The risks of Property development

Salient points Michael, especially for those considering development.

I am also in the same position where I am considering developing, but actually very much considering using Metropole due to my inexperience in this area.

Given all the commentary on property prices etc, would not this post-boom climate, be a better time for development (other considerations aside)so far as end valuations for any project are not likely to be skewed optimistically by a bouyant property market?

Disclaimer: This post is rather long. Please skip this thread if you are easily offended by length, not interested in developments, and think you may be offended by my writing style, are in a hurry, or don’t care for the lavish use of exclamation marks. My opinions are not necessarily shared by others, (so sue me!) and …er…my hobbies are filmmaking, debating, dinner parties, and laughing…um…

Hi Michael

>With little upside in the general property markets for the foreseeable future, >many investors are looking at property development as a possible way of >increasing their profits.

Yes, people like meeeeee!!!
However unlike the Melbourne apartment builders, I am doing it in an area with considerable upside, a shortage of rental properties, and other factors.

>Property development has been made popular by a number of seminars or workshops >which suggest property development is lucrative and easy.

Never having been to a devo seminar, (so sue me) I do think it’s going to be lucrative, and as far as ‘easy’ goes well there is a lot more to it than buying a property, but not much more to it than renovating a property, give or take council. (so far.) This is because as with my renovations I am not actually going to do any banging of nails myself, it’s just a matter of organisation.

>Over the years I have seen many inexperienced property developers and quite a >few that I thought were smarter than me go broke.

Yep, and I have taken every precaution that I won’t go broke in many different ways.

>A downturn in the property market
I have guarded against this by developing a particular type of property with a particular rental yield in a particular area with a particular construction, after consulting with all relevant property professionals in the area

>Increases in interest rates resulting in increased holding expenses
I have actually guarded against this as well

>Increases in construction costs during the project.
I have a large buffer for error in my budget which is still going to make the numbers work out equal and 10+ CF+ve. My buffer is 26-45 percent going off an off the plan valuation.
> Many inexperienced developers think they have entered into a fixed price contract yet are hit with cost variations;

I am inexperienced with development, but I am very experienced with contracts, so much so that I could see the holes in the contract I was prepared to sign and ripped it up and wrote a much better one – which the contractor readily accepted as he could see it was far superior – not just for him but for me. It was also about 8 pages long instead of one, and we agreed on procedures for (almost) everything that could go wrong. The things I didn’t guard against are things I am able to wear through the usual protection strategies such as insurance, cash reserves etc

>Changes in the supply and demand ratio for real estate market such as we are >currently seeing in the inner city apartment market which depresses property >values;

Indeed, and I have mitigated this by being the first (recent) developer in the area not the last. However I know there is a wave behind me, because there are wall to wall new subdivisions in the area. Even if my places are only to fuel the already stretched rental and housing demand for the influx of workers on the coming developments behind mine, I’ll be quids up

>Unexpected disputes with building or trade contractors or unions which can >cause costly delays to a project;

I’ve probably used…ah, 50 tradespeople in the last year and never had a dispute with any of them – so I am not expecting any problems.
But if I do have a problem I will just sort it like I always do! Basically every time I’ve ever made any $$ it’s been ‘solving a problem’ of some sort.

>Changes to the laws relating to property development such as the laws relating >to zoning and town planning restrictions on land use, environmental controls, >landlord and tenancy controls, user restrictions, stamp duty, land tax, income >taxation and capital gains tax.

Some of those are unlikely once you have your consent, the council stick to that and any changes are to properties after the law change. Also laws take a bit of time to come in to effect so you do have some warning. A lot of other things yes will change in time but it will be to the developer’s favour such as suddenly being able to build 6 instead of 5 on your site. The world seems to be getting more population-dense. Sites that had one house on them now have two – that’s a trend. In cities people are building upwards. That’s a trend. The other things you mentioned like stamp duty changes – well anything can happen I suppose, and yes, as you become more wealthy your tax bracket changes – but any savvy investor whether a developer or not is prepared for those sorts of things, and has a buffer. If not, yes, of course, they could be wiped out.

>Unexpected delays and increased holding costs may be encountered when town >planning (DA) approval is required for a development. Councils are currently >very slow in assessing development applications and they reject many >development / town planning applications.

