How to create massive wealth through property development

Last month I explained how property development can be an effective strategy to achieve your financial freedom within seven to 10 years – or less. In part two, I want to share the numbers to show how you can do this for yourself and create a $6 million portfolio with $3 million equity. 

The table below sets out the property values, debt and equity position each year if you developed a four-townhouse (T/H) project every second year over a 10-year period (meaning five small projects). I assume that you sell two of your properties and retain two in each of these small projects. I’ve assumed a modest five per cent per annum long-term growth rate on the portfolio as historically most Australian markets have delivered at least this result.

The numbers also reflect the profits on the two townhouses sold each time.  So, in year one we had four townhouses worth $2 million of which we sold two for $1 million leaving us with $1 million-worth of townhouses (the value). The debt is also reduced by four x $100,000 (being the profit on each townhouse). As I think that being able to sell your own stock is a vital skill for developers, I’ve not factored in selling fees – although you can adjust the numbers for agents’ fees if you don’t choose to master this skill. (Agents are in the business of generating commissions, so they’re not necessarily going to get you the best price or terms for your project.)

DIY Small Development – How to create a $6 million portfolio in 10 years

Strategy: You do a 4-townhouse development every two years
You sell 2, and retain 2 in the years you develop.

Assumptions:
Value of each townhouse = $500,000
Profit on each townhouse = $100,000
Assumes you sell your own stock so don’t have to pay agent’s fees
Assumes interest-only financing
Capital growth on porfolio each year = 5%

Numbers on your retained townhouses

margie1
If you assume your portfolio will generate an income of around 4.5 per cent after costs each year, you’re making an annual cash flow (in today’s dollars) of $135,000 on your $3 million equity. And as these are new properties, with your depreciation schedules you may find you’ll pay very little tax on this cash flow.

As an added bonus, the capital growth of your portfolio from the end of year nine onwards, at five per cent growth, will be around $306,778 each year. This means that instead of selling your properties for additional cash flow you can refinance your portfolio and take out some equity growth tax-free over time as needs be (e.g. to finance travel or renovations or other lifestyle expenses).

Ideally, you’ll have a day job while doing this strategy so you can obtain residential financing, as banks love to see evidence you can service your debt – even when you’re only borrowing at a 60 per cent loan-to-value ratio (LVR), as we are in this scenario. If you don’t have a day job, you can resort to low-doc loans but these are harder to get and come on less attractive terms generally. Alternatively you could explore a “done-for-you” strategy, where you put up some risk equity (generally around $150,000) but someone else does the developing. This is commonly referred to as “wholesaling” and is an increasingly popular way for ordinary people to break into developing without having the skills to complete a project.

Wholesale Investment – Turn $150,000 into $1 million+ in 10 years passively
(while an experienced developer does all the work for you)
Strategy:
Put up $150,000 investment to finance a development and share the developer’s profits
Assume:

  • In year one you put up $150,000 and at the end of the year attain a townhouse at 20% below retail cost
  • The original $150,000 is refinanced at the end of the project and recycled every year into a new project
  • You invest in one wholesale deal every year for 7 years (using recycled $150K equity)

Value of each townhouse = $500,000
Profits on each townhouse = $100,000 (developer’s profit)
Assumes you are a passive money partner but share equally in the developer’s profits
Capital growth on your portfollio each year = 5%
Numbers on your retained townhouses


In the table above you can see how by using just one $150,000 capital injection you can be a money partner on small- to medium-sized developments and how that can generate a $4 million portfolio and more than $1 million in equity. All off one initial $150,000 investment that gets recycled each year (or 12 to 15 months on average) at the completion of each project.

The downside of “wholesaling” is that you’re reliant on the skill of the developer to generate your profits. So, the main consideration when considering this option is to do extensive due diligence on the experience and track record of your development partners.

By Margie Baldock

Margie is a property developer, entrepreneur and professional investor, who has undertaken $72 million worth of property projects including renovations, subdivisions, construction, options and project marketing in the past eight years. She is always looking for new projects and joint venture partners. www.prosperdevelop.com and www.PositiveGrowthProperty.com.au

Making money in development

The key to making money in property development, whatever the market does, is to carefully plan for a realistic rate of return and retain the flexibility to adapt to changing circumstances.

Target a 15 to 20 per cent return on development costs

When planning your development project, the bottom line should be the return on your investment. That is, the profit you make after you’ve sold the property or refinanced the property before tax. This is typically called your net profit.

