I see and read a lot of articles that encourage investors to undertake developments. Nothing wrong in that per se but what is slightly irresponsible is that in so doing they consistently fail to outline the risks that attach to moving down the supply chain.
This is an effort to right that wrong.
I want to look at the key elements of the process and outline both the risks and how they might be managed, because it is very much about the risks and an investor’s appetite to embrace that risk. I’m going to concentrate on residential development because commercial is a whole other ball game.
Starting with the land.
You need an unencumbered title; a conveyancing solicitor upon purchase should ensure that is the case but those are the words you want to hear. Should the title be in any way encumbered, you would need to decide whether that is a risk worth taking. Typically, this might be a covenant, or lien, or some charge or condition set against the title. It can be used to negotiate a reduction in price, but you would need to be sure that the saving outweighs the cost or the effect of the encumbrance.
You should also look for issues such as easements, or lack thereof. Others’ access rights, trees, services, basements or underground structures or contaminated ground. This should all be part of the due diligence process and dealing with any of them carries a cost. Over-head power lines may be problematic, particularly in respect of scaffolding.
When purchasing land for development purpose you’ll need to have some idea of what can be built so the land value can be assessed. So, for feasibility purposes, you’ll need to know approximately the number of houses/apartments that can be put on the site. That influences the purchase price completely.
Frequently vendors have a limited understanding of what can be achieved on a site and this can be an opportunity.
It will require either knowledge and understanding of the planning rules or paying someone to undertake a feasibility study. I would strongly suggest one or the other occurs. Typically the constraints will be density, site coverage, recession planes (blocking of sunlight) and parking. There are others but these are unlikely to be critical.
Having understood the potential of the site you’ll also need to understand the costs, and they include;
access way and parking
curtains, washer / driers etc.
A basic residual calculation will determine a land value concomitant with whatever profit level you seek to achieve.
In my view you should be targeting 20% net profit on cost (after GST if applicable, and it probably will be); anything less and funding becomes difficult and the risk increases.
That said, if funding isn’t an issue, and you are looking to hold long term, a lesser profit level may be acceptable. It all comes down to appetite for risk and your strategy for the development as a whole.
A key part of this is the ground. You will need a Geotechnical report.
From that, a foundation design can be determined, and this is vital because work in the ground is probably the biggest risk you’ll face.
If there is no Geotech report offered with the sale, you should think long and hard about how that might be mitigated.
There are ways and means; contingency is one. A conditional contract until the Geotech can be undertaken and the foundation (at least in outline) designed, is another. That though, carries a potentially unrecoverable cost.
My view that if a vendor is expecting a reasonable price for the land, then he/she ought to provide the basic information necessary to inform an offer at the level that is expected. I have seen many sites where the vendor expects full value for the land but has done nothing, other than offer it for sale, to enable that value to be realised.
Assuming this has all been done, you will now need a contractor; this is a major issue. You need one that is good, reliable, experienced and not only solvent but who will stay solvent. Don’t forget, profit and loss accounts and balance sheets, are only a record of a moment in time and are only current for a short period of time.
How do you determine all this?
You must at least seek references, visit other projects, talk to current/ex clients. There are possibly financial checks that can be done but not on private companies.
Profit and loss accounts, even if rendered are no more than an historical snapshot in time. Fletchers here in NZ and Carillion in the UK, didn’t look too bad 18 months ago!
Have a signed contract and agree a completion date.
Makes sure instructions to vary works are in writing.
Most residential builders will require some form of advance/mobilisation payment (not so, commercial ones). It shouldn’t be massive.
Subsequent to that payments are in arrears against value of work done or milestones achieved. Do not pay further monies in advance.
Makes sure whoever designs the foundations offers a reasonable level of Professional Indemnity Insurance. What is offered up in NZ by the IPENZ short form is inadequate. You might be able to fix an architectural mistake with $50K or five times the fee but if your foundations fail, that will go nowhere.
I insist on at least $1M.
Do use the Personal Properties Security Register. (Look it up). It will provide some protection in the event of contractor insolvency.
Do not let problems fester. If there is an issue, address it. Talk to the contractor and seek an agreeable solution. Record everything in writing!
And it does no harm to seek legal advice on your options early on.
Getting to a formal dispute footing or citing a breach of contract should be a last resort but if it comes to that, so be it.
If, for any reason things do go wrong you must act. If you do nothing but bemoan the fact that it’s gone wrong, I can guarantee you one of two things will happen;
- If you are making a profit, it will reduce.
- If you are making a loss it will increase.
Do not sit around feeling sorry for yourself. Whatever it is, get is solved; almost certainly the quicker that is done, the less it will cost.
The perception of property development is that you buy some land, put your feet up, light a cigar and as buildings magically sprout from the ground, you open your drawer and the profits just roll in.
That is far from the reality and I don’t want to paint too negative a picture of it.
It is complex, there are varying stages, multiple balls in the air, technical and commercial issues to address and people to deal with and if that sounds too hard, either don’t do it, or pay someone to do it for you.
It is done, profitably and often and is not beyond the ability and application of most (in my view) but it must not be approached with complacency. It is a team effort and should be a collaborative one.
Do not leap to a large, complex scheme, walk before you run and most of all, learn from your mistakes!