Making money in property 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.

When planning your development project, the bottom line should be the return on your investment. The key to making money in property development

I target a 15 to 20 per cent return on development costs.

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.  

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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. How banks cover 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.

What will the end values be on completion of your project?  Market falters

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.

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About

Bryce is a property development specialist, having successfully sourced, project managed and completed hundreds of development projects for Metropole’s clients, helping them create substantial wealth.Visit Metropole.com.au


'Making money in property development' have 12 comments

  1. Avatar for Property Update

    February 8, 2018 Anney

    Thanks Michael for the info link. I’m very keen to move ahead. Now, what about finance? do you provide brokering services too or I need to go elsewhere. I understand that not all finance broker specialise in property development loan. Can you recommend one?

    p.s been watching your youtube and podcast – great advice.

    Reply

    • Avatar for Property Update

      February 8, 2018 Michael Yardney

      Yes the finance brokers we work with specialise in development finance, but you need equity and serviceability.
      Why not have a chat with one of our property strategists – click here

      Reply

      • Avatar for Property Update

        February 8, 2018 Anney

        Sounds good.
        One other question though, as this will be my long term investment strategy. Will my investment journey with your company be a ‘do it for me’ or ‘involve me in the project’? meaning, I come up with the equity/serviceability (finance) and you do the rest or I have the option to get involved in the ‘development’ project process? meaning I learn about property development as I invest?

        Reply

  2. Avatar for Property Update

    February 1, 2018 Anney

    Good article.
    Can you clarify…. 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.
    1) the 15% return, is that a net profit after all the development cost and expenses including loan interest paid?
    2) investment fund return up to 75%. How did you calculate that? base on a $2mil dev project hence investment fund is $400k and $1.6 mil borrowing? therefore 75% return?

    Reply

    • Avatar for Property Update

      February 2, 2018 Michael Yardney

      Anney
      In principle your calculations are correct – as in all investments the return on your own funds invested is what is important.
      Howvever, you would need much more than 20% of the funds to undertake a development – often 30% and up to 40% as there are many costs the bank doesn’t pay for

      Reply

      • Avatar for Property Update

        February 2, 2018 Anney

        Thanks Michael for your reply. Great advice and tips.
        So, undertaking a development would require 30-40% deposit/funding? that means 60-70% LVR required? Now, the 30-40% funding, can this be all from and equity funding? and will this funding depends on the project size e.g. 2 townhouse will require less than a 4 townhouse project, won’t it?

        Reply

        • Avatar for Property Update

          February 2, 2018 Michael Yardney

          Correct Anney
          A 2 or 3 unit project is funded like differently to a larger development which requires “commercial funding” with much stricter criteria

          Reply

          • Avatar for Property Update

            February 6, 2018 Anney

            Thanks Michael.
            1) Realistically on a 3 townhouse project in Melbourne, what would be the development margin expected (in general)?
            2) I’ve seen an equity partner investment opportunity, the return on equity is about 25% and 10% development margin expected. What are your thoughts?

          • Avatar for Property Update

            February 6, 2018 Michael Yardney

            Steer clear of the equity partner opportunity – I’ve seen those to and there is a new group around with minimal experience “taking” people’s money.
            If they were successful developers why would they need you as a partner
            Run …very quickly, in the opposite direction

          • Avatar for Property Update

            February 7, 2018 Anney

            Michael, do you offer a one-stop shop property development process – from site sourcing right through to construction?

          • Avatar for Property Update

            February 7, 2018 Michael Yardney

            Anney – yes we do and we’ve been doing so since 2001 – you can find out more about Metropole’s Project Development Services here

  3. Avatar for Property Update

    April 27, 2015 Bunbury Real Estate

    Investing in a property development is quite risky for new investors but thanks for this article. This gives them a good heads up.

    Reply


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