How to determine if a development is feasible

You’ve found what you think is a brilliant development site. Now it’s time to jump on that roller coaster and start the ride of your life as you commence the analysis process. Will the project be feasible? What is feasible, anyway?

Let’s find out. Feasible is really another word for “is it going to be financially worth it for you to spend your time, energy, money, blood, sweat and tears developing this site?”

Some advice I can give you about property investing, and anyone in property will also tell you, is to stay emotionally unattached to the property, as this is where bad decisions can be made. I have seen it many times, and this is where it can all come undone.

Firstly, it’s important to determine your development strategy and your investing criteria before looking for a development site. Your strategy may include:

-          Land subdivision

-          Renovating an existing dwelling

-          Dual occupancy or low-density development

-          Renovating an existing dwelling to build new villas/units also on the land

-          Medium-density development

-          All of the above

Your budget will help to determine your development strategy. A simple land subdivision will be less costly (but not necessarily quicker) than a larger villa/unit development, for instance.

As part of your strategy, you will need to think about what profit margin you would feel comfortable making from a development. You may have heard about the”20% profit margin” rule for developers. Once all development costs are taken from the potential sale result of the properties, (when selling the properties) there will be a 20% profit margin. Personally, I don’t always work back from a certain profit margin, as I find this restrictive.

Most of my clients are looking to boost their portfolios and hold the new properties long term, so we also need to meet other criteria. By other criteria, I mean rental returns on completion. For instance, if a client wants to create a positively geared development, the end gross yield will need to be about 10%, and we will actively search for development sites in very strong rental areas of the Hunter to meet this objective. Other criteria will include the amount of equity we can create from the project. We strive to create more than $100,000 in equity after our project management fee.

To determine the feasibility of a site, you will need to:

-          Talk to an accountant who specialises in property and one who preferably develops property him or herself so that he or she can advise you on the best structure to purchase under and explain the tax implications when developing such as GST and CGT.

-          Meet with a financial lender or a bank to determine your budget and the best loan structure for your development. It’s important to choose a lender that offers construction loans and find out what their lending criteria is around this – e.g., not all residential lenders will lend to you for a four-unit site. Check interest rates on these loans.

-          Meet with solicitor to determine costs. Your solicitor will check for restrictive covenants or easements that may affect the land. He or she will also make sure services are available and connected, especially if you are developing in a new area, as well as finalising the deal for you.

-          Read the local development control plan and local environment plan and speak with your council’s town planner to find out development application and construction certificate costs. Get friendly with the town planner to find out which developments are wanted in the area, as this could save you time and money by getting it right the first time.

-          Meet with an architect and builder to determine what you can build on the site. Some builders offer standard designs, which will save you design fees. If they do this, then they will be familiar with the local planning requirements. If you are not happy with a standard design, engage a local architect to design specifically for the site. Get a quote.

-          A surveyor will give you advice on the subdivision process. He or she will prepare your subdivision plan and estimate costs relating to the subdivision including sewer extension and service connection costs.

-          Once you have a concept design and before you lodge your development application, meet with builders to determine construction costs. Try to get three quotes and make sure they offer you a fixed price contract.

-          Talk to real estate agents to determine the value of your development and rental returns on completion, as this will have huge impact on the success of the feasibility.

-          Research other costs such as stamp duty, reports, Insurance and Interest payments.

The aim is to keep the above costs to a minimum so you will receive a higher profit margin. All this information can be kept in a spreadsheet, or there are software programs to help you with this process.

Below is a quick one page analysis I do to determine if a development is going to be feasible. In this case the client is keeping the three properties we have created from one.

Purchase price three-bedroom house on 1,012 square metres of land: $210,000
Estimated set-up costs, stamp duty, legals, pest and building reports, survey: $8,500
Estimated renovation cost: $8,000
Build cost for a two bedroom duplex (2 x villas) to be built behind existing house: $353,000
Contingency: $20,000
Note: build costs includes all council, subdivision and other fees & charges. I always ask my builder to wrap all development costs into their contracts so my clients can maximise their lending.

Total development cost to create three properties from one in Hunter Region of NSW: $599,500

Estimated end values:

Renovated three-bedroom house on 400 square metres: $220,000

Two-bedroom villas, $260,000 each: $520,000

Total end values: $740,000

Potential gross equity to be created: $140,500

Note: lending costs are not included at this stage:

Estimated rental returns:

Renovated house $300 per week

Two-bedroom villas @ $280 per week each: $560 per week

Total rental return: $860 per week or $44,720pa

Gross yield on completion of development: 7.5%

Gross rental yield: How it works
One of the first calculations you will need to understand if you intend renting the properties on completion is the gross rental yield. To calculate the GRY you need the annual rent and the total cost of the development. If we use the above example:

Annual rent: $860 per week x 52 = $44,720pa
Total development costs: $599,500
Gross yield: $47,720 divided by $599,500 = 7.5%

The yield on the above example of 7.5% is ideal at the moment as anything over 7% is considered to be a strong yield. Some of our developments are creating up to a 10% gross yield.

Once you have obtained the estimates for your development and the figures are looking good, you have some actual estimates to go back and speak to your lender about and ensure you can finance the project. There are various finance options, so seek professional advice on the best one for your situation. Then before you purchase, ensure you have discussed the best legal entity to be purchasing under for your individual circumstances with your accountant.

When your finance is preapproved, you can then start to negotiate the purchase. Always ensure you have a preapproval before making an offer so you can move quickly to exchange. This is a good negotiation tool. Ask for a longer settlement and a lower deposit, which will reduce your holding costs.

There are many more things to consider for your site selection, so it’s important you do your due diligence. In the development game, time is money. So you will need to learn to assess a potential site very quickly. One way to fast track the analysis process is to engage other professionals to do this important work for you. If it is your first development then work with an experienced project manager so you can learn from them as you progress through the complicated and challenging journey of your property development. Enjoy the ride!