In this issue we begin a 12-part series on property development. At the end of the series, you'll have a complete guide on how you can become a property developer.

PART 1
In this article we discuss:
What is property development?
The first step
Getting your finances in order
The property development team

Property development is usually the next stage for property investors wanting to grow their portfolios and increase wealth. But it's not always an easy step to take and there are pitfalls and traps for the inexperienced.

What is property development?
For the purposes of this series, we'll concentrate on small to medium development which is achievable for ordinary investors.

That is, we're not looking at the big end of town or major unit developments.

It could be something as simple as subdividing a block of land with an existing house on it and building another at the back. Or maybe the zoning allows for more than one additional dwelling on the block, such as two or three townhouses. An investor may have a development block on which to put a number of townhouses or villas, or it could be a small block of units which are renovated and put on separate titles.

Other options include buying a development site where the zoning allows for a number of dwellings or buying a block with an older house which can be demolished to make way for new dwellings to be built.

Either way, it's probably best to start with something small and relatively easy to cut your teeth on.

Property developer Michael Yardney of Metropole Property Investment Strategists  says it's best to start off small, as most mistakes are made in the first few developments.

"The simplest development is a renovation to add value to an existing property," he says. "And the next simplest is building another house on an existing block."

The first step
First you have to decide whether you're suited to property development.

Author and development manager Bob Andersen says it's important to determine whether property development suits your investment and risk profile.

He believes one of the biggest mistakes first-time developers can make is not seeking professional advice.

"I've seen them get into all sorts of trouble – the wrong site, the feasibility isn't done correctly or things are missing," he says.

Yardney says new property developers should understand the risks involved in property development. There's the development risk – will it be approved; the finance risk – will you be able to finance the holding costs for the term of the project; timing of the development – are you building in a rising market; and the market risk – will your project still be marketable in a year's time?

He says you have to figure out why you want to get involved in property development in the first place.

"People perceive property development as a way of making extra money," he says.

"There's a thought that people who get involved in property development make large profits, but they also take big risks. Some people go into it because they think it's exciting, but they're the ones who get themselves into all sorts of trouble because they're looking for excitement when they should be looking at it as an investment.

"But with property development, you can manufacture capital growth rather than waiting for your investment properties to go up in value with normal growth."

Yardney says the simplest way to get started in property development for ordinary investors is by doing a renovation. This gets them used to budgets, contracts, engaging consultants such as architects or building designers, town planners, building contracts, etc. And there's less risk than doing a larger development.

Property author Peter Cerexhe says people should never go into a property development under funded.

"Come up with a budget and double it," he says. "A fixed price contract is almost never a fixed price."

Andersen says property developers have two options – building new dwellings to sell for a cash profit or holding on to the new stock and putting it into their investment portfolio.

Then they have to decide whether they'll be a passive or an active developer.

"A passive developer would be somebody who engages someone else, such as a development manager, to do all the work for them," he says. "So they keep their day job and the development manager would carry the project right through. Technically they're the developer because they would acquire the land and finance it in their own name, but the development manager would do all the work. At the end the development manager delivers the finished product to the passive developer."

Andersen says using a development manager for first-time property developers can be part of the learning experience.

Active developers want to "get their hands dirty". They want to be involved in the whole process from start to finish. Andersen says active developers may do it full-time or part-time. Education about property development is an important component for the active developer.

"An active developer may engage an individual or a firm for advice when they're doing their first project," Andersen says.Active developments may use development managers as mentors for the development process.

Financial capacity or risk must be determined before getting involved in property development.

Andersen says you have to be able to afford to be a property developer. You can employ a financial strategist or finance broker.

"You need to find out what your financial capacity is in terms of buying," he says. "And then you can decide on what size project you can afford to do.

"The other thing is where your comfort level lies.

"It might be that they can afford to do a $2 million project but their comfort level might be to do a $1 million project first up."

Yardney says it's important to understand the financial risks, particularly for those getting started in property development. But equally important is getting the structure right whether you're building to sell or building to hold.

Andersen agrees, saying a lot of first-timers don't get the structure right.

"It depends on whether you're going to be an investor-developer and holding it or whether you're going to develop property and sell it," he says.

"Structure is important but it's even more important if you're going to hold it because of the tax implications.

"People get into strife all over the place from being badly structured or unstructured. And just not having the basic knowledge – they try to do too much themselves.

"Some people have experience and time, but not money, so they'll leverage off other people's money, such as joint ventures or raising capital from other people. Other people don't have experience or time but have the money, so they may join up with the person who has the experience and time to do a joint venture."

Yardney says the main advantage to becoming a property developer is that you're buying at the wholesale cost rather than at the retail level.

"So there's no builder's margin, no marketing costs, no development costs, no agent's commission – you've made all those," he says. "There's a profit potential – developers usually make a profit, although we don't advocate that people sell. And you get better rents. The tenant doesn't know that you've built your development at wholesale cost – they're still paying retail rents. The other benefit is good tax depreciation."

Educating yourself about property development is another essential component in taking your investing to the next stage. There are only a few books available in Australia (have a look in API's Business Mall at the back of the magazine). There are also a few property development courses, seminars and workshops throughout the year, or you could engage a mentor or advisor.

To continue on Page 2 of this article please click here

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Getting your finances in order
Financial feasibility of the project is vital if you are to succeed as a property developer.