Luckily mine is guaranteed approved by the council, or my money back. (another risk-mitigator I wrote into the contract myself – agreed!) and the time frame is not too bad, just 2-3 weeks. The approval guidelines and advice was sought in advance of everything, and I am complying, so I doubt it will be a problem. Me and the council dude are on first name terms, etc etc. All part of the game!

>The cost of obtaining approval or fighting council’s rejection in a court of >appeal is continually rising;

so is the cost of living, inflation, the Kiwi dollar -life, so it’s swings and roundabouts.

>Some inexperienced developers find that some of the improvements they have made >to their properties do not result in an increase in value.
I think many experienced developers find the exact same thing. I.e. the average capital growth of melbourne apartments in ten years from 1992 – 2002 was 4 percent.
>They learn the hard way that increases in value do not necessarily occur in >line with expenditure on improvements;
Indeed, but this can be said for experienced developers too (i,e, melbourne apartments for the last ten years.)
Another thing is that buildings depreciate, land appreciates. The reason I reckon melbourne apts don’t go up in value the same as houses is because they don’t have a very high land component compared to their price. My developments will have a higher land component like townhouses or units rather than high-rises, so in a lot of ways it is so different what I am doing to what the common garden variety melbourne apartment developer does that it is probably not even comparable. Also I hear that CF+ve developments are rare as hen’s teeth, but mine is going to come in at around 11 percent yield in a town where you can’t even buy a skanky old hovel on a ten percent yield any more.

This is because of land going up in value rather than ‘the improvements’. I think, novice though I am, that the best thing a new developer can do is to choose the right site and type and construction, any mistakes and you could lose just like Michael is saying.

>As you can see many of these risks are outside the control of the developer.
>I know, because at Metropole we act as property developers for our own projects >and as project managers for many clients (we are currently involved in 80 >development projects in Melbourne.)

I think it’s just another example of people doing it one way over and over again and getting a certain result and then becoming masters of that result, and then people like me coming in and doing a different thing, in a different way, with a different result, and becoming (I hope) masters of my particular result. But being ‘judged’ for want of a better word by masters of a different system. It’s like being on a retail forum and discussing MLM versus owning a shop. It’s all ‘development’ that we’re discussing, but it’s I bet so different than how you’re doing it.

>We are aware of the risks involved in a development project and this helps us >minimise them so that our clients do not get any unpleasant surprises. Most of >our projects are very successful, but I have to be honest and admit that we >also into the same problems in some of our projects and they are not as >successful as we initially hoped.

I think that developing is more risky, it’s got to be, you’re creating something out of thin air. and you have to be prepared for the ‘what if’s. If you are not, you get wiped out. A lot of people are not smart enough to figure out what the actual risk is, or don’t get the right advice from the right people. I mean advice from people who understand the MARKET which you are going to appeal to and what they want. Also I think a lot of people are just too highly geared (at risk to start with) and shouldn’t really be doing developments to begin with. I do think that you have to have a bit of equity and cash behind you before you start doing it which is why I am only starting now after I have some money and properties behind me and a very healthy LVR which a lot of developers only dream about.

>I am not a property developer; I never have been, nor do I intend to be (well >not in the immediate future). Why???

Perhaps, because you have been scared off by Michael’s post.!????

Interesting that you were attracted here anyway, perhaps then for a different reason than being particularly interested in development.

>I too have seen many “developer” friends go from owning a hefty portfolio to (some, not all) near bankrupt, those that survived are currently renting and paying off someone else’s mortgage!!!

It depends where you live (if you rent) as to whether or not you are paying your landlord’s mortgage off or not. Basically if you rent a negatively geared place at city yields of 5 percent or less (2-3 for where I live) then you are not even covering your landlords’ interest only repayments let alone holding costs. it is actually the other way around, and the landlord is subsidising the tenants. However if you are the owner of CF+ve properties like I am then the tenant is very much paying off my mortgage because my interest rate is 7.6 but my yield is 15.6 so there is a surplus – I am making a margin on the bank, basically. So things are not always what they seem, especially in Australian cities where most of us live. I think too few people actually understand this concept, and it was a shock to me when I calculated how much worse off I would be to buy where I live rather than rent. But that was a tangent, but one I had to respond to.

