Finance Advocates Expertise featured on The API Magazine

5 questions to ask before taking on a development

Posted on Thursday, December 12 2013 at 10:00 AM

By Shannon Molloy

Considering leaping into the world of small development? While there are big profits to be made, there are also some serious pitfalls along the way. These are the five questions you should ask yourself before you take on a project.

The notion of building a few townhouses or units and walking away with a big profit isn’t as far-fetched as it might’ve seemed a few years ago.

But in the years following the GFC, when capital growth was much slower to materialise, savvy investors turned to development as a way of manufacturing their own big profits. And it has exploded in popularity since.

Small development could take the form of knocking down an old house to build three or four – or more – townhouses. It could be a matter of splitting a block to build a few villas at the back. Or, in some cases, it might look like a unit block of 10 or so dwellings.

Whatever the project, there are numerous things to consider before rushing in with little more than a hardhat for projection. Here are the five questions any would-be developer should ask themselves before getting started.

1. Do I have the time and expertise?

One of the biggest mistakes a rookie small developer can make is to assume they can sign a building contract, wander off to do their own thing and secure a return when they come back.

That’s more of a common occurrence than you might imagine, according to Renato Sturma, a senior associate with Finance Advocates Australia. He regularly handles the finance arrangements of small developers and has seen some newbies struggle with the time commitment that projects can require.

“If you’re time poor or not comfortable with coordinating every facet of a development, a project manager is worth their cost. There are plenty of them around and it’s worth looking into.”

In the early stages of a project, Sturma says he’d visit a site at least once a month. As work ramps up, the visits would become more frequent.

“You need to keep on top of your builder and make sure work is progressing well.”

There are decisions that’ll need to be made along the way. If they’re beyond your scope of knowledge or you’re not available to make them, the job can become delayed.

“Delays start to cost you money. There’s a lot to juggle and it can become overwhelming, particularly if you’ve got a full-time job elsewhere.”

2. Am I building to sell or will I hold?

So, you’ve decided to take on a small development and you’re making steps to get it off the ground – no pun. Have you paused to ask yourself what you’ll do when it’s all said and done?

“Deciding whether you sell, hold or do a mix of both should be something you do long before you begin a project,” Sturma says.

“You don’t want to make that decision halfway through construction because the implications can be complex and costly.”

The majority of developers sell the end product to realise the profit, he says. Some might hang on to one for a period of time. In rare occasions, a developer might keep all of the dwellings when built.

“It depends on your scenario and goals,” he says. “Your construction lender will expect their money back at the end of the build. If you’re not selling, you have to organise your take-out finance.”

There are a number of tricky tax considerations too. If you’re building in the backyard of your principal place of residence, there could be some capital gains tax discounts available when you sell the original dwelling. If it’s a site you’ve bought specifically to develop and you’re selling the end product, that effectively makes your operation a business. You’ll have to pay GST as a result.

“Many new developers don’t appreciate the GST and taxation components. You need to get your head around that.”

For more information on the tax consequences of developing, check out Julia Hartman’s comprehensive column in the August issue of API.

3. What do I know about the builder?

Developer and builder Johnny Leary of Portfolio Builders thinks the decision about who’ll bring your project to life is one of the most critical. You’ll want an experienced, quality, properly qualified and switched on builder who’s easy to work with, professional and able to stick to both a budget and a schedule.

But how do you go about finding a potential builder and then checking them out?

“The first thing I’d do is look at what’s being developed in the area, find a product you like and go have a chat with the builder,” Leary says.

“Look at their previous jobs to see what the quality of their work is like. Ask for a ballpark cost per square metre – what a similar project to yours would roughly cost. It’s an estimate and will give you an idea of whether it’s in your expected range before you bother getting a thorough, formal quote.”

Query the builder’s timeframes and ask for details of their other jobs and how far they are from completion. You’ll want someone who can fit in with your schedule and not be juggling too much.

Leary says it’s worth asking to speak to some former clients. If you’re not comfortable requesting this, bypass the middleman and go straight to the customers.

“Go and knock on the door of someone you know has recently been a client and ask about their experience, the level of customer service and what the builder was like to work with.”

Sturma says he’s come across four cases in the past 18 months where a developer has hit serous issues due to picking a bad builder.

“Construction has stopped, the builder has gone broke, for one the quality of work was poor… that’s why it’s crucial to pick a good builder.

“A good builder should be proud of their past work and happy for people to sing their praises.”

