Any investment presents risks and rewards that must be properly understood before buying.
This is certainly the case when buying property for redevelopment. You can keep yourself occupied, but all your hard work could be for nothing if you’ve not done your homework.
“Less than 1 per cent of development-potential sites generate a profit”
You may be surprised to hear that small developments are by and large not profitable.
Less than 1 per cent of sites advertised as development-potential sites generate a profit for the new owners. In fact, the really good, profitable sites for a buy/develop/sell strategy typically generate just 15 per cent profit.
Don’t be greedy and hold out for the traditional 20 per cent yield properties as they are so few and far between you may miss out on few good deals by chasing a big one.
It can be far more lucrative to buy, develop and hold on to properties. Why? Because while you are earning rental income you can benefit from the depreciation schedules and increased capital on your balance sheet for further borrowings and developing other projects or investment options. And, down the track you can always sell off one here and there if you require cash to fund other projects or your lifestyle.
Benefits of buy/develop/hold projects
- Generally in areas that attract strong capital growth
- Additional properties add value to your balance sheet and bring in good income
- Offer valuable tax deductions through depreciation
A good retain-and-build duplex project might generate $90,000 to $110,000 in additional value, based on a project that meets the 15 per cent profit range, whereas a triplex development might create between $100,000 and $115,000 of additional value.
This is for those developers who do not wish to sell straight away. You can see how quickly that profit could be eroded through selling costs, such as GST, capital gains tax and agent’s fees.
How it works
As a buyer’s agent we help people find properties with potential for a positive outcome.
We advise buyers looking for a redevelopment project to:
- Know and understand their budget
- Be comfortable with their commitments
- Speak to a mortgage broker or bank to discuss how much they can borrow
- Consider the cost of the initial purchase price as well as for the subdivision and development (regardless of when they are to occur)
Buyers may purchase a property with the intention and financial capacity to redevelop it immediately, while others may max out their borrowings to buy the property and work with a savings plan to fund the development down the track.
We look at investment properties with the zoning for immediate redevelopment, or if the client needs two or three years to raise the capital to redevelop, we can buy something where the zoning is due to change in the future with some certainty.
TIP: Match the property type to the area. It is just as important to not overcapitalise in a cheaper area as is it to ensure you don’t under-spec in a more expensive area.
TIP: Including premium add-ons, such as stone bench tops and high-end appliances to the kitchen may be a waste of time for properties in areas below median value, but almost certainly required in well-heeled suburbs.
Duplex site subdivision costs can average between $60,000 and $80,000 for a basic subdivision, with services connected.
The total depends on the site and requirements such as fencing, retaining walls, demolition and tree removal.
If you choose a profitable subdivision site you could make around $40,000 just by titling the blocks. However, these developments are hard to find.
If you are retaining the home and you re-title the lots before building on them, you can approach your finance provider about your refinancing options. Banks are generally willing to lend more money for two titled blocks than for a single site.
BENEFITS OF REDEVELOPMENT PROJECTS
- Redevelopment adds value to the original property.
- You create your own growth, rather than relying on the market alone.
- Regardless of the market, if you choose a good area and there is capital growth, you maximise that opportunity.
- You are effectively purchasing properties at wholesale price – by adding a house to the property or bowling it over and building more than one, then effectively the developer’s profit is in the buyer’s pocket.
- You have bought one but you end up with two or more properties with the one set of acquisition fees – you create quicker equity in what you’ve got.
- The new property has the best, highest depreciation schedule, lowest maintenance costs/issues, and will provide a good rental return.
- The original property (if kept) can be updated and refreshed, creating a more attractive depreciation schedule for that property, and the updated décor will attract a better tenant, and yield a better rental return.
- If you have not overcapitalised, your portfolio could be headed towards neutral or at least lower negative gearing.
HOTSPOTS: Where to find redevelopment projects
It’s not just about the suburb, so identifying hotspots is difficult. In fact, it’s a case-by-case proposition where two neighbouring properties can produce varying profit outcomes from a redevelopment project.
It also changes with time and an area that has favourable development projects now may not have in six months’ time.
- A popular Perth suburb for duplex developments where you can retain the existing home
- Sometimes price levels don’t allow even a modest profit on almost all available sites, while at other times there is a profit for developers
- The selling prices of the sites sometimes rise a little too high compared with the values of the end products and it takes time for the market to adjust
There are profitable projects in areas set for rezoning. But the key is choosing your timing so you don’t take too big a risk by buying in too early.
EXAMPLE: Hamilton Hill
- The local council rezoned parts of the area, but it’s a big risk to buy in before you know which parts are going to benefit from the rezoning
PITFALLS OF THE REDEVELOPMENT PROCESS
It is easy for inexperienced buyers to seize on an opportunity to buy a site advertised with development potential and negotiate a deal without fully understanding the costs involved in the development process. These costs and council requirements can vary widely from site to site.
First-time and novice developers may not be aware of all the costs to check when evaluating the feasibility of a potential redevelopment site. The benefit of experience is knowing what to look for and ensuring all contingencies are covered, so the true profitability of a development is clear from the outset.
For example, some sites require drainage studies and works, and this can come as a surprise to first-time developers.
In other cases, the local council may charge a Public Open Space Contribution – this means you have to pay towards the upkeep of common resources like parks, playgrounds and community services provided by the council before they’ll rubberstamp your application.
One council in WA charges 5 per cent of the total value of the unimproved land value of a site as a fee for certain blocks within their catchment. This sort of cost can remove the profit from a deal if it is not made clear at the time of purchase.
A large and often misunderstood requirement is whether a site requires retaining walls and what this means to the overall cost of the project. The experienced and prepared investor can factor these charges into the feasibility and make appropriate offers to purchase having understood their financial position.
Other encumbrances on the site such as a drainage easement could reduce the land size available for development and therefore the number of dwellings that can be built on the site. This can severely reduce the profitability of a site if it was bought based on the number of homes required to achieve a profit.
Experienced property developers and buyer’s agents know the rules and how to massage the project to generate a return. For example, by doing a little extra work on the site layout and drawing on unusual provisions in the planning laws, sometimes three properties can be created where an inexperienced buyer may only be able to get two units approved.
TIP: Include a surveyor on your project team to confirm the land can be subdivided as you expect. Where it cannot, the unexpected result can dramatically change the nature of the development.
And finally, some owners think that doing work themselves will save costs but (except in rare cases) this is a false economy. Consider people who demolish a property themselves, but are only available to do the work on weekends when they are not working their normal job hours, delaying the project by many weeks. In addition, they may be shocked to find out how expensive it is to take trailer loads of rubble to the local tip. The cost of hiring professionals can be easily justified in terms of expediency, reduced surprise costs, and achieving the end result of having good tenants or a property to sell so much faster.
If you’re ready to invest and you’ve got any questions about finance, call us for a free Financial Health Check: 08·9381·7450 or download our Finance Services information.
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