>IMHO all too often people get caught up in their greed, and think that if they >can achieve profits with single property investments, all of a sudden they can >”develop” a string of properties and hit the big time!!!

It is not necessarily greed that means you make profits, just that you understand investing and business and how you can multiply your money. I had a lump sum and I could have done a term deposit, property, business or shares and I did property and business. So when that multiplied I found I had a bit more to play with and so now I’m developing. I see it as a way to help my family out by creating an investment that in the current market can’t be bought. and if that’s greed, well, so sue me.
But I feel that development is actually at the top of the heap out of all investing strategies, as it’s pure creation.

And BTW I don’t take advice from the ignorant, and I don’t let negativity get me down. If I did, i wouldn’t be here now. I welcome negativity, as it makes me stronger. However it can be very tiresome too, but once in a while, it’s quite envigorating. By my responses, I realise how on to it I am. By challenges, my reactions to the ‘what if’s give me a good idea of how I am guarded against that if it happens.

>I say crawl before you walk, and walk for a while before you run, otherwise you >could fall flat on your face!!!

I agree and I wouldn’t say that everyone could get the same result as I will. That depends on the person, the investor, first and foremost.
There are a lot of stupid people about, and good luck to them, but I don’t take advice from them either.

>I’m not saying “property development” is to be avoided, only researched, >perhaps even moreso than if you were to research into the purchase of a single >property. It stands to reason, mutliple your research by the number of >properties you intend to develop (and then triple it again just for luck).

I agree, as a first time developer I have been looking into it ever since I purchased the site, which I thought somewhat loosely ‘one day I might develop this land’. At that time it was just a speculative buy and hold negatively geared piece of land that cost me the price of rates to hold, which I was quite OK with, that I was hoping quadruple in value within a year. In fact it was my ‘insurance’ against another speculative venture I was undertaking elsewhere and even I called it my ‘insurance’ property!

When the land doubled in value in three months and the house prices rose over a critical dollar mark, until now there is nothing under a certain price range, nothing cashflow positive since november on asking price, currently nothing CF+ve even at negotiating ten percent off asking prices, and when the new subdivision sections started selling, suddenly it became viable. I did various costings (many) and learned a lot in the process. I tweaked by amount of bedrooms and square metreage after talking to various property professionals with the aim of getting maximum value for my cost. One key decision here improved the numbers considerably.
It’s just the same as renovations. You can spend a lot and not get the value, or you can spend SMART and get more than the value.
I think developments in many ways are very similar to renovations apart from the beurocracy and increased risk, but I do evaluate what I am going to do and if it’s viable with the same sort of criteria and analysis as I would cost a renovation budget for the purposes of increasing rent.

I also looked into house relocations and other building recycling. House relocations I reckon are the halfway point between renovations and new developments. the author of the book kept saying how similar the costing/planning/strategy for a removal and renovation of a house was to a new development – except (my opinion) that you have the grief of two sites to sort, not just one – and you still only have a ‘second hand’ house.
In many ways, building new is FAR easier than a relocation, in so many ways – beaurocracy for a start, as councils are much more amenable to you building new, as are your neighbours.

With my development my aim is to get the most rent and the highest valuation in proportion to what I am spending, and a valuer is a key guiding light in this, as is a trusted real estate agent, and a trusted rental manager.

So my final costings to date have come in at aprox. half my original per square meter cost (i.e. my first quote.) If I had done these same costings as I have today 6 months earlier, despite being extremely competitive, I would not have got the valuation and equity result I am now expecting and the development would not have been so viable.

As a result even of the lessons already learned, I am buying the land for the next development now – even though I won’t commence for 6 months or so – in an area where I see the same characteristics as my current development town was showing 6-8 months ago.

I will further leverage by using the exact same supplier and plans, just tweaking the site plan a bit.

“I am inexperienced with development, but I am very experienced with contracts, so much so that I could see the holes in the contract I was prepared to sign and ripped it up and wrote a much better one – which the contractor readily accepted as he could see it was far superior – not just for him but for me. It was also about 8 pages long instead of one, and we agreed on procedures for (almost) everything that could go wrong.”