Your final decision should be about far more than cost, Leary says. In some cases, it can be worth paying a bit more for a builder who’s going to be better to work with than the guy offering the cheapest quote, he says.

4. What are the site’s basic attributes?

Before you get too excited about a potential development site you’ve found, you should know a long list of intimate details about it. That’s the view of Cam McLellan, successful developer and founder of Open Corporation.

“When you go to see a site, you should know the council regulations first,” he explains. “Say you’ve got to have a five-metre setback, three metres on the driveway if you’re keeping the existing house and building units… whatever the case is, take a tape measure along.”

With knowledge of the council’s requirements, you’ll be able to draw a basic mud map of the site. Mark out the boundary, where the current dwelling sits, any major trees and the like.

“You’ll be able to see in black and white the amount of development potential of a specific piece of land. From there, you can start planning what could go on the site.”

Maximising the number of dwellings you can get on a block will improve your return, McLellan says. If you’re unsure how to do this, a draftsman can help.
You should examine the typography of a site too and seek expert advice when in doubt. What looks flat to you might not be so flat in reality.

“To the naked eye, looking out across a site, a 1.5-metre fall mightn’t look like much but it can cost a lot to correct. Something like that might add another $10,000 or more to your costs.”

Check for the existence of any easements also. Most properties have an easement of some sort, typically along the back of the block where services run. On occasion, you’ll find them going down the side. In rare and frustrating cases, it could run straight through the middle of the block.

“An easement is an area you can’t really build over. Some councils will let you construct something on it, but they’ll make you sign something saying if they ever need access to it, you’ll tear down whatever is there.”

5. Have I done the numbers?

Being across the numbers on a development project is about more than accurately forecasting the sale prices you’re likely to achieve. Although, Leary suggests that’s where you should start when seeing if a potential development stacks up.

“I always start at the end and work my way back. Be very realistic with your end numbers – the sale revenue or what it’ll be worth when you’re done. I’d never speculate on that, but base it on a sound and reasonable assessment.”

With the income sorted, it’s time to very carefully plot the outgoings. That includes the thoroughly itemised build amount, a contingency, tax and holding costs.

“I’d whack on a contingency of about 10 to 15 per cent to allow for cost blowouts and other things. On profit, most people preach the old 20 per cent profit margin rule. Because I’m the builder and the developer, I work on 15 per cent for the build and another 15 per cent for the project itself. That’s my golden rule.”

For small developers, especially given the project timeframe is usually between 12 months to 18 months, it’s important to be conservative. A safe approach is to underestimate income, overestimate costs and base your numbers on a thorough examination of every possible variable.

“Keep in mind things like council open space contributions,” McLellan says. “Earth works are another commonly overlooked or unanticipated expense. But the big one I think is time – people don’t appreciate how long it’ll take, the holding costs, interest and their own personal time spent on it.”

On the flip side, there could be cost savings to be had that limit your outgoings and increase your profit at the end of the job, he says.

“You don’t always need an architect on these types of projects. You don’t really need to go out and design up a unique project that’s over and above what’s required for the area. Get a draftsman who’ll charge you $2000 for the design and engineering works, compared to an architect who’ll come in at $15,000.”

A note on risk

Like any aspect of property investment, your suitability for small developments has a lot to do with your risk profile. It’s such an important consideration that a good sixth question you should ask before taking on a development is, “What’s my appetite for risk?”

Dianne Crichton is a market adviser with Your Property Search and says a higher return is generally associated with a higher risk. The smaller the potential risks, the lower the returns – typically.

Given small developments offer big potential profits, there are endless pitfalls to be aware of.

“If you’re looking for low risk investments, you’d be deemed to be a cautious investor,” she says. “Alternatively, if you’re looking for high-risk investments you’d be deemed aggressive in your approach. A medium risk profile would then deem you to be assertive.”

How do you determine your risk profile? It starts with assessing your position, your goals and how comfortable you are with upping the ante on your investment strategy. Here are some important considerations to help formulate an idea of your risk profile:

How much capital do you have to invest?
How much time do you have to devote to a project?
How secure is your employment?
Do you have a family to support?
Do you have lots of financial commitments or liabilities?
Could you cop a one to two per cent increase in interest rates over the life of your project?
What would happen if property prices slumped before completion and you had to face a lower return?
How highly leveraged would you be on the deal?
What if the project is delayed by three months? What if it runs behind by six months?

