This article was first published in Australian Property Investor magazine and is copyright and reproduced with their permission.

While some may still be pining for those good old boom days, others have come to terms with the fact that a fairly flat property market lies ahead, for a while at least.
These astute investors are starting a new trend for the new times and, as Matthew Page, valuer with Knight Frank Tasmania succinctly puts it; "It's all about value adding now."

The right time to subdivide
So do you rest on your laurels and await the next value rebound, relying on the nature of cyclical trends and the fact that they will predictably take us back to more lucrative, asset appreciating times?

Rod McShane, founder and director of Australian Private Realty contends that this run-of-the-mill investment method has had its day and the future of wealth creation lies in expansion and development.

"With greater interest and media focus on real estate, recent years have seen an increase in demand to get into the market. This demand has had some positive influence on the market place, which has now flattened out in many regions. Rather than purchasing more to increase a property portfolio, the average investor might well look into their existing real estate to see if there may be opportunities to subdivide."

All around the country, State Governments have been developing blueprints for future urban direction within their capital cities, suburbs and country towns. These are based on population projections which not only show general growth within the country over time, but also a vast increase in aged and single person household demographic clusters.

Harley Dale, senior research analyst with the Housing Industry Association predicts this is going to be an increasingly obvious trend and hence feels property development is, "a topical thing to be looking at, in the sense that you would expect subdivisions are going to become more prevalent in the future and it's an aspect of housing that's going to increase over time."

Dale says; "The two primary reasons for that are what's going on with growth boundaries in cities and density requirements for housing. Sydney's the best example of that, where you have significant land constraints, which in turn will channel more people down the route of subdividing in terms of property investment."

Secondly, Dale says, "We're probably going to see this as a more viable investment option, simply because there's been a massive increase in the price of land in recent times. This has been particularly occurring on the fringes of capital cities. This trend could direct people's thinking more towards subdivision of an existing part of a portfolio they already own, rather than looking to develop a new block."

Dale also points out that currently, "Housing markets are pretty tight and rental markets are quite firm. Hence, you have a situation where underlying demand for housing is strong, but you're facing certain constraints such as land supply and the inflated price of land.

"People looking to invest in property are going to see an incentive there to supply the market, but within constraints that might promote more subdividing than we've seen in previous cycles."

What is subdivision?
Subdivision necessitates active involvement from the investor, unlike passive ventures where you purchase a property and rely on long-term capital gains. It's an endeavour that requires hard work and should not be entered into lightly.

Subdivision can involve purchasing a raw parcel of land to create a small to large housing estate or building on an existing property with a second dwelling, such as duplex or dual occupancy sites.

It can also encompass purchasing an existing apartment block to separate or strata the title, so that instead of one product, you have the bonus of selling single units within the complex.

Subdivision may involve creating an entire new block of townhouses or units for the medium-density market on an acreage allotment in an area where a council encourages this activity.

Property investor and author Steve McKnight describes a recent deal he was involved in to illustrate how rewarding and simple subdivision can be; "We bought eight previously strata-titled dwellings as an entire package deal and we're just going to sell them off individually.

"We haven't had to do any of the development work, it's all been done for us. But we had the advantage to buy wholesale in terms of purchasing all eight units and then selling retail, by selling them off one at a time."

Peter Comben walks us through an alternative scenario.

"Another option is to develop commercial land with something like storage units, which are very cheap to construct and provide good cash-flow returns. Most commercial developments, if you retain the property, will provide at least a thirty plus per cent return."

Building a successful subdivision portfolio
Many experts believe that you can combine subdivision and being an active participant in literally building your property portfolio, with passive investment. So where do you start with this approach to wealth creation?

McShane suggests, "The most viable subdivision for the average investor to start with would be a small one. The smaller the subdivision, generally the less risk. A house on a large block suitable for two dwellings may be the ideal first time subdivision.

"Consideration then has to be given as to whether you're building a second dwelling to keep the property long term or to sell it off and place the money back into debt reduction of an existing mortgage."

Setting up a scenario whereby developing a property can create positive cash flow that will assist in reducing debt on any existing loans and even purchasing further property to retain in your portfolio, is highly recommended by those who know best.

Martin Ayles, an Adelaide local, discovered property development initially by accident. He had been buying and renovating property as investments for a number of years, before an opportunity arose for him to subdivide an allotment with an existing house.

After his initial project paid off, he realised the potential he'd been missing out on and has been hooked ever since.

Ayles advises first timers try, "Smaller residential subdivisions. Perhaps starting out with a duplex or an allotment where you can split one into two."