A 15 per cent return means your (net) profit was 15 per cent of the total development cost of your project:

Therefore, the return on the total development cost is 15 per cent ($300,000/$2,000,000) but the return on your invested funds, which may be only $400,000 (having borrowed the rest), could be up to 75 per cent.

Why do I target at least a 15 per cent return?

In the “good old days” I was able to achieve a better profit margin than this, but today I suggest this rate of return because I’ve learnt that property markets falter and there are even periods where prices fall! They always have and will continue to do.

However, a 15 per cent margin is a good compromise between providing a safety cushion in case of sudden changes in the market, and being an achievable and maintainable target.

If you work on a 15 per cent margin, you’ll simply:

  • Make good money in a good market.
  • Make sufficient money in a bad market.

Obviously, if you firmly believe the property market is about to slump, you won’t get involved in a development at all. However, if you stick to the 15 per cent rule you’ll learn to be highly disciplined and effective in your negotiations.  Crucially, you’ll learn to walk away from a deal when it’s too risky.

This means, be prepared to walk! If the market is overheating and the opportunity of a safe 15 per cent return is not available, walk away. Wait until the market is in a better condition before you purchase your property. There are just some stages of the property cycle where you’re better sitting it out.

How banks cover their risk

If you think about it, banks use 15 to 20 per cent of a property’s value as a buffer against their risk.

We can see this clearly in the terms for standard mortgages. In order for you to get a mortgage, a lender usually requires that you put up 15 to 20 per cent of the property’s value.

This is based on their assumption that the market is highly unlikely to drop more than 20 per cent, so that even if the mortgage holder (i.e. you) went bust, the lender would still get their money back by selling the property and keeping the deposit.
If financial institutions use 20 per cent as the level at which there’s no real risk, then so should you.

If you also apply this principle – aiming for a 15 to 20 per cent return – you’ll be drastically reducing your risk exposure.

The risk conscious approach

To minimise your risks, when doing your financial feasibility on a potential development site always look at the potential downside – when you’re calculating potential returns of your development always take a pessimistic view.

Test your ability to finance the property under the worst possible conditions. Assume that interest rates will rise substantially and that end values and rental values will hold or even drop. What will the end values be on completion of your project? What could these fall to if the market falters?

If you’re planning to develop and hold rather than sell your property, which is my preferred strategy, when you’re calculating potential returns from rentals take a similarly pessimistic view.

If after these realistic calculations you can still make a good return, you can go ahead with your development knowing that even in a worst-case scenario where the bottom falls out of the market, you won’t lose money.

The crucial thing is that this level of security will enable you to hold on to a property until the market corrects itself (as it always does). Essentially, holding the property as a long-term rental will buy you time.

By Michael Yardney

Michael is director of Metropole Property Investment Strategists,www.metropole.com.au. His books are available from www.businessmall.com.au

Housing boom could last for two years

PROPERTY developer Stockland is confident the housing boom will continue for at least another two years.

LOW interest rates, population increases and an undersupply of homes is fuelling strong growth, the company said after its net profit rose 55 per cent to $462 million in the six months to December 31.

Underlying profit climbed 8.5 per cent to $290 million, thanks to a 73 per cent rise in earnings from its residential business, chief executive Mark Steinert said.

Growth in all its businesses, with its residential division the standout performer following substantially increased sales amid low interest rates.

“We expect, particularly in the eastern seaboard, an elongated residential cycle expected to show reasonable levels of growth for at least the next couple of years,” Mr Steinert said.

“Even though the broader economy is quite mixed, the (housing) undersupply and population growth underpins the housing industry.”

When asked if he was concerned about the Commonwealth Bank’s warning that weak confidence is a “significant economic threat,” Mr Steinert said the outlook was good in the major cities.

“In Australia, the regions, particularly those exposed to mining, are experiencing low or no growth, while the metropolitan areas are experiencing strong growth,” he said.

The low Australian dollar was helping to boost other sectors of the economy, including tourism, the overseas’ student market and food production, he added.

The headwind was the mining investment wind-down and how it will affect jobs and people’s confidence in taking on a mortgage.

However, Mr Steinert rejected the notion that the housing market was overheating.

Instead, he said he expected, over time, the market would “moderate” from a high level.

He said parts of inner Melbourne and inner Sydney had “been very hot” but were still “relatively cheap” compared to house prices in similar cities around the world.

And this was partly driving overseas buyers.