This online calculator provides a good summary of your most likely risk profile and the sorts of considerations that come with it.

The 7 sins of property investing

Posted on Thursday, December 12 2013 at 10:00 AM

By Heidi Davoren

We talk to seven experts about what they believe are the crucial mistakes when it comes to property investing.

We talk to seven experts about what they believe are the crucial mistakes when it comes to property investing.

A lot can go wrong when buying a property and the process isn’t always straightforward. To assist with making your purchase a little easier we asked seven experts including a mortgage broker, real estate agent and property lawyer what they believed were some of the biggest mistakes made by investors when buying real estate.

Mortgage broker

Investing in property is an exciting and potentially life-changing decision, Mortgage Choice spokesperson Jessica Darnbrough says.

“Assuming the right choices are made from the beginning, property investment could put you in a better financial position in the long run.

“One mistake buyers often make when purchasing property is becoming too emotionally involved and paying more for the property than it’s worth.

“Those buyers with a small deposit of five per cent to 10 per cent who will require mortgage insurance may run into difficulties having finance approved if they’ve paid over market value for a property.

“If a valuation comes in under what a buyer has paid, they’ll be left to come up with the remaining funds which can be particularly difficult with a small deposit and high loan-to-value ratio,” she says.

“When investing in property the key is to think with your head and not your heart. If property buyers ensure they only look at properties within their price range and stick to their investment strategy they should be on the right track to successful property investment.”

Economist/Accountant

Economist with Reality Economics Liam O’Hara says investors shouldn’t try to reinvent the wheel when buying property.

“When thinking about investing in property people generally have the attitude that they need a lot of money to start with, that it’s difficult or that they need a university degree,” he says.

“Additionally, they listen to negative people as there are always stories about the person who got caught out in some property scheme and lost all their money. Therefore they allow fear to stop them from even investigating their options in the first place.”

O’Hara offered the following advice to first time investors:

• Often investors don’t know their tenant. Investing starts with the tenant. In other words, buy a tenant first, and then pay for the property.

• Investors also don’t claim all deductions under the law, so an accountant that really works for you is important, otherwise make sure you do your own research.

• Think about what can go wrong and insure against those unexpected events.

• Hold on to the property through tough times, don’t panic and sell too quickly. Remember it isn’t a get-rich-quick scheme, slow and steady wins the race.

Renato Sturma is a development finance specialist with All Financial Solutions and says as a financial expert he sees too many investors fail to consult their accountant about the best name to purchase their properties in.

“Always check with your accountant first as to the best structure and what name or entity your investment and loan should go in. Should you buy it in your personal name, company name or trust?

“Too often investors purchase a property before speaking to their accountant, then do their finance application only to find out later they’ve either put it into the wrong entity or another entity that would have served them better taxation wise,” Sturma says.

“At that point it’s probably too late to change it without additional, and sometimes expensive, costs to restructure the loan and the documents how it was meant to be, not to mention the lost time.”

Real estate agent

Jason Abbott, principal of PRDnationwide Coolangatta, says one of the biggest mistakes made by buyers is failing to do enough homework and research on the area they’re looking at investing in.

“They have exaggerated expectations on the returns they’ll make and often don’t have a clear understanding of the type of property they should be investing in to suit their budget,” he says.

Abbott reiterates Darnbrough’s sentiments that these mistakes are often a result of investors making emotional decisions rather than ones based on facts and figures.

“Being clear as to the type of investment – lifestyle enhancement, purely financial or a mixture of both is important.”

Abbott also believes investors make a mistake by not discussing the best financial strategy for their specific needs.

“Is a positively geared property or negatively geared property best for their financial position?

“Investors need to make sure they find out all of the expenses associated with the property such as council rates, body corporate fees (if strata titled), is land tax applicable, what will they need to allow for general maintenance each year etc.? What income can be generated from the property, what is the occupancy rate like for this sort of property and are there many vacancies of similar properties in the area?”

Insurance

A spokesperson for the Insurance Council of Australia (ICA) says research commissioned by the ICA showed more than 80 per cent of Australians were risking their homes and other valuable assets by not having enough insurance.

Property investors and landlords should consider how to protect their premises, its assets and the income they receive from their tenants, according to the ICA.

“They need to look specifically at the property they’re purchasing to determine what insurance policies they’ll need to protect their asset. For example, standalone properties will require home building insurance whereas strata properties won’t,” the spokesperson says.

