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.