While most Perth property is only just starting to perk up, interest in subdivision and development sites has been building up for the last year. The right sites have a buzz of interested buyers at the home opens.
As an example, a corner triplex site in Greenwood auctioned recently had 9 registered bidders vying for the property in a fierce bidding war. A whopping 61 bids delivered a sale price of $521,000. This was $80,000 over the reserve price! It was by no means a bargain, and there were many hugely disappointed bidders left without a property.
Here is the exact history of the bid amounts and times. (Click here)
It’s not an isolated case and developers, including forward-thinking Mums and Dads and SMSFs, have been active, buying up the bargain subdivision and development sites while others sat on the side.
This post looks at the types of properties small developers are going after, how they choose them and what strategies they use.
Small-scale subdivision and development
Firstly, what sort of properties are these small developers choosing? We’re talking properties zoned for higher density, such as triplex sites.
They are older homes, mostly built in the 1970’s and 80’s, where you’re paying a minimal amount for the bricks and mortar with most of your money going towards the land, zoned for subdivision and development.
- EXAMPLES:
- Triplex sites
- Retain and build
- Corner blocks
- Quad sites
Many investors see these small property development sites as superior investments to hold medium to long term. Some will subdivide and develop to rent out. Others choose to keep the existing old home, anticipating price growth on their development site to surpass demand for a single residential investment property.
In the meantime these innovative investors are creating their own capital growth by adding value through subdivision and property development.
Key Learning:
Create your own capital growth by adding value through subdivision and property development.
This works best where the strategy is combined with selection of the right development site and location.
For example, north-west of Perth along the corridor left and right of the Mitchell Freeway, where there are pockets of properties zoned well for small-scale Perth property developers, they have been buying up sites and properties for development.
“The project is completed at really low purchase and construction prices, with a plan to keep the newly-built properties and rent them out.”
Part of the thinking is that the property prices are currently at rock-bottom. Building prices at bargain basement levels. And the combination provides the perfect recipe for a great strategy, of buy, develop and hold.
The project is completed at really low purchase and construction prices, with a plan to keep the newly-built properties and rent them out. Developers expect this strategy to pay big dividends.
While rents are currently low, they are starting to pick up and, in any case, developing three new homes on a site has a great positive effect on cash flow because of the higher rent from the new homes.
Subdivision and development costs and finance
Development sites sell at a premium to single home sites, especially those with the most favourable development criteria ticked off. They can be anything from $50,000 to $80,000 more than the equivalent single residential property, depending on the features and location of the site.
If you’re just going to subdivide only, subdivision costs might range from $60,000 to $80,000, comprising around $35,000 for new services such as power and sewer and $25,000 to $50,000 for whatever else the site needs, such as driveways, tree removal and fencing.
- BALLPARK SUBDIVISION COSTS:
- Services $35,000
- Rest of subdivision $25,000 to $50,000
One builder we work closely with advises his clients subdivision will be more than $50,000, but usually less than $100,000!
This would include allowance for surveyor and a subdivision manager, so you don’t have to plan all the detail, find the trades yourself and meet them at site or check on their work.
Subdivision costs must either be paid in cash or borrowed against equity in another property. You can’t borrow the costs against the value you expect to create by subdividing.
“The gold standard if you can afford it is to complete the whole development, and if possible do it as ‘built strata’.”
Subdivision alone doesn’t usually maximise your return on the site. With the right site it can make you a profit, but it’s not a common strategy because much of your profit is lost on entry and exit costs and taxes.
The gold standard if you can afford it is to complete the whole development, and if possible do it as a “built strata”. This means you get approvals and get straight into the building as quickly as possible. It is the most cost-effective way because it’s quicker and you incur less interest. You also deploy your development resources more efficiently, with each service being commissioned once only, not doubled up in the two processes.
“Build strata” construction and subdivision of three 3×2 homes would typically cost $700,000 to $750,000 turnkey – including absolutely everything turnkey, where you juts get handed the keys to your new homes.
On top of that is bank interest, which will depend on your loan amount and lender. We are fortunate to have some strong relationships with lenders where we can finance the construction at very low rates.
This is important because, even though the loan is fairly short-term, you’re paying interest without receiving rent. Even if you capitalise the interest, it adds up fast, so the lowest possible rate makes all the difference.
- TIPS:
- Build strata lets you develop straight away
- It’s the best way to go, if you can afford it
- If you can’t afford it, subdivide first, then build
- If you can afford it, develop as “built strata”
You need stronger financial credentials for build strata because the bank valuations on these projects is quite low until construction is complete. We assess our clients’ finance upfront before they finalise their target strategy so they don’t get caught out half-way through.
If you cannot afford to do a “build strata” project, it’s generally better to do the 2-stage process of subdividing then building, rather than miss out altogether. It may cost you $20,000 more, but you end up with three good investment properties rather than wishing you had.