He adds, "Subdivision is an extremely powerful method of dividing to multiply your profits, however if you sell everything – money's easily spent. I recommend a ratio of about five to one, so for every five that you build, retain a minimum of one.

"I'd also suggest trying to get the properties generating cash flow rather than having them negatively geared. For instance, if you build five properties, let's say you sell four and keep one, then you would pay all your profits into that last one to reduce your debt down so that the weekly rent could more than cover the mortgage."

Ayles believes using your smarts with potential profits will determine your long-term ability to cash in on this method of property investment.

He reiterates, "The critical part is what you do with the money that you make from the development because it's one off and not passive, so you've got to then take that money and reinvest it into something that's going to create a passive income for you, be it a retained property, shares, paying off some of your portfolio to reduce debt, etc."

McKnight agrees with Ayles contention that creating and generating positive cash flow through property development is a favorable approach over managing a negatively-geared portfolio.

"Develop and sell some to bank the profit, pay off debt and hold a large number of positive cash flow properties in your portfolio. Over say, a 10-year period, you might end up with 10 or 15 positive cash flow houses which could provide a significant income."

The process to maximise profits
It's crucial that anyone considering tackling property development, whether on a large or small scale, has done their homework, mapped out the process from start to finish and accounted for any contingencies.

Comben recommends, "Have good due diligence methods to prove that what you're proposing is going to work. If it's a subdivision, it's all about coming up with the right concept, meaning you have to work out something that fits with the planning codes and applies to the land. You also have to make sure that you're actually going to make a profit."

Tim Kelly of Rigby Cooke Lawyers says, "The first thing an investor should do is have a look at the title and talk to a lawyer and at this stage, don't sign anything until they've spoken to a surveyor. They're the ones who'll prepare the plans and perhaps let them know whether they think they'll get the surveyed plans through. So find an experienced and local surveyor, who knows the area, council, etc – he or she can be of invaluable assistance to the investor at the beginning."

McShane is on a similar track when it comes to beginning any development journey. "Contracting a builder and or solicitor with experience in subdividing is a huge advantage to step you through the initial stages."

He continues, "The first step is finding out whether subdividing is feasible. In most cases the local council concerned can provide you with the information that you need. They can advise you of special conditions required to be in place, issues such as zoning and in the case of building a dwelling to subdivide off, they can advise of plot ratios, including minimum space requirement for each dwelling."

Once you have this information then you'll need to establish cost estimates so that you can calculate possible risks and rewards.

McShane says, "If you're subdividing off land, the council may be a good place to ask for help. Most councils have guideline procedures in place for subdividing so they can be a great source of information for the first timer. They're also not commercially driven, so they're more unbiased and will just give you the procedures and costs."

Queensland developer John Dudley has had great success with raw land subdivision and housing estate construction. He believes that the secret to success is teamwork.

"With the assistance of a professional team, anybody can subdivide. The key person to lead the team is usually a surveyor, who will probably be able to recommend a good engineer and town planner.

"If he recommends them, it's likely they will have worked well together in the past and you could also inspect some finished jobs. The surveyor's probably capable of coordinating the project if the developer is reasonably inexperienced. The other three necessities are a competent solicitor, a source of finance later in the process and an effective marketing team with extensive house/land package experience. The ability to sell the end product in varying market conditions is paramount."

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Redevelopment risks
Like every type of investment, especially within the residential property market, there are a number of risks involved in property development that you should do your best to be aware of and minimise.

According to Hopkins, "The main risks involved in property subdivision are a lack of knowledge, contacts, expertise and intuition."

Ayles says, of all the property development sins that, "Greed is the biggest mistake developers make by far."

He adds, "Underestimating your holding costs, build times and weather, paying too much to purchase a project and over-estimating the potential sale price upon completion of the project can all be detrimental."

Time is usually the resource that can have a major impact on the success or failure of a project. If holding times blow out from initial estimates, you can be left with a hefty excess interest bill, among other things.

There are risks of certain delays that will be out of your control altogether, such as time taken for council processes and applications. And of course, the major concern with the approval process is having your application denied altogether. 

Comben suggests, "To manage this risk, make sure you do your due diligence thoroughly before going into the project. I encourage people to seek the advice of a professional who knows the planning provisions of that locality inside out. You can't be entirely certain you'll get the approval you want, but provided you've secured the site with an option, you can always choose not to exercise that option and walk away from the project."

Comben also warns against undertaking a project that succeeds on all counts during actual construction, but can be a major flop when it comes to converting to sale at completion.

"You don't want to build what the market doesn't want. Oversupply can be the biggest killer and eat up a significant chunk of profit. Studying demographics, knowing what other developments are happening in the area and talking to local real estate agents to get a feel for what buyers are seeking can prevent this."

