In this continuing series of articles, I'll take readers on a step-by-step journey through the property development process.
Today Part 19 brings us to the final instalment as I walk you through what to do with your completed project and the next steps as a property developer.
For those who do choose to sell, obviously, the optimum way to do so is with vacant possession – in other words, without any tenants on the premises.
In order to achieve this outcome and make maximum profits, it is crucial to get your timing right when it comes to securing the Certificate of Occupation and the Certificate of Registered Titles.
The last thing you want is for your completed property to be sitting empty and costing you money with slow turnaround due to delays with paperwork.Further, you need to clarify the tax implications of selling your completed project right from the beginning, before you even turn over the first clod of dirt.
There will be a GST (Goods and Services Tax) component that comes into play upon sale and depending on the type of entity that owns the property (eg. Individual, Trust, etc), there may also be trading tax or Capital Gains Tax to consider.
Of course, all of these payments to the tax man should be accounted for upfront, because that will help you to determine what your profit margin is going to be and therefore whether developing a property to sell is the best financial move you can make.
Tips: If the numbers do stack up and you decide to sell upon completion, the best approach is to employ a local real estate agent who is intimately familiar with the area.
You want someone who works in the neighbourhood on a daily basis and has a sound knowledge of the market and the type of buyer you will attract to your product.
I’m a great believer in having an exit strategy planned out before you even start.
So if you must sell, make sure you put that whole process in place prior to doing anything else.
It’s also advisable to get input from the agent about what sells in the area and advice on such things as the appropriate level of finishes that you should look at achieving and market demand because the product you offer the market is what you base your potential returns on.
Basically, the idea is to realise your return as quickly as possible after completion, without tripping over your own feet because you’re in such a hurry.
To achieve this ideal scenario, I prefer to start the marketing campaign before completion in order to create awareness that the product is coming up and to generate interest from prospective buyers who you can invite to view the property before it is finished.
To let
If your intention is to hold the property and rent it out upon completion, the idea is to get a tenant in and therefore have the property generating income, as quickly as possible.
This is because at the end of the construction stage, as long as you don’t have a tenant in place and no income arising from the project, you are at your maximum debt exposure and your interest bill is at its peak.
Essentially you want to get a tenant in to help you pay for the interest on your investment debt.
However, you don’t want to push a tenant in so quickly that you prevent the builder from tidying up some of the minor defects that always tend to crop up with a new build.
Ideally, you should give the builder a little bit of grace to finish off the project to the highest level of quality possible and fix any small problems before the tenant moves in.
Once the premises are occupied, it becomes more difficult for the builder to gain ready access because once tenanted, you have to deal with the other bit of legislation that comes into play, which is the Residential Tenancies Act.
Once the property is let, you can’t automatically assume that you can get access to address any issues because you’ve given the tenant the right to enjoy the benefits of occupation.
So making sure the build is properly finished is the first priority.
Then of course the next priority becomes, again as quickly as possible because of the financial implications, the titling and refinancing.
I would strongly suggest that the optimum way to rent out your completed property is with the assistance of a proficient property manager.
If you choose the right property manager who is familiar with the area, they will be able to advise you as to what type of rental figure is achievable in the area for your particular product, what competition you might have for your property and the vacancy rate.
They may also have potential applicants on file who are looking for a dwelling like the one you are offering for lease.
As much as you, the developer, can do your own due diligence, your ultimate focus will always be on the development process itself, whereas a property manager is skilled in achieving rentals.
Just as you want to find the right architect, surveyor, accountant and builder to make your development a success, when it comes to leasing your property it’s all about getting the best person for the job.
In terms of when to start your rental marketing campaign, while it’s not advisable to allow prospective tenants to inspect the property when it’s still under construction, you should aim to start advertising the upcoming product in order to generate interest in your property, with the intent of building up towards an official open for inspection, as soon as the dwelling is habitable.
Holding on to maximise your profits
So what is the best way to go?
Do you sell your property, take your money and run, or do you hang onto it to maximise your gains over the long term?
While there is no right or wrong answer to this question, I have to say that there are distinct advantages to keeping your development as part of an ongoing property portfolio.
Note: While this option might not seem as attractive in the short term, the long-term potential it has to create significant wealth is undeniable.
The primary advantage of holding your completed development is that you are essentially getting long-term investment gains at cost price.
In other words, while the completed property will cost you the price of the land and construction and holding costs (which should add up to below its market value), your capital appreciation will actually be generated on the end market value of the product, not the lower cost of the development to you.
For instance, if you bought a property for say $1,000,000 and it cost you $850,000 to construct 2 new townhouses plus costs, making your total spend say $2 million, and the end value of those three townhouses totalled $2.3 million, your capital appreciation over the long term is made on that end value figure of $2.3million, even though you only paid $2 million for the property.
In other words, you've bought at "wholesale."
Basically, your future capital appreciation is made, not from what the development cost you, but what its end market value is.
Secondly, there is the ability to generate rental income at a higher yield.
Remember that you are achieving a market rental on the end value of your property, but it cost you much less than that.
So while your yield on the end value might be at 3.5%, the yield on your actual cost price would be higher, possibly up around the 5% mark.
Thirdly, of course, there’s the equity that you have manufactured through the value add process.
The equity that you’ve created arises out of the savings you made at the outset when you only paid stamp duty on the land purchase price as opposed to the full end value of the development, as well as the value you’ve added to the property by creating a new product.
On the other hand, if you were to sell, the first person to come knocking at your door would be the tax man and once he claims his slice of the pie, you would be taking a smaller cash profit than what the project promised on paper.
The bottom line...
If you choose to sell you might be realising your returns there and then, but you’re also giving away the ability for longer-term capital appreciation.
Furthermore, one of the main challenges with property is that the exchange costs are very high.
In other words, if you buy another property you’re going to be stung at least 5% for stamp duty, plus buyer’s fees and legal fees.
As a result, if you were to then realise the profits from a development and put that into a new development, much of your return goes into a tax on your project plus the stamp duty for that next purchase.
That is essentially why I believe it’s more important to look at the development as a part of the big picture – the big picture being your entire portfolio.
Yes, the development is important in its own right up until the very last paint stroke is applied, but in my view, it’s even more important as part of a longer five or ten-year investment plan.
At Metropole Projects, each one of our clients is in a unique situation when they decide to become a property developer.
Some undertake this challenging task because they want to make quick cash at the end and therefore intend to sell the project upon completion.
Others have a longer-term plan and choose to rent the finished product out, holding it in a property investment portfolio.
If you want to learn more about the property development process you may be interested in How To Get Started in Property Development
Why not contact us and have a chat with one of our property strategists about your options.
You may also be interested in reading our Team Series or check out our graphic guide to the Property Development Process.