Development site selection
The biggest hurdle is finding the right site. One in 20 properties on the market is a development site. Of those, let’s say 1,000 development sites, only the top 10% would make great subdivision or development projects, about 100 properties.
So, in a given buying budget range, let’s say $600,000 to $700,000, we might search through several hundred properties to find the development sites. Next we assess and eliminate 50 to 100 and shortlist 10 to study further against the criteria for a good project.
We whittle this down to 1 to 3 top choices, given all the pros and cons.
Funneling Down:
From 20,000 properties, we whittle it down to the top 1 to 3 choices.
These criteria could include the shape of the site, the zoning and the location. Even within a single local government area, individual precincts can have different development rules.
For example, some might require you to keep the existing home and just develop the rest of the site, while others may require you to demolish the existing home to gain the development green light.
Nearby attractions and ease of getting to work and play affect attractiveness to tenants and future buyers, so all the critical investment boxes should be ticked off.
Other features that make a development site one to go after or avoid include the slope, location of services and easements.
In some areas you might be forced to create a 6-metre-wide driveway, leaving you too little space for your new lots. In still others, you may have to merge two blocks before you can apply to develop.
Those are nasty shocks to find out afterwards if you weren’t able to do a thorough due diligence check before putting pen to paper.
Even worse is finding out your particular property requires you to cough up several thousand dollars per new lot as a “development contribution”, pushing your costs way higher than you bargained for.
On the other hand, some Councils just require compliance with the standard R-Codes and some development sites are just easier to deal with than others.
Checklist
Here are just some of the reasons we might reject a site:
- House is too valuable to demolish – it might have been renovated
- Busy road or intersection – turnoff for some tenants and future buyers
- Irregular shape – adds to development costs and limits appeal
- Street very unattractive – you can’t change the street!
- Site is minimum size – resulting lots would be too small to build a decent house
- Wrong suburb – not attractive for tenants and future buyers
- Site costs too high – multiple costly requirements add up too high
- Steep slope – retaining costs too high
- Wrong location – not enough growth drivers
- Limited development – development result not right
- Outcome uncertain – too risky for gaining approval
No perfect property subdivision and development site
However, it’s critical to remember there’s no perfect site. There are always site costs and provided your site doesn’t carry every type of costly requirement, all sites have some needs, such as tree removal, retaining walls or a pool to be removed or many other combinations.
If there was a perfect site, every developer would be after it and the price would likely be bid up way too high. If you aim for the perfect site, you’re unlikely to become a developer, so it’s valuable to learn that up-front.
Buy the best site you can find within your budget, do a thorough due diligence and ensure you don’t pay too much. Our due diligence for clients comprises about 30 steps and makes up a document of about 25 pages to ensure every box is ticked, with no nasty hidden surprises lurking.
One more wise tip that professional developers do – allow a small slush fund for the inevitable unexpected costs that come up along the way, so you don’t get caught short. A typical contingency is 5% of your building or subdivision costs.
Which is the best strategy?
We encourage the buy, develop and hold strategy for many reasons.
When you develop and sell, so much of your gain is used up in transaction costs, including selling agent commission, marketing costs and income tax. Then, if you repeat with a new development, it’s like two steps forward and one step backwards.
When you develop and hold, you’re increasing your property investment portfolio and holding an asset for rental return and long-term capital growth.
Rental return on new units is generally higher, maintenance is low and depreciation benefits are good, all contributing to improved cash flow. The increase in rental over the old demolished home should way surpass the interest on the construction loan, if it is structured right.
Some of our clients pay principal and interest on the new property loan, even though it is an investment, aiming to pay it off and keep the 3 newly developed properties, eventually debt-free, for a very comfortable later income.
Three homes at gross rental of $450 per week each means an annual income of $70,200 gross. If expenses are 20% all-up, net income is $56,160 and just two such projects over a working career could net income of $112,000 every year.
- Example:
- 3 new homes renting @ $450pw
- $56,160 net rental per year
- 2 projects – 6 properties
- Income $112,320 per year
Rental increases aligning with inflation means the buying power of the income would hold as time passes.
Next steps
Keen on dipping your toes in the water? It’s truly a good time for subdivision and development now, before property prices and building costs rise. If you can’t afford to develop now, buy the site and rent out the house as long as you need to until you have enough equity and cash to build.
It’s not for the faint-hearted but if you’re willing to do your homework and give it a go it carries not only material rewards, but a sense of achievement and fun. You’re creating something and providing much-needed homes for the future.
Tip: Don’t hesitate to use professional help and enlist the assistance of a buyer’s agent, such as Property Wizards. The cost is far outweighed by the peace-of-mind and not having to learn from costly mistakes.
LEARN MORE
If you want to learn more about property investment strategies, or you’d like to clarify your investment strategy and goals, why not complete our Getting Started form to get the ball rolling.
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Call us for a free Financial Health Check: 08·9381·7450 or download our Finance Services information.
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