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Property Developing 101

For property developers during the halcyon days before the Global Financial Crisis it was easy to make money, everything they touched turned to gold . However post GFC it is a lot more harder to make money and you have to be extremely careful how you go about it . Developers building speculative houses, ”houses that you build, speculating that they will sell, as opposed to building specifically for a new home owner, ie a contract ” . These can be tricky to build as it is very dependent on market conditions, however there are some fundamental’s that I learnt that I will share with you . if you follow these guidelines you should be ok and not make the mistakes that others have made .

Step 1 , Know your market or area well, don’t build houses in areas you don’t know or what product is selling well, if you live in a certain area you are probably owning your own home or renting and you know the reasons why you live there, what you like about it, and also you will have a good feel of what properties are worth . So if you know the area where you want to build and you know the product that is selling you are now ready to take your first steps .

Step 2, Do not build anything until you have seen what has been built and how much it has sold for, this way if you have the information available you can actually back-cost the house that sold and see if any profit was made . One example that I came across a few years ago was a new subdivision that had cheap land for sale, it was cheap because it had power-lines running through it, it was tempting to buy because there was a 20 % discount on this land . Fortunately there had been some houses already built and I knew the sell price and simply back costed the last two houses that sold, to my surprise they actually made no profit . The power lines has stigmatised the area so much that it was a futile exercise .

Step 3, In my previous example I told you back cost the project and to do this you need to know these four fundamentals, the land cost, the build cost, the holding costs and finally the marketing and commission costs .

The land cost can easily be found out by using tools such as www.rpdata.com or my favorite website www.pricefinder.com.au  to see what land has actually sold for, don’t rely on the retail price of the land as sometimes the land has been discounted.

The build cost, unless you are a Builder yourself you wont know how much it cost to build, you will need to talk to local builders who build similar products, you will probably find that most local builders have standard plans and can easily give you a quote for something similar, the price will have to be a full turnkey price, “a full turnkey price is when you can move into the house and there are no extras you need to pay for “, it is quite a common for Builders to quote cheap prices that don’t include items such as carpet, water tanks, landscaping, driveways, fences etc . You must have the full price to make this exercise work .

Holding costs are such an important part of developing and this is where a lot of people have become unstuck, most people will have to borrow money on the land and the build for the house, for a standard house on a flat block of land allow for at least a years holding cost on the land and 6 months on the build of the house, ie you pay $240,000 on the land including stamp duty and borrow at 8 % your holding costs for the year are $19,200 for the land, the house build cost at say $200,000 at 8 % is $16,000.00, using a rough rule of thumb divide the interest costs for the house build by 2 as you progressively drawdown this amount and will not be hit straight away with the full amount . In total you will have $19,200 for the land and $8,000 for the house equalling $24,000.00  in interest costs.

Marketing and Commissions costs, these are another cost that must be factored in back costing, its a simple reality that you have to market your house to sell it, allow for at least $2000.00 for marketing and negotiate with your agent for the commission costs, on average 3-4 % of the sell price .

Step 4 , Is it viable ? If you are going to invest money in a development over a period of a year or two you need to factor in not only the costs involved but the opportunity costs as well, what is an opportunity cost ? basically ”what would be an alternative investment return if i invested somewhere else ? ”, if you are developing and the return is only 5 % but you can get 10 % in some other investment then obviously you wouldn’t go with the 5 % return .

Ok, we can now back cost our development and see if it is feasible, lets take a 4 bedroom house that has recently sold for $500,000 our back costing will look like this :

House sold for                           $500,000

Land cost                                   $240,000 – including stamp duty – varies between states

House build cost                        $200,000

Interest costs                             $  24,000

Marketing / commission             $ 18,000 

Total back cost                           $482,000

We can then see from this example we have made $18,000.00 profit, is this feasible / would you go ahead with this ? it would really depend on how much of your own initial capital you put in, the time factor to get that return and the level of risk, ie is the market going up or down and also what other return would I get if I invested elsewhere ? generally you would like to have at least a 5 – 10 % gross return, this exercise came in at 3.6 % so it would be somewhat marginal . Remember if it took longer to sell that profit could easily be wiped out by the interest costs alone. (GST has been omitted for clarity in this example )

Step 5 , You have now back costed your development, review it, does it look promising ? is it marginal ? if its marginal, revisit the project, how about building a 5 bedroom house ? what about offering a better product ? all of these options can be played with until you come to your conclusion .This is the basics of developing, it can be scaled up or down but if you look at the four fundamentals you can always see if it is a worthwhile proposal or not.

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