Picking up from the first article in this series Property Development Article 1 – Locating an Architect and Builder, let’s move on to the next step in the development cycle.
This step involves looking to analyse potential areas/suburbs that may be suitable for a profitable residential development project. This is followed by a detailed search for properties that meets your criteria.
The key word here is obviously ‘profitable’. You could technically conduct a residential development project in any suburb, as long as you comply with the standards set out by the particular local government council. This however, definitely doesn’t mean that you could make a profit by simply building in any location.
There are four main factors to consider when determining the suitability of a particular area.
1. Council Regulations
2. The cost of the land
3. The development costs for the area (yes, they differ greatly)
4. Previous sales in the area
Before we get into the search for properties and the hard numbers you will need to run, let me quickly call out that local government regulations exist and vary between each area. I won’t go into what these regulations are as they differ greatly per council, however the best thing to do is to get in contact with the town planner who can provide you with all the relevant information for that specific area.
You will need this information to know what you’re looking for in prospective properties. To give you an example, in one particular area the minimum land size for development of a duplex was 550 sqm with a 15.5m frontage. This is obviously critical to your property search as you wouldn’t bother looking at properties that don’t meet this criteria.
Now, let me give you two real life examples when I conducted this exercise of searching for areas and properties and how they produced vastly different results.
Example 1: The numbers don’t add up
Originally, I was hoping to develop in the suburb I lived in so it would be easier to meet with the builder on a regular basis. After looking at numerous blocks of land I found that the average development site was selling for $800,000.
I knew of a reputable builder in the area who advised that a standard 2 storey 4 bedroom duplex, would cost roughly $790,000 to construct. In this particular area, the previous sales for a duplex, as described above, was roughly $800,000 per duplex.
So, if you add up the numbers (($800,000*2) – (800,000+$790,000) = $10,000.
As you can see if I developed this project, I would have made a loss after taking into account all the other development and sales costs such as selling fees and council fees.
Example 2: A profitable project
I moved my search closer to the city to a more affluent area. Even though my overall costs would be higher, if the numbers added up I was comfortable with outlaying more capital.
After looking at numerous blocks of land I found that the average development site in this area was selling for $1,100,000.
I obtained two different quotes from two different builders and was ultimately given two drastically different numbers. The fixed contract builder quoted me $1,100,000 and the other builder who would work on a time and materials basis quoted an estimate of $800,000.
After reviewing the list of materials provided by the second builder, it made total sense to me at the time how he had gotten to this figure. My previous two developments were both fixed cost contracts but I thought I knew enough to pick out any obvious flaws in his reasoning.
The previous sales in this area for a 2 storey 4 bedroom duplex was roughly $1,250,000 per duplex.
So, if you add up the numbers (($1,250,000*2) – (1,100,000+$800,000)) = $600,000
Now that figure is more like it. Now it absolutely becomes worth it to research this project in more detail. Let’s look at some of the other costs to consider now for a project of this size (this isn’t an exhaustive list but it calls out the major costs):
Interest on Home and Construction Loan: $33,000
Council Fees: $15,000
Subdivision costs: $8,000
Building Certifier: $3000
So even after some of the major costs, there was still $526,000 in profit.
Assume a 10% overrun in costs and we arrive at a final gross profit figure of $473,000. Which nets a return of investment of 25%. In any world or investment class, this is a fantastic return.
What comes next?
Now it’s important to stay close to your builder and architect during this phase of the process. Even though a particular property meets the local council regulations, that doesn’t mean the build costs and property design is the same. The particular property I landed on had a slight elevation to the front and side of the property, so I needed to get the tick of approval from both the builder and architect before I moved onto the next step.
Now to wrap up this step in the process I want to confirm really clearly that even though it sounds pretty simple, it definitely isn’t. Firstly, finding a site like this took months of work and analysing dozens of properties.
Secondly you will see later in this series that I made a mistake with going on a time and materials agreement rather than a fixed contract. So I definitely didn’t make $423,000 so easily, but thankfully due to the quality of the project, even this miscalculation of judgement still resulted in a profit, albeit a much lower one.
The next article in this series will focus on your architect drawing up your respective plans. More about that soon though. I hope you enjoyed this article!