There are generally two types of property investors depends on their property investment strategies:
- Passive Property Investor
- Active Property Investor
If you are a passive property investor like 80% of the investors, then you will probably follow the more conservative approach of buying and holding properties and waiting for the value of your properties to increase over time.
The buy and hold approach is a proven way of creating wealth long term and there is nothing wrong with it, however if you are in the 20% of the property investment population, you might want to take the matter into your own hands and manufacture the growth yourself.
Small residential property development is one way of expediting the wealth creation process and by small, I mean building four or less dwellings on one title because anything above four is treated as commercial development, which is an entirely different topic.
I have always wanted to do a project ever since I started researching property investment and finally had a chance to take one on about 2 years ago.
Here is a quick look at the project.
Apologies for the quality of the video.
I purchased the block about 2 years ago and started building 3 units in June 2017 after going through the lengthy process of getting the planning and building permits from the council.
In this article, I will share with you 9 things I have learned so far and hopefully, they will be useful to you.
1. Understand the Why
Don’t do it because it looks fun, or it potentially generates instant growth.
Make sure you review your overall property investment plan and understand what your goals are.
Understand whether doing a project now will put you in a better financial position to continue to grow your portfolio.
Comparing to the standard buy and hold strategy, starting a project requires a lot of working capital and it could take anywhere from 1 to 3 years to finish if there is a major delay.
If you are just starting out, it’s better to build your foundation portfolio with a couple of residential properties that are medium priced and located in the metro area.
The reason for that is those type of properties are more likely to withstand any unforeseen changes in the economy.
Also, you will be able to tap into the growth in those properties fund your development in future.
For me, I had built my foundation portfolio before I purchased this block, however my borrowing capacity was hitting a bottleneck due to the overall debt I had accumulated over the years.
I had to do something to increase my income so the bank would continue to lend me for future purchases.
So the situation was pretty clear for me.
I needed to manufacture growth and cash flow by doing a small development.
2. Pick the Right Structure
By structure, I mean the structure under which you are purchasing the property/site.
You could buy a property under your own name or under a trust name.
Most people will just buy under their names for a normal property, however, with a development, the structure could be different depending on your plan for the project.
If you are planning to sell, you will be better off setting up a trust and purchasing the site under the trust.
There are a couple of tax benefits to you when you sell your units eventually.
The downside to that is the trust is a separate entity and all the gains and losses while building and holding the units will be contained in the trust, and therefore you wouldn’t be able to claim negative gearing.
That could be a showstopper for a PAYG person.
For me, I was still working full time as a PAYG employee at the time, so I needed the negative gearing benefit to offset the holding cost.
I chose to buy under my personal name, and I was fine with it because my plan is to keep all 3 units as rental properties.
This is not tax advice, it’s just a reminder for you to consider different options when deciding how to make your purchase.
Because once the transaction takes place, it’s going to be costly to change the structure.
So this brings us to the next point.
3. Have an Exit Plan
Just like how you should’ve formed a blueprint before you started investing in property.
Ask yourself the question – what’s going to happen to my portfolio in 20 years?
When do you want to stop investing, and what’s your desired outcome?
Are you selling some of your properties? or are you going to work as hard as you could to pay them all off and keep them as rentals? etc. etc.
Now, with your project, you need to have an exit plan as well. Are you selling them straight away?
Or are you going to keep them for now and sell in 3 – 5 years time?
Having the end goal in mind allows you to reverse engineer and work out what needs to be done now.
It also allows you to decide how you might want to build the project, whether they are going to be investment grade build or built with a higher level of finish to attract home buyers.
If you plan to sell, you might want to engage a selling agent to sell your units off the plan.
If you plan to keep the properties as rentals, you could also engage a property manager to start the campaign towards the end of the construction.
4. Do Your Due Dilligence
Before you even talk about the price for a site, you need to find out what could be done on this block of land.
Is it really a ‘gold mine’ or just a ‘lemon’?
The first question you need to ask is “What are the state and local planning policies & overlays that apply to the site?”
Each local council has its own planning policy and you are only allowed to develop the site as per the policy.
I would always start with the Victoria Planning Map website to check the zoning and overlay for the particular land I am interested in.
For example, recently one of my clients was looking at a block of land in Knox city and it has the following zoning and overlays:
- Design and Development Overlay – Schedule 2
- Significant Landscap Overlay – Schedule 3
- Neighbourhood Residential Zone (NRZ1) – Schedule 1
What do they mean?
First, let us check the council website for the specific polices around the zoning.
Section 4.0 in the zoning document mandates that ONLY ONE dwelling could be built on the lot within the NRZ1 zone.