More than 45 per cent of Stockland’s sales are from first home buyers, 20 per cent are investors (predominantly Australian) and the rest are people downsizing or upsizing.

The company said it’s on track to achieve the upper end of its earnings per share range in the full year, which has been tightened to a range of 6.75 to 7.5 per cent.

Mr Steinert said the company’s commercial property business was also a key driver of first half earnings, with operating profit growth of 4.7 per cent.

IG Markets market strategist Evan Lucas said the company’s result was strong.

“There guidance in terms of EPS is at the top end. The figures are positive. It all looks very good in the short term.”

At 1525 AEDT, shares in Stockland were 11.0 cents, or 2.39 per cent, higher at $4.71.

LOW INTEREST RATES BOOST STOCKLAND’S PROFIT

* Half year net profit of $462m, up 55 pct, from $298m

* Revenue of $1.33b, up 33 per cent from $966.5m

* Fully-franked interim dividend of 12 cents, unchanged

BY PETRINA BERRY, AAP

First-home loan demand at 10-year low

GROWING demand for investment properties have pushed first home buyers down to their lowest share of the home loan market in more than 10 years, new figures reveal today.

The latest monthly home loan figures show first-home buyers’ share of new loans issued in December fell to 14.5 per cent — the lowest level since 2004 — at the same time as first home buyers’ average home loan size rose by almost $5000 to $332,000, the highest ever.

Owner occupiers (which includes first home buyers) borrowed more than $18 billion in December from banks, building societies and other lenders, a new record and 3.8 per cent higher than a month earlier.

Investor borrowing, meanwhile, over the same month rose 6 per cent to $12.6 billion, bringing their share of total new loans issued to 41 per cent, the highest since records began in the early 1980s.

Economists worry the growth of investor demand in the home loan market is increasing the likelihood of a house price bubble.

Separate ABS data showed capital city house prices rose 7 per cent in 2014 and by more than 12 per cent in Sydney.

In December the average price of dwellings across all state capitals was $571,000.

The number of home loans approved in December rose 2.7 per cent to 53,900, better than the 2 per cent rise economists had expected.

New loans issued for the purchase of existing dwellings rose 3.3 per cent to almost 45,000.

Adam Creighton, Economics Correspondent

Sydney

Coalition tightens rules for foreign purchases of agricultural land

THE Abbott government has tightened the rules on foreign purchases of agricultural land in a bid to have a more transparent system.

From March 1 the Foreign Investment Review Board screening threshold for purchases will be reduced from the current level of $252 million to $15 million, with a foreign ownership register of agricultural land also due to be established.

Making the announcement in the NSW town of Murrumbateman, Tony Abbott said the restrictions would result in the “right investment” for the nation.

“Foreign investment is important to us but it’s got to be investment that serves our national interest, it can’t just serve the investors’ interests,” the Prime Minister said.

“This is not saying that we don’t want foreign investment, we do want foreign investment but it’s got to be … the right investment that serves our purposes. It needs to be transparent.”

The new $15m threshold delivers on one of the government’s election promises and will apply to the cumulative value of agricultural land owned by a foreign investor, including the purposed purchase.

Mr Abbott also announced that the Australian Tax Office will start collecting information on all new foreign investment in agricultural land from July 1, regardless of value.

Agriculture Minister Barnaby Joyce said Australians living in regional and rural regions wanted a tighter control on “who owns what”.

“In the past we were left with this ridiculous scenario where someone could go to the north of Yass and buy $240 million worth of land one day, then go to the south of Yass and buy another $240m of land the next day … and never have to go to the Foreign Investment Review Board,” he said.

“People want to know that we are in control of our nation and we determine what happens and how it happens and we have complete transparency in how it happens.”

Further changes are expected within weeks aimed at foreign investment in residential real estate.

The Greens said the FIRB changes were a “step in the right direction” but called for an outright ban on the sale of agricultural land and water licenses to wholly-owned subsidiaries of overseas governments.

“It’s critical we make sure that Australia’s agricultural land and water are seen as key national assets not to be sold off recklessly,” Greens leader Christine Milne said.

“As global warming and extreme weather events disrupt food production worldwide, land grabbing and outsourcing food production by major importers of Australian food is undermining trade rules and threatening our food security.

“The Greens have long been calling to drastically reduce the threshold for the national interest test to $5 million, so the new $15 million threshold down from $252 million is a welcome move from the government.”

Senator Milne also encouraged the ATO to include water assets in its register on foreign investment activity.

Rosie Lewis, Reporter

Canberra