Dealing with the ups and downs of property development

If you’re planning to get involved in property development, it’s important to understand that you’re entering a very challenging adventure.

There’s no sugar coating it – you’ll face many ups and downs.

However, most successful developers have one feature that stands out above all else to get through these challenges ­– they’re tenacious.

I’ve found that tenacious people succeed because they’re driven by, and stay focused on, their goals.

After all, success doesn’t come instantly. It requires focus and determination.

Imagine the pride you have when you’ve found a way to get past obstacles like these.

  • You look at 50 potential development sites. They’re all too expensive or unsuitable and the only good one has been snapped up before you look at it.
  • You employ an architect who constantly wants to design his own thing and you have to take control of the situation.
  • You have difficulty obtaining finance because you’re an inexperienced property developer but you find the cash anyway.
  • When you start to pour the foundations for your property it rains continuously in the trenches and the foundations keep collapsing.

Stay positive and remain focused on your goals, even when everything seems to be going wrong. Your hard work and tenacity will have paid off when you finish and make a handsome profit.

Managing risk

Okay, so now you think you’ve got this property business rumbled, let’s just take a look at how the mighty tumble.

Nearly all developers start with one small property, they have a stake, they invest in the property and they make a profit – looking for a margin in the order of 15 to 20 per cent.

Once this first project is finished, they take their original stake and their profits and buy a bigger property. They then take the profit from this property and the stake and buy two other projects and on and on it goes.

Ten years later they’re worth, say, $10 million and it’s all invested in property.

However, when they started they demanded a 15 to 20 per cent return but now they have to accept 10 per cent because the market is frantic and they can’t find projects that return 15 per cent.

The double-edged sword is that if they stop buying property they will realise their total profit but be out of business.

So in desperation they break their golden rule and get into projects that will yield smaller margins and if (and when) the market drops they lose everything.

To protect yourself, adopt this key principle of a successful property development:

Aim for a margin on development cost in the order of 15 to 20 per cent (depending on the size, risk and time frame of your project).

Your development must still work financially for both a sell-on and long-term hold and rental scenario if you can’t seal your project on completion because the market has turned against you.

What I’m suggesting is that if you’re primarily planning to buy, develop and sell on, then ask, “if the market crashed tomorrow, what rental income could I expect to achieve with this property, and will that cover my financial costs – even if interest rates worsen?”

What are the other risks related to developing real estate?

While we all like to look at the bright side of things, developers must also understand the potential risks associated with the process. These include:

  • Rising interest rates, which would result in increased holding expenses.
  • Increases in the cost of construction due to the rising cost of building materials or labour.
  • A downturn in the property market occurring (for reasons such as rising interest rates, cyclical movement in the real estate market and depressed or unstable general economic conditions) resulting in lower property values or increased holding costs until properties are sold or leased.
  • Variations occurring in the local real estate market between supply and demand causing adverse fluctuations in property prices.
  • Disputes with builders or other trade contractors.
  • Changes to the laws relating to property development, including laws relating to zoning and town planning, restrictions on land use, environmental controls, landlord and tenancy controls, user restrictions, stamp duty, land tax, income taxation and capital gains tax.
  • When town planning approval is required for a development, unexpected delays and increased holding costs may be encountered while the application is proceeding through the council maze. It’s even possible that approval won’t be granted or will be granted on unfavourable terms.
  • Unexpected structural defects or building deficiencies that may be encountered resulting in unexpected expenses being incurred for repairs or refurbishment.
  • Some inexperienced developers find that some of the improvements they’ve made to their properties don’t result in an increase in value. They learn the hard way that increases in value don’t necessarily occur in line with expenditure on improvements.

As you can see, many of these risks are outside the control of the developer.

I know this all too well having been involved in property development now for close to 30 years. In fact currently the team at Metropole are project-managing 45 medium-density development projects in Melbourne for clients.

Our experience makes us acutely aware of the risks involved in development projects and this helps us minimise them so that our clients don’t get any unpleasant surprises.

While our projects tend to be very successful, I have to admit that we also run into some of these issues.

The trick is to learn to be ‘risk conscious not risk adverse’. If you never take a risk, you’ll never make a gain.

The fact is one of the big differences between successful and unsuccessful people is the successful people take risks while constantly looking to minimise their risks.

Starting at the appropriate level

While property development can provide great long-term returns, if you’re new to development, you should start small and build up. As you grow in experience, and benefit from the profits of your early projects, you’ll be able to take on more ambitious challenges.

You’ll learn 80 per cent of what you need to know about property development in your first four or five projects and by aiming for a 15-plus per cent return on your development cost, you give yourself leeway to make a few mistakes and still make a reasonable return.

With proper planning and preparation, you can make great profits in the long-term and eventually move on to bigger projects.

By Michael Yardney

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