McKnight points out, "What people fail to understand is that profit made from developing is taxed, there are GST issues and there's always the risk that you'll develop a property and won't be able to sell it, that's why it's important that you stagger your developments, so you don't have them all for sale at the one time."

Possibility and potential
In terms of where to undertake a subdivision, there are a number of considerations to take into account to ensure you maximise your potential for a positive and profitable outcome.

McShane notes, "The majority of subdivision work for splitting land off existing titles and building separate dwellings has been carried out around the inner suburbs. Demand for low-maintenance, inner-city living has always been high and this location has commanded higher prices than the suburbs for this style of property.

"Demand will dictate return, so if you own property in the inner suburbs that can be subdivided, you should seriously consider it."

Comben believes however that these high demand areas may not be the most suited for subdivision, due to excessive competition in these markets.

"Its probably better to go for a product that hasn't yet been identified as having subdivision potential, because you'll have a better chance of making a profit. If it's land subdivision, consider growth corridors, generally in outer suburbs.

"Look for larger parcels of land where council planning codes will allow multiple dwellings. Many councils are changing their policies because they're being encouraged to by State Governments, so therefore you need to do a bit of research and find out where codes have been changed to increase density."

Ayles, who has had success in various areas of Adelaide, especially those inner-ring suburbs where demand for housing is high, yet supply is constrained by natural impediments, imparts these words of wisdom: "I would recommend one of two things; either the inner suburbs, say within a 10 to12 km radius of the CBD or outer, perhaps lower socio-economic areas, for instance in Sydney it might be Penrith, in Adelaide it might be Elizabeth.

"In these outer suburbs, there's plenty of opportunity, larger allotments and councils are generally encouraging towards forced development. Also, in this tighter market, low-cost housing is actually becoming easier to sell and therefore you could look at creating a micro or niche market for first homebuyers and the like."

Many State Governments, as mentioned, are facilitating development opportunities in green belt areas that have been designated as corridors of future urban growth.

John Dudley, developer and company director, points out such an area, located in the State where he has experienced success – Queensland.

He says, "Massive growth predictions by the Queensland Government, underpinned by strong interstate migration and significant jobs growth make southeastern Queensland and its western corridor one of the best and safest locations to develop land in Australia. This is where we operate in an increasingly competitive market."

Is subdivision for you?
Subdividing for profit is not an activity for the faint-hearted, the impatient investor seeking easy capital gains, or the passive investor who'd prefer not to get their hands dirty and have to do a lot of research.

McKnight believes this active investment strategy best suits the investor with "a bit of time on their hands." He says, "If you're time pressured you might find developing frustrating, because not only do you have to orchestrate and coordinate council, for your first few deals at least you're going to have to orchestrate and coordinate tradespeople. Getting the right trade at the right time certainly is a skill and an art."

John Hopkins of the John Hopkins Group believes that property development requires the commitment of undertaking the equivalent research of a full-time, three-year university degree.

"If you really want to be a successful property developer, you need to know the law of property, town planning and town planning issues as they relate to particular municipalities, you need to know town planners within that municipality, you need to be able to understand construction and in particular architecture, you need a solid understanding of finance and how to go about either selling or renting property, which necessitates knowing property professionals, for example valuers and estate agents.

"So when you pull all of those things together it can take some people a long time to establish themselves as developers."

Hopkins asserts, "If someone wants to be a subdivider, renovator or developer they need to conduct an in-depth feasibility study over approximately three years on a varying range of property development, subdivision, renovating, trading and speculating opportunities.During this period they should not purchase property, because if you have the discipline to do 36 months of serious and detailed feasibility studies and not purchase a property, in my view you stand a chance of being a successful property developer."

Tenacity is perhaps the most vital attribute anyone wanting to develop a property should possess. Comben points out, "An important quality is the ability to remain highly motivated. It's one thing to say I want to be a developer and create profits, positive cash flow, or capital growth investment properties, but it's another thing to remain motivated once a deal falls through or you have trouble with a planning application or construction of a project."

Finance matters
McShane advocates, "Always calculate what you feel may be an average result as well as worst-case scenario. As an example if you're looking at selling off one of the dwellings that you build, what if it took 12 months to sell? What would the extra holding costs be on the finance and how might this affect your potential profit as well as your cash flow?"

McKnight poses much the same contention: "You need to quantify the likely cash flow outcome in the worst possible situation, which for a developer would be sitting on an asset and renting it out. Therefore, before doing the development I would crunch some numbers to determine what my cash flow outcome would be in this scenario."

Most will estimate that you need around $20,000 to $30,000 behind you to enter into a development in the first place.

