Experienced developers know that it is impossible for them to do all things themselves and to ensure that their project is successful; they would employ the best professionals to get the best results. Your team is likely to to be made up of a property lawyer, accountant, finance broker, architect, real estate agent and a development/project manager to oversee the whole process.
11. Create plans for success
A successful property development will not happen unless there is careful planning and undertaking a thorough feasibility study. From the initial concept to the final stages of sale or leasing you should have a written plan in place. A feasibility study can be likened to a business plan. It will not only assist in reducing your risks but will be an aid to any finance you may require for a project. Some developers may claim that they rely on their intuition and therefore do not need an intensive investigation into their proposed development. While this approach may be acceptable in smaller residential projects, this method will result in failure on much larger commercial projects.
In addition to the feasibility study, analyse all the potential risks in your development and plan on how to mitigate these risk. Being thorough and confident of your plans you will be well placed in for any eventualities in your project. During the course of the development, there will be times when immediate or quick decisions will have to be made. These decisions will be correct if you have pre-planned your options. It is far better to be proactive rather than reactive.
12. Develop for the market and not for personal taste
Never let emotion get in the way of good business sense. Do not develop a property that suits your personal taste, but develop a product that will appeal to the broader market. Do not be swayed by architects or designers who want to create their own hallmark. I am not preaching that one should develop cheap and nasty buildings, but a good architect should be designing pleasing architectural buildings within the budgets set in the viability study. If an inspirational design has been created, one that would appeal to the market you should work on it until it complies with the construction budget.
13. Negotiate a superior financial package
By negotiating a superior financial package with your lender, it can undoubtedly improve the returns on a development. If the bank’s fees and charges to the service the development loan are lower, then there will be more money in your pocket. In evaluating the financial risk, the structure of the loan will play a vital role, especially if the development fails to perform as projected in the initial assessment.
In property development, there is always a possibility that something can go wrong such as an increase in interest rates, the property market plunges, your builder goes into liquidation, there is a delay in planning approval, there is budget blow-out, your builder does meet the contract deadlines, your purchaser fails to meet the settlement date etc. It is difficult to forecast these mishaps, and they could happen through no fault of yours. It is therefore wise to arrange your finance package that allows you to be flexible in your lending repayments if required.
14. Leverage your equity position
One way of improving profits in a development is to create “Free” equity and with much leverage as possible. Therefore, aim to place the minimum personal equity in a development. If a project can stand on its own, i.e. the return on the development will cover the interest charged on the amount of money borrowed, then the development has the credentials to be successful unless market forces change in the short term. In later a chapter there are several techniques explained on how to create this “Free” equity. By using the minimal amount of equity on the development, you are not risking your own personal funds, and this allows you to keep these additional funds for any eventuality that may occur during the development process.
15. Strive for quality in your developments
Don’t develop a property with a focus only on numbers. That is, do not develop to maximise the absolute highest profit. In my career, I have encountered developer clients that want to squeeze as many residential units on a property as possible without any consideration for quality. The extra unit or two they have squeezed do not sell which is where their profit is sitting.
Furthermore, the building industry is riddled with stories of bad workmanship and poor service. We often hear of developers selling inferior products. It is very easy to spend a great deal of money in marketing your development, but if you do not deliver the goods as promised, people will eventually catch on, and you may be losing more money in the long term. Like any other successful business, superior quality service is of utmost importance. This will enhance your reputation as a credible developer. Also, keep an eye on your builders and ensure that the quality of their work maintained at all times.
16. Control your budgets and costs
Cost overruns in property development can negate the assessed profit of a development. Be firm with your budgets and ensure that there is a profit to be made at the end of the project. Your feasibility study should determine how much to spend and where to spend it appropriately. If you make any construction variations and this always a possibility, be sure that these variations are within budget range and always get these changes in writing from your builder. There is nothing worse than finding out at the end of the project that your profit has been eroded by variations that have not been accounted for.
17. Sell or rent your development quickly
If you are developing with borrowed funds, it costs you money, and it hurts more if your buildings are completed and you are unable to sell or rent immediately. Selling off plan or pre-letting your buildings before you start building will lessen your risk, but this is easier said than done as a reasonable amount of money will have to be spent on marketing. In your feasibility, you should also make an allowance for a holding period (interest charges over a period while the building is unoccupied) or a vacancy factor so that if you rent or sell earlier, this would be a bonus.
18. Do not be insistent on price
If you are insistent about your asking price or rental, you may find yourself in a precarious situation several months down the track especially during a downturn in the industry. Unless you are developing without debt, this may not be a problem, but still, this may be money lost while the building remains empty. Empty buildings have a negative impression on the marketability of the development, as people will think that there is something wrong. Therefore, always look at any offer and do your sums as you any be losing twice the amount (interest plus loss of rent) of money by not accepting a lower but genuine offer.
The above rules are a useful guide not only for a novice developer but for a seasoned developer as well. Over time you will establish some of your own as you progress in your development career. Please read the guidelines several times to ensure that they are embedded in your memory.