The ACI says other points property investors and landlords should consider when looking at insurance are:

• Insurers may treat professionally managed properties differently than self-managed properties.

• Holiday properties may require a short-stay landlord policy.

• You can reduce your premium by taking out a higher excess.

• Check your policy to see if it covers contents inside the property that you allow your tenants to use.

• Strata insurance won’t cover you for the risks associated with leasing your unit or apartment.

• Think about using an insurance broker who can help find a policy that’s most appropriate to your needs.

Architect

According to Archicentre general manager Cameron Frazer, there are a number of mistakes investors make when buying property.

Archicentre conducts pre-purchase property inspections and many of these are requested by people who have purchased properties and after moving in discover major faults, many of which are related to illegal building, Frazer says.

"Archicentre Accredited Architects conducting pre-purchase property inspections have found a range of situations from illegal building to a lack of maintenance,” he says.

One of the major problems for homebuyers is that many illegal building activities have been covered up or are in inaccessible areas such as under the floor or in roof cavities, which require an expert inspection to detect any problems, he says.

"However, all homebuyers should check the paperwork and permits of recent building additions or balcony and deck constructions before purchasing a home. Where new wiring and plumbing has taken place on a property, certification by qualified tradespersons should be available," he warns.

According to Frazer, some of the common illegal building signs uncovered by Archicentre Architects during pre-purchase property inspections include:

• The removal of interior load bearing walls during renovations causing sagging roofs and ceilings.

• Illegal plumbing connections and drainage causing damp and health hazards under the floor.

• Illegal wiring where the homeowner has added additional power points, extra wiring or light fittings.

• The addition of rooms in roof spaces without permits or appropriate support structures in the roof.

• Damp areas in the house through lack of ventilation.

• Tacked on additions which don’t look like part of the original home.

• Dug out areas under buildings with illegal wiring.

• Elevated timber decks and balconies which shake when walked upon.

• Damaged roofs (cracked tiles or old corrugated roofing).

• Damaged or broken guttering.

• Timber deteriorating or rotting due to lack of suitable care (painting/oiling).

• Water leaks.

• Structural deterioration in exposed areas such as decks, verandahs and pergolas.

Frazer says the harsh reality of the impact of illegal building for sellers is when they go to sell their homes and prospective buyers request the appropriate paperwork including building permits and documentation from licensed plumbers and electricians certifying work that has been carried out.

"The bottom line is that if the documentation can’t be produced then it becomes highly likely that buyers won’t want to inherit the legal or safety risk."

Valuer

Propell National Valuers state manager (Victoria, South Australia and Tasmania) Matthew Singleton says the biggest mistakes investors make when purchasing property is not doing enough research, buying with emotion and not seeking professional advice.

“Common mistakes include looking in a specific area, getting conditioned to pricing and market conditions then purchasing in an adjoining inferior location that’s assumed to be similar,” Singleton says.

“The investor should know the location and the asset drivers inside out. That is, know the level of demand – how many people are attending and bidding at auctions, clearance rates in the area and how long private treaty sales are taking to transact.

“Know the preferred location for infrastructure and facilities such as schools, transport, shopping, parks, CBD, beaches. Look at price trends in the area. Have values been falling, increasing, what are the drivers of this? What are the vacancy rates of locality?

“The more research and information known about the property and location will enable a more informed investment decision that will reduce risk and ensure that above market value prices aren’t paid.

“It’s all about return on investment so yield, capital growth and demand should be the key drivers of the investment purchase making sure the personal preferences of the investor don’t cloud the decision.

“Many mistakes can be overcome by engaging independent professional advice from a valuation specialist to assist with an investment purchase.”

Conveyancing solicitor

Solicitor and property law expert Tim O’Dwyer says investors usually make mistakes buying property when they’re pressured by an agent or are rushing to make a decision.

“In my experience it’s when an often over-keen and agent-pressured investor rushes in and signs a legally binding agreement without first obtaining sound, independent legal and taxation advice,” O’Dwyer says.

“A perennially critical issue, in my view, for both the property investor's solicitor and accountant is to determine (preferably collaboratively) with their client the person/s or legal entity to be the most legally-advisable and taxation-relevant purchaser of the proposed investment property.

“Before you sign anything you must ask the question – ‘who will be my buyer?’ Your solicitor and accountant will help you work out the best answer.

“Get it right, or it may come back and bite. Get it wrong and, at the very least, you may find yourself liable for double stamp duty.”

Profitable Small developments

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