McKnight explains, "When push comes to shove and you need something to happen, you need access to cash and if you don't have that, you might find all your budgets for time and money are blown out."

When it comes to actually seeking the financial backing to complete your project, Dudley suggests, "It's always wise to apply to two different financiers as you're approaching settlement and have to be able to complete. Start the financing process about 90 days out from settlement so you have plenty of time to maneuver and look for alternatives if things don't go right.

"Different financiers will use different valuers and although the financier may be willing to lend it will all come down to the valuation, which can vary considerably. No supportive valuation means no finance. In the event that finance is not forthcoming you'll need to look for a private investor or as a last resort, possibly a joint-venture partner."

Many developers will use the technique of pre-selling, or selling off the plan, to furnish the completion of a subdivision project and minimise borrowings.

Ayles points out that unavoidable and unplanned delays in the timing of a project from start to completion can also make a dent in your cash flow and budget projections.

He says, "You need to account for challenges along the way, such as with council approval or finance applications. They can bump your holding costs up by another 12 to 18 months, which can mean somewhere in the vicinity of $35,000 in interest, coming straight off your profit."

Comben warns, "Your ability to source finance for a development will depend on the profitability of the project rather than your ability to service the loan. If banks won't lend money for a development project, chances are it's not a good project."

The virtues of value adding
Gone, at least for the moment, are the boom times, where simply buying, holding and maybe adding a touch of paint would ensure investors reaped the rewards of residential real estate. Now it's definitely about taking an active role.

Page observes, "It comes down to investors looking for opportunities where they can value add. In other words, can they find themselves a property that can be developed, because there's still pretty strong demand for investors to build due to low rental vacancy rates. As long as we're underpinned by that continual strength I think there's still going to be opportunities.

"However, if people are going to be passive about their investment, they're not going to get the spectacular type of growth that was occurring before without much effort."

Hopkins believes that, "The two benefits to subdividing for profit are one; that like any business you can make income and if it's a profitable business all the better, two; if you're a genuine investor you can make a profit upfront on that investment, therefore the yield ought to be higher so you have higher cash flow."

In a tighter climate this strategy is definitely worth consideration.

As Comben states, "The investor needs to look at such a strategy because when the market flattens out, there's really nothing else they can do to add value to their property to increase equity or cash flow. We've seen property values go up and now that they've leveled off it's a good effective proposition.

"If you're going to make a 25 per cent margin on your development, say you build four units, you'd get one for free; it's actually adding value that wasn't there before and increasing your portfolio in the same instance."

Ultimately, speaking from experience, Ayles sums up the greatest benefit to property subdivision, particularly for anyone who may be a bit of a control freak: "It's a great way to add to your portfolio, essentially because you're creating equity rather than trying to buy equity and obtain it through capital gain."

Regulating development
Tim Kelly of Rigby Cooke Lawyers gives advice on legislation that governs property subdivision and the important things investors should consider.

"Going though some of the basics in terms of legislation, you're going to have a subdivision act, a planning and environment act, you'll probably be involved with different authorities if you're subdividing whether it's for water, drainage, electricity, who'll all have to submit their reports and recommendations before you can get to the end and obtain a statement of compliance. They're the sort of acts and authorities you'll come across during the process."

He steps would-be developers through the process from finding the ideal piece of land to making application to a council for development approval.

"Once you find your land or land and building, you then have to look at the title to see if there are any restrictions, in terms of covenants.

"You may have to make application for variance or removal of a covenant to the titles office or through a council or a court. You apply to a council for a permit for what you want to do, depending on what the council then say, they will most likely require you to advertise your application and you might get a situation where you get objectors.

"Council will make a decision based on their requirements as to whether they believe it's an under or over development or suitable use and based on whether there are any objectors.

"At this point, depending on whether it's good or bad news, you've then got organizations such as VCAT (Victorian Civil and Administrations Tribunal) you may need to approach. You may have to argue your case and get a decision through them to allow your subdivision.

"If it's a suburban property, the government has in place RES codes for development so you need to consider whether you're meeting those requirements and standards too. If it's in the country though, that doesn't apply."

He lists the legal documents developers need to become confidently conversant with in order to get through the bureaucratic red tape involved in any proposed real estate subdivision.

"The basic legal documents are the application to council for subdivision and later down the track, the lawyers submit the application to the titles office to register the plan of subdivision."

On the plus side, Kelly says, "The titles office is the quickest part of the deal – a matter of weeks. Before that we have to get the application done, the approval through the subdivider's bank and the easiest bit is usually that last part in applying to the titles office."

This article was first published in Australian Property Investor magazine. For a special subscription offer for Property Update readers, please click here.