The best way to determine whether the project is viable is to do a financial feasibility analysis. There's a lot to cover in this subject, so we'll do it in two parts. The first part will look at topics such as land acquisition costs, finance costs, professional fees, construction costs, and land holding costs, among other things.

In the second part next month, we'll cover selling costs, miscellaneous costs, GST, development profit, cash flow analysis and other details required to finalise your financial feasibility analysis.

Getting started
It pays to do a rough feasibility study on the site you've chosen before getting into the more detailed analysis.

Property development author and head of Ayr Infrastructure Development, Ron Forlee, advises beginners to do a pre-feasibility study working with broader figures.

"We'd look at the current research that's been done on the particular development that you're going to undertake," he says. "You have to decide whether it's going to be a building or a land development.

"You have to go through all your development costs in terms of land purchase, stamp duty, construction costs, planning fees, architect's fees, consultant's fees.

"Once you have all the development costs and you're going to sell it you have to look at the sales commission, what's your interest factor that you're going to be holding over that period, and then you can determine whether it's going to be viable. You have to ask yourself, is it a good location, is there demand for that type of building and then you can make a decision whether to purchase the site or not."

Smarter Property Development head Peter Comben says small developers have to determine what the end value of the project will be.

"It has to be determined in the current market," he says. "There's no good predicting what might happen in the market, it has to be based on real figures."

Comben says if you want to build a four-unit project, then you should find a similar sized development and find out what they sold for (if you plan on selling).

"I encourage people to work backwards so they can determine what the end value will be rather than hoping it will make a profit," he says. "You actually make your profit when you buy the land."

Forlee says the novice developer has to do "quite a bit of homework" before embarking on a project.

"If you've done your homework, when a developable property does come up for sale, you would have a better idea," he says.

Forlee says once the purchase has been finalised, then you have to do a much more detailed feasibility study.

"That is, getting more concrete figures in terms of your construction costs, for example," he says. "You can either work with a builder or get quotes on plans that you've had drawn up. You need to get firm figures from your lending institution."

Comben says 50 per cent of any development project is usually in development costs, which we'll look at shortly.

Author and developer Bob Andersen, of Positive Property Strategies, says most novice developers underestimate their costs associated with development.

"Everyone understands land acquisition and construction costs, but it's all of the little things that all add up. They think they're making 20 per cent on the costs, and then when all the costs come in, they're only making 6 or 7 per cent."

He agrees with Comben that you have to work on present day prices for construction and sales.

"Don't factor in capital growth," he says. "Market value may pick up a bit, but construction prices might also go up."

Rental income
Forlee says if you're doing a residential development and plan to keep it for the long term then you need to look at the current rentals in the area.

Comben says when determining what people pay for rent in the area you've chosen, you have to realise that you'll most likely get more than that because you'll be offering brand new product.

"You'll get your best return on rent from day one, because people like new properties," he says. "Later on, the rent doesn't drop, but it won't keep up to the values."

If you have an existing house on the property you're going to develop, Andersen says you can rent that out while you're waiting to develop it.

Obviously, once building is complete, the sooner you get a tenant in, the better he says.

"That happens when you get your certificate of occupancy from the council," he adds.

Sales
If you're planning to build and sell or develop land and sell, you may want to sell off the plan. Alternatively you may want to sell to investors with a tenant in place.

It pays to see what similar developments are selling for in your area to determine what your project may sell for.

Andersen and Comben say you have to use present day market prices when looking at sales.

Land acquisition costs
If you're using a buyers agent, there will be a fee based on the contract price. It's usually between 1.5 per cent and 3 per cent.

Then there's the actual price you'll be paying for the land. You'll need to know whether GST applies. (There will be more on GST in next month's issue.)

Legal fees will have to be paid for the drawing up of the documents. these fees are paid at settlement of the land.

Andersen says it's wise to have the lawyer provide you with a written estimate of the fees they'll charge and the searches they'll undertake. You can save money by conducting some of your own searches.

Stamp duty varies from state to state and is usually paid on settlement.

Andersen says land acquisition is the second biggest element apart from construction.

Finance
If you're going to borrow money to build your small development, it has to be factored into the financial feasibility analysis.

Comben says lenders aren't going to want to put their money into something that's risky.

"If you can prove that you have a significant margin for your project the lenders will be happier to fund the project," he says.

It's also good to have contingency funds, he says. This money can be adjusted as you work through your numbers.

"For example, you might have to have a retention system for your stormwater and they can be very expensive, say about $30,000," he says. "You need to have a contingency amount for those 'what if' scenarios. I advise people to have never less than 3 per cent of the total construction costs. That way if there are some blow outs, there's room to move."