Mini – what aspect of the work are you talking about here? I can’t envisage anything much that would require only an 8 page contract… demolition may be a couple of pages perhaps.

The biggest thing I think for people doing developments is the taxation implications. Take for example:

Joe Casual – works as an engineer and earns an income of $120k. On the side, he builds a house a year and sells one of his older ones. His turnover does not attract GST and he is taxed on normal CGT rates, so if he makes $100k, his total earnings are $220k and very roughly he would pay $45k tax on his income and $25k on his capital gaoin, net income = $150k.

Joe Wannabe – chucks his job in as he has heard of the fabulous lifestyle of developers. A typical development (not Minis – but 90% of typical city developments) struggle to make 20% gross. Being a developer there is no CGT exemption and you will be GST registered. so 54.5% of the profits are lost in tax (unless you park in a company or something, but eventually it will come home to roost). so to replace $150k p.a., and say a typical development takes at least 18 months, you need your development to generate $494k clear profit.This means you need a development in the order of $2.5m of hard costs, requiring 20% equity or say $500k at risk. Additionally you won’t have a cashflow, so need to be able to live off something and pay your mortgage. The mortgage interest rate will be higher as you won’t have an earnings record and will probably find yourself on low-doc rates. All this is just to achieve what Joe Casual is doing stress free, 9 to 5 and with nothing at risk.

Obviously there are ways around these things, perhaps keep working whilst you do it and just be a stress ball, ducking out on lunch breaks and having whispered arguments on the phone at work with contractors etc.

The main point is, once you cross from being a casual investor to being a developer, you need to do more than twice the amount of deals just to be in the same position.

Extensive list of ‘Off The Plan’ property available for sale in Perth.

John – 0419 198 856

all I am trying to say there Mini is that the way the tax system works means that a trader is taxed more than twice as much as an investor, therefore logically a trader needs to produce more than twice as much profit as an ivestor to have the same net profit. Unfortunately that’s a cold hard fact, so when crossing over from being an investor to a trader you have to be very sure you are going to go hard, because being a small time trader will see with you less dollars in your pocket than just sitting back and investing.

Extensive list of ‘Off The Plan’ property available for sale in Perth.

John – 0419 198 856

Ausprop & Mini,

Tax implications and nett profit are not the only things to consider – in fact they may not be the over-riding factor at all – just have a chat to lots of farmers.

There is a lot of implied value to being your own boss and running your own show – regardless of the financial implications…once again farmers come to mind.

When you get some pedantic boss telling you when you can go to lunch, what to say, what not to say, taking ‘the glory’, stealing your ideas, talking down to you and belittling you in front of your peers etc….the run your own show option starts to look extremely attractive. Finances play 2nd fiddle. Obviously, if you are hocked to the eyeballs this option doesn’t even present itself.

Cheers,

Dazzling

“Go hard or go home”

“the way the tax system works means that a trader is taxed more than twice as much as an investor,”

Haha – I am laughing ironically here because this may be true for you and for what your tax specialist has told you, but it depends, it depends, and it depends….

Ok, so if you are developing in Australia, you should do it by starting a Nevada zero-loss company which does the development as trustee for a Monaco based company whose settlor is a foundation in the Bermuda Triangle (a little known tax-haven, where ships loaded with gold bullion tend to go missing, and BTW no wonder they couldn’t ‘find’ Michael Hutchence’s assets when he died.) Make sure you only own 48.9 percent of shares in the company, because otherwise you will be audited. That’s step one. Step two is to start an International Business Corporation based in the Virgin Islands, which pays you a wage as the ‘investment fund manager’. Legitimately work from wireless while reclining on a sun-lounger at the Four Seasons in Bali! But I digress. Where was I? OK, so this company then takes a loan from the trust, but never pays it back, thus incurring a loss, which is tax deductible – and there is no income tax due because it’s not income, right? So then you distribute the loss through a Loss Attributing Qualifying Company through an Australian on/shore/offshore structure, which allows you to distribute the losses to your grandmother, your ex-wife, and your future ex-wife AKA girlfriend, but mostly to your grandmother, who needs the losses to offset her rather high income and tax bracket. Granny of course earns so much because she is the main beneficiary of your rental income from your ten other buy and hold company/trust/IBC structure clones, each of which only owns a maximum of three properties. Anyway, enough about Granny’s tax situation! I digress!
So then you start another structure, this time it’s a corporate trustee based in the Cook Islands for a Vanuatu trust with the settlor in the Bahamas. This company signs a document (which is perfectly legal in Vanuatu and compliant with the tax laws, mais bien sur,) and appoints you as director of a charitable foundation, which you ‘control’ but don’t ‘own’. Then, when the development is complete, you just gift it to the charity, and write the whole lot off as a tax loss = zero capital gains tax. And with a side benefit that your annual Carribbean Cruise is tax deductible.