Yardney says you may find a site but you have to do a feasibility study first to determine whether it's developable.
"Work out what sort of profit you want to make (if you're planning to sell)," he says.

"Most people work on 20 per cent profit margin, but that's not always achievable. Make sure your expectations are realistic.

"You have to check whether the site is able to be developed, what are the council requirements, what zoning is in place and what is the demographic of the neighbourhood."

When you find a site, Andersen says you have to do due diligence on it and financial feasibility analysis.

"That's what people want to know about – it's the numbers – the financial feasibility analysis," he says. "Things like purchasing a site, contracts, and conditions. A lot of these things you can leverage off other people's experience, such as solicitors, accountants or development managers. Or you could engage an architect who has fully managed development projects before."

Andersen says it's important to get development finance – which is different from ordinary finance – for an investment property.

"I recommend a beginner goes through a finance broker as opposed to dealing direct with financiers," he says. "You need a good finance broker who deals with development finance, who may not be the broker who deals with retail finance (such as buying an investment property). You need someone who understands the intricacies involved in financing development projects. That sort of person can help you determine what size project you can afford."

Cerexhe says you should build into your budget the finance to pay for all of the steps throughout the development so that you don't waste time.
"Time is money and you're usually financing 100 per cent of the land costs and 100 per cent of the building costs, so it's important not to have any delays," he says. "You have to build in some (financial) headroom because delays can cost thousands."

Financial feasibility and financing your project will be covered in-depth in future stories in this series.

The property development team
We've already mentioned the finance broker and the development manager, but who else do you need on your team?
Yardney and Andersen say it's important to have a good property accountant who can set up the right structure for your development project, no matter how big or small.

A property lawyer who understands the complexities of conveyancing, subdivision and on-selling is a must, says Yardney.

Andersen says the lawyer is the one who writes the legal part of the structure while the accountant deals with the taxation side of things. He says structures can cost between $1000 and $3000 but can save the property developer an "enormous amount later".

Someone could build four townhouses and hold on to them for a few years and then sell them for a profit of $300,000. If the right structure isn't in place, the developer could be up for tax on that amount rather than $150,000 under the capital gains tax discount of 50 per cent.

Cerexhe says engaging a town planner can be very beneficial for beginner property developers to steer them through the process.

"For the first-time property developer, if they're doing anything more than renovating a house, they should get a town planning consultant," he says. "They might not need one later on, but they should for the first one. The reason for this is because most town planning consultants work for the local council, so they know all the people involved and they know the direction that planning is heading in that local area. This is the type of thing that's not written down anywhere. They'll know if your project will fit in with the ambitions of the local councilors and can help you turn your project into something that the council actually wants to encourage."

Cerexhe says the fees for a town planning consultant are remarkably cheap for the layer of protection and expertise that you buy. Town planners can go into bat for you if there are objections to your project and they can attend council meetings on your behalf. He says it's wise to get them involved with your architect or building designer from the start.

A town planning report costs between $1500 and $3000, which Andersen says is money well spent, particularly if there's a likelihood of people objecting to the development.

For a simple land subdivision, Andersen says the basic consultants required are a surveyor, town planner and civil engineer to take care of the site works.

"But if it's more complicated, involving building works, such as three townhouses or putting two more dwellings behind an existing one, you'll still need the surveyor and town planner and the civil engineer, but you'll also need to employ an architect or building designer."

He says you'll have to decide between whether to use an architect or building designer. Building designers are usually less expensive. Some architects and building designers incorporate the development approval process as part of their services. He recommends not using a major CBD architectural firm for small projects, such as three townhouses, as you'd pay more for the services because of their high overheads.

Yardney says you should use an architect or building designer who is realistic and commercial and who specializes in development projects rather than one you would get to design your house.

Cerexhe says employing a surveyor at the start of a development project can also have benefits.
"If the block is on an unusually shaped block or it's undulating, the surveyor can look at the shape of the land to see what can fit on it," he says.

"It may be that the block is on a slope and the garages could be set into the side of the slope underneath. They come at it (the development) from a different angle. I know of instances where the surveyor and not the architect has been able to squeeze in an extra dwelling by looking at the shape of the land."

Yardney says depending on the complexity of the project you may need a civil and/or structural engineer, particularly if there are drainage and sewerage works. He says a recent addition to the development team is a landscape artist.
"Nowadays, many councils require landscape plans as well," he says.

Sometimes you also may need an arborist (tree specialist) because a lot of councils are fussy about their trees – some can stay but they won't allow others to be cut down.

Obviously you'll need a builder for construction of the development. You may engage one yourself or use a development manager to procure one for you. A real estate agent can assist at the beginning of the process to determine whether the project you're planning to do is what people want to buy, says Cerexhe.

Yardney agrees, although he says it's sometimes hard to find a good one who will give you a fair market opinion.

If it's a big project, you may need a marketing firm to promote and sell your development.

The team
Some of the experts you'll need to recruit to your property development team could include:
• finance broker
• property accountant
• property lawyer
• builder
• development manager
• surveyor
• town planner
• structural/civil engineer
• architect/building designer
• landscape artist
• arborist


Next time: how to find the right site for your development. Watch out for the next article in this 12 part series.

This article originally appeared in Australian Property Investor Magazine and is copyright. It has been published in Property Update with their permission. For a special subscription offer to A.P.I. for readers of Property Update please click here.

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