Andersen says finance costs will depend on whether you're using a retail or commercial lender. He says as well as factoring in interest rates, there are also fees for valuations and mortgage duty.

The amount charged for a valuation will depend on the size of the project but can range between $3000 and $10,000.

Mortgage duty varies from state to state and is payable once the mortgage documents are registered.

If you're using a broker, you will have brokerage fees. These fees can be negotiated with the broker and are usually about 0.5 to 1 per cent of the amount being borrowed.

Interest is generally paid on the amount borrowed on a draw-down basis as the project progresses. Interest is higher than for normal property investment. And then there are the establishment fees. The lender will usually charge between 0.5 per cent and 1 per cent of the loan amount and it's charged once you've accepted the lender's offer. Non-banks charge more for establishment fees, ranging between 1.5 per cent and 4 per cent.

Andersen says it's prudent to factor in a rise of a quarter of a per cent to the interest rate you obtain at the beginning of the development as a buffer against further rises.

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Fees and charges
Consultants' and professional fees
With these fees, it will depend on the size and type of development you're undertaking.

Andersen says if it's a simple subdivision, you may only require a town planner and a surveyor. But if it's a bigger project, he says you'll also need an architect or building designer, a landscape architect and a civil engineer. These professionals will be needed for the development application. You may also need a structural engineer, someone to do soil tests, and a hydraulic engineer for drainage. A certifier is required to certify your building plans, which can be a private certifier or one from the council.

Contributions
Councils usually charge a contribution fee if you're building more than two units. It's worked out as a percentage of the land value at the time the development approvals are issued.

There are costs associated with getting the development approval from the council. You can usually find out from the council what the fees are for development approval, building fees and contribution fees.

These can include sewerage, water and park fees, as well as certifying fees.

Andersen says most beginners realise the fees for development approvals, but forget to factor in the contribution costs.

"In a lot of places, but particularly in Queensland and New South Wales, contributions have gone through the roof," he says. "There are contributions for sewer, water and park lands and in some places for social infrastructure."

In a small development, he says the park contribution is usually a cash contribution to the council.

The number of people occupying the site determines water and sewerage fees. There may also be a water and sewerage connection fees.

Construction costs
Forlee says you should always try to negotiate fixed price contracts for residential projects.

"In most circumstances, say you're doing a four-unit site, you can normally fix the price for that," he says. "For construction, you need to have provisional funds. For earthworks, you may get a ballpark figure of $1000 per unit, but they may hit rock and it's then $5000 per unit. When dealing with builders, try to firm up as many figures as possible. What are the specifications, what are the finishes and what about the landscaping – because a builder might just give you a quote off the shelf."

Comben says you'll need to get estimates of construction costs for the type of project you want to develop.

"This will depend on where the project is and what the project is," he says. "You're probably looking at between $800 per square metre and $1200 per square metre, depending on the type of finishes you want. So you'll need to have an idea of the size of the buildings and include such things as garages."

If it's in a regional area, he says costs can be much higher for materials and labour, so that's another matter to consider.

Quantity surveying firms offer prices for construction costs all over Australia. That's one way to find out how much your project will cost.

"But there's nothing like getting a real builder to price a job," Comben says. "Construction of a simple unit development will cost more than for building a single dwelling. You should talk to a builder who is doing this type of development in the area.

Andersen says building construction is usually the most expensive element of a property development.

Architects and building designers often have a good idea on square metre rates. He says some firms can tender the construction for the small developer.

With your initial detailed drawings, he says a builder or architect can give you a ballpark figure on construction costs. Once you have more detailed drawings, you'll be able to have a firmer price on building costs.

He advises talking to builders, architects and building designers who have done similar projects to the one you're proposing.

"I always like to factor in a contingency of about 4 or 5 per cent on construction prices."

Land holding costs
Forlee believes small developers shouldn't gear up for the land purchase.

"If you're looking at a development site for say $1 million, it's preferable that you don't have any debt on it," he says. "You're paying interest on that land otherwise. If approvals take two years, you'll be paying interest for that time. The price of the land may have escalated in that time, but it's still a risk factor."

Comben says if there's a house on the property you're planning to develop, you should keep it as long as possible before starting the development. You can get some rental income while you're doing the development. You can also borrow 80 per cent against a residential property, and Comben says this is the best funding available because of the lower interest rates and helps keep the holding costs down.

Andersen says a lot of people forget about land tax. This tax varies from state to state and is based on the unimproved value of the land. If it's a fairly small project, small developers may not have to pay land tax if the value of the land is under the threshold determined by the state or territory you're doing the project in.

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

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