well, if I didn’t sound so convincing, I would be laughing more, but….
what is my point here?
You go to 5 different tax specialists, varying in levels from the ‘village accountant’ to the ‘guru that Eric Watson/Kiyosaki/Bob Jones has on retainer’ , and one will charge you $150 per trust and $500 for a company, the next $2400, and the next $10,000 not including legals and paying the Monaco settlor and the Bermuda Triangle Ship Driver. And so on. And yes it is true that as you get bigger you may grow out of your previous advisors and need to go to the next level.

It’s a mine-field out there, I tell you! I am ‘reluctantly’ structuring at the moment offshore in the country where I am developing, where I have non-resident tax status. (funny that.) And as to whether or not I will be deemed a trader, well, define ‘I’.

“therefore logically a trader needs to produce more than twice as much profit as an investor to have the same net profit. “

Hang on, we are discussing developments and your assumption is that we’re all traders. define ‘trading’. Selling for a profit? Well, I’m not talking about trading – I’m talking about developing. Most developers sell, sure, but mainly because they have to. (they’re traders, and that’s how they make their living.)
Maybe they will build 6 and get to keep one. Do they pay CGT on the one they keep? Did they trade that one? Did they sell off the plan?

” that’s a cold hard fact, so when crossing over from being an investor to a trader you have to be very sure you are going to go hard, because being a small time trader will see with you less dollars in your pocket than just sitting back and investing.”

I can see why if this is true for you, then yes, of course, the sensible thing to do is to stick to the ‘sitting back’ (sic) part.

One man’s cold hard fact is the next man’s fallacy, ah, what can I say other than – shake my head, then continue with my discourse for those still with me…

“There is a lot of implied value to being your own boss and running your own show – regardless of the financial implications…once again farmers come to mind.”

Yes, quite! Go the farmers. I quite relate.

Hi again
I’m in the position where I relate to both Ausprop and Mini! [cap] (And in case anyone’s wondering, Yes, this is possible!)[buz2][buz2][cigar]

I well remember having drinks on the waterfront at a certain business dinner, when the host (a well known mega-millionaire) pointed out a ’30- something’ leggy blonde and very matter-of- factly told me: “When you get big enough to need to move offshore, give me a ring and I’ll introduce you to her. She’s my offshore tax law specialist.”

So for the foreseeable future, Ausprop’s right because our structure was set up by the $2500 accountants Mini mentions above, and our current sub-division is in the name of that entity. But there may well come a time, Mini, when I PM you for some tips and contacts re registering offshore. So I guess I’ll be privileged to pay around $10,000 for their services, is that it, Mini? [biggrin]

Mini, would you mind PMing me the contact details of your Offshore specialist, plus any other tips / info you think I might appreciate? I’d really appreciate it.

Thanks to everyone for your input.
Cheers
Greg

Just do it mimi!
.
From memory your new developement/s are in NZ. I thought the whole idea was growth. Not just in the financial sense but also personal growth through new ideas and experiences.
.
You will no doubt learn skills through this new venture that will be invaluable throughout the rest of your investing career.
.
I got the sarcasm re the OS structures. It’s not hard to see that you need to be paying loads of tax before you go to those lengths to avoid paying a bit.
.
Forget about the naysayers. Do your due dilligence and steam forward with the new project.
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Good Luck.
.

Guys, what a breath of fresh air, and thanks for that.
Don and Liz I have been really enjoying your guys’ posts and some have hinted that your portfolio has become nice and hefty and I think that’s awesome, congrats.