In other words, regardless of the size of the block, you can only build ONE property on the title.
All of sudden, this site looks way less attractive despite of its huge size.
As always, I would contact the city council planning department to confirm whether I could build multiple units on this block and sub-divide it. Sometimes the agent do not even know what planning guidelines apply to the particular block he/she is selling, after all, it’s not their job.
As you would have probably realized by now, there is no point even talking about the price and cost until the legal aspect is confirmed.
Above is just a small part of the due diligence required before we even talk about the price. In addition to assisting my clients with the financing, I also guide them through every step of the buying and/or developing process.
Those requirements might significantly increase your build cost even though you get the block for a relatively low cost.
You could then cross check with the local city council website to find out what those requirements mean.
5. How much should you pay for a site?
Property investment is essentially a business and should be treated as such.
Taking on a project is like developing a product/service for your business to sell.
For a product, you would research the market to figure out what’s selling in the market and for how much.
Once you know the selling price for your end product, you would then subtract from it the costs such as labour cost, marketing cost, tax, your profit, and buffer etc. etc.
Finally, you would have the figure you want to pay for the material (site) The same principle applies to buying a site for development.
Start with your end product in mind, do your homework, figure out what’s selling in your selected area.
Make sure you use recent and comparable sales data.
By ‘recent’ and ‘comparable’, I mean:
- Recent: within the last three months, and
- Comparable: the same type of development, within the immediate vicinity (same street if possible.
You might have to broaden your search.
Just be aware that the further you go for comparable sales data, the less authoritative your data will be.
If you can not support your figures with hard data, it is an indicator that you may have difficulty obtaining finance.
Let’s say if you are looking to build 3 double story townhouses on the site, and they are selling for $500,000 each in your area.
Now, the end value of your finished project will be around $1.5M.
Let’s say the construction cost is around $700,000 for 3 such units, and the development cost is around $20,000 to get permits etc.
Now, you do the math, how much would you pay for the land?
That’s the simplified version, In real life, there is a lot more to consider in terms of cost before you could reach your budget, however you get the idea.
I have included a cost model and a demo video walking you through it.
6. Not Every Site is fit for Development
When it comes to choosing the site, the only thing mattered to me is the numbers.
Don’t be emotionally attached to those blue-ribbon suburban streets.
Remember you are in this to create capital gain and/or generate cash flow.
You are not buying your own home.
You need to consider the hard facts like site orientation, the width of the driveway, how the existing property on the block is built and what’s on the nature strip etc.
With a fee, a draftsman and a town planner can help you inspect the site, however you could also do some preliminary check yourself.
I have built a quick site selection checklist.
7. Approvals Take Time
There are two approvals required before you can start building.
You need the Planning permit and the Building permit from your local council.
The process could be lengthy as it could take up to 12 months to obtain both approvals.
One tip is to try to reach an agreement with the vendor to submit the planning application prior to the settlement.
That means you could potentially get your planning permit as soon as the site is settled!
I could’ve negotiated with the vendor, however, I didn’t and application process didn’t start until 2 months after the settlement.
Lesson learnt for me.
8. Explore Your Finance Options
There are a number of ways to fund a development depending on your circumstances.
One thing I would like to point out, without being technical, is that make sure you talk to a qualified mortgage broker about your options.
I applied for the construction loan from the same bank that funded my purchase of the block.
The result was less than ideal.
I would’ve had to fund 50% of the development cost had I gone through them.
I took the same application to another lender and the result was much better.
Different lenders value the development differently and look at your income sources with different views as well.
Don’t be discouraged if you are knocked by one bank and think it’s the end of the world.
Because you always have options.
9. Things can go wrong. Have some buffer
Like any projects, there are always variations.
My development is no exception.
Just when I thought I had done enough planning and covered all possible scenarios, I was still hit by unexpected delays.
Once the construction began, I was told the soil was too moist, so the builder had to pour more concrete in to make sure the foundation is solid.
That was $10,000 unexpected. Ouch!
Lucky they didn’t hit any rocks on the site, otherwise, I could be in a world of pain.
Make sure you have some buffer set aside for unexpected situations like this.
Conclusion
It’s an exciting and rewarding process to take on a development project.
Do your homework and treat it like a project that has a scope, implementation plan, back-out plan, deliverables and an exit plan.
Understand your why. Why you want to do a project, and why now.
Make sure you review your exit plan and make the purchase under the appropriate structure to maximise your gain.
Due diligence and feasibility analysis are two critical steps you can’t afford to miss.
Most importantly, treat your project as a business. Move on if the numbers do not stack up.