> From memory your new developement/s are in NZ. I thought the whole idea was
> growth. Not just in the financial sense but also personal growth through new
> ideas and experiences.
Absolutely and totally and utterly.
My first property purchase sort of did me in emotionally and mentally for about 3 months, with the self-doubt kicking in like mad, had I done the right thing, was it going to work out. Well it did and I bought three more in the next 8 months.

There are fairly cheap ways to build, using various leveraged methods, (I am dying to work my way up to building tilt-slab townhouses but being the first in an area to do it not the last.) NZ is a world leader in many building techniques which they export to all over the world, such as Russia (very into concrete and steel apparently) and Asia. Anyway if you build with a financially viable method, the rent that you will get for these places very much works out. The valuation off the plan is a great risk mitigator and even if the valuation is the same value as the land + building costs and I *don’t* get the expected 26-45 percent equity on completion, then it’s still going to be a better rental cashflow investment than anything i could buy in the current market.

So another assumption that people have made is that everyone sells their developments. well I am sure that many do because they have to or because they live on their realised profits but the great thing about CF+ve is that you can live on that. How cool to have an investment property that should need virtually zero maintenance for years and years, is still under ‘guarantee’ for ages! that will certainly be a first, and makes the CF+ve return mean even more than it would normally. So if I’m not selling, am I a trader? Well, no, I’m not. So my tax situation is way different than someone who is selling. So many people made assumptions about this that and the other and really I am disclosing more than I meant to sort of in self-defence, but just to point out to people who don’t realise, how many judgements they make that they don’t realise they are making.
.
> You will no doubt learn skills through this new venture that will be
> invaluable throughout the rest of your investing career.
Absolutely, I am currently negotiating and signing up deals about 10 times the size of the deals I used to do, and it just feels utterly natural, but 2 years ago I wouldn’t have believed I would be doing that now plus developing to boot. And I will say that when you move up a notch everything gets much easier, it’s like you get treated a bit more special by all the people in your team whether that be lawyers, agents, etc, I’m finding it a real blast actually.
.
> I got the sarcasm re the OS structures. It’s not hard to see that you need to
> be paying loads of tax before you go to those lengths to avoid paying a bit.
Yeah – I am not paying loads of tax, (and not avoiding any either) because I am self-employed and therefore almost everything I do is tax deductible, it’s amazing. -if not for one business, then for one of the others I do.
It’s actually a bit of a rort that is one of the ‘tax benefits’ of the self-employed rather than the employees. However the downside of that is that I don’t look as good to a lender as I should do, ah, swings and roundabouts, I’m ok with it all.
> .
> Forget about the naysayers. Do your due dilligence and steam forward with the
> new project.
Absolutely!!!!!!
call me some time and I’ll fill you in! we can have coffee and shoot the breeze!

> I am amazed with the amount of property work you seem to have on,
well you’re not wrong, and both my business partner and I both have PA’s now part time. I look forward to having one full-time, all fully tax deductible, of course! I use film-industry freelancers (much brighter higher class of person than your average boring temp agency backpacker) and they invoice me – fully tax deductible of course!

>get them to invoice me. you can
> afford the time to write such lengthy posts…not complaining mind you – enjoy
> reading them, just must be a drain on your time resources.
Hah, well the time I don’t notice if I am enjoying myself (funny that!) and I am a hugely fast typer because I had piano lessons since I was 2 (not joking) and my lil’ fingers fly!

> The topic of offshore co’s and trusts however, in general, does not frighten
> or scare me as we set up a company in some tin pot little island in the WI
> about 2 years ago for a very modest sum ($3K USD). Have never been there and
> really see no need to, but I’m told at high tide the country pretty much
> disappears for a few hours !!

That is so cool!
yes, I have an offshore resident structure for my offshore development and I am in the process of starting up a dinky lil set-up just for the fun of it with
designertrust.com
I am not going to put anything in it for a while. just look at it, play with it, and get it out at parties (joking), but the rest was serious

> We’ve had no grief about it, no intricate paperwork and certainly ne need /
> desire to consult with way over the top, high priced lawyers.
Exactly

> Humans are funny really when some are literally petrified at the thought of an
> action, where another is quite calm and blaise about the identical action.
Exactly

Guys – don and liz and dazzling – it’s been a pleasure