February 26, 2013 by Dymphna

How to Positively Gear a Development Project

I was speaking to a friend of mine recently about–what else?–Real estate, of course.  He’s a fellow I’ve known for years, who’s a very successful land developer.  We were talking about the problems that some real estate investors run into when they’ve decided to buy a block of land for development…

And the problems they run into trying to make a profit from all their time, effort and money they’ve invested in their development project.

Because as we all know, there are quite a lot of council fees, development costs, as well as building and design expenses that have to be covered before we make a dollar of profit.

For example, in a single house development project in a desirable area, the land may cost $240,000 and the build costs can easily be the same or even more. What usually happens is that by the time the project is finished, the investor ends up with a debt in the high $400 thousands and a negatively geared investment…

And if you have ever listened to my podcast or webinars at all, you know that I hate negative gearing! I call it ‘legalized poverty’ or ‘how to go broke in real estate investing’ and have no use for it.

But just how do you avoid ending up negatively geared when you’re in the development game?  How do you trim costs while increasing your profits at the same time so that the end result is a positively geared property?

You might be surprised at how simple it can be…

(And by the way, if you’ve found yourself in a negatively geared development project, don’t feel too badly about it. Even the big boys run into these problems quite often, actually. They don’t like to advertise that fact, but it’s true.)

Although every development project is unique, there are a few key points that you need to consider very carefully before you dive into your project…

Know where you’re building and why

First of all, know the area where you are building.  That sounds simple, doesn’t it?  Say you’ve bought a block of land in or near a working mine, for example. Business is booming and folks need places to live. It’s perfect, right?

Not so fast. When it comes to developing land, look for more than one reason to buy a block of land.  Not just a single reason like it’s nearby a mining operation.  Look for other reasons, too.  For instance, is there a city nearby?  Are there facilities like hospitals or a university?  Is it easy and cheap to get there?

This is important because single-industry areas are subject to the whims of the market, aren’t they?  And since a development project can take anywhere from 12-24 months or longer in some cases, a lot can change in that period of time.  That’s why an area with multiple sources of renters can be a smarter play.

Divide and conquer

Next, make sure the block of land you’re buying can be divided.  Take that one block, cut it in half, and build smaller houses or duplexes that rent for the same amount as a single house would.  Rather than build on a 1:1 ratio of one house on one block of land, turn that ratio into 2:1, or even 3 or 4:1 ratio. The biggest savings comes with this strategy because you’re getting the most use out of the land.

In addition, construction costs are less for each unit because you’re building multiple smaller units, not one big unit.  Each smaller unit will rent for about the same as the bigger one would.  Therefore, your rents are multiplied by a much greater factor.  This is alone will change the gearing equation to your favor.

Also, when you do divide the block of land, you will have the option of building on one part and selling another part.  You can put money from the sale in your pocket or use it to pay down the debt on the other part, which will also improve the gearing of your development.

Build in savings

In terms of housing costs, about 30 per cent of costs are products. You can really cut those costs by using better and more efficient construction parts. For example, lightweight energy efficient materials such as composite plywood can easily save you a good 10 per cent on construction costs alone. On a $240,000 construction project, that’s $24,000 that stays in your pocket!

When you consider the costs when you’re building multiple homes, you actually save quite a bit of money just by choosing the right construction materials.  Make sure that your contractor understands this from the very beginning.

Profit by design

That brings us right into our next strategy, which is using cost effective designs…

Building smaller but smarter homes without wasted space is a winning strategy.  There are big design costs in a building a house that you can avoid.  The biggest design costs–about 15 per cent–are hallways or directional areas to get from room A to room B. So guess what? Don’t build those; they’re not needed and you cut another 15 per cent unnecessary expense from your budget.

Another cost to avoid are “dinosaur rooms” like formal dining rooms or living rooms, which are used less than 15 per cent of the time.  If they’re not used and they’re expensive, why put them in?

A better and more economical use of the space is to build multi-use rooms that can open up into an indoor-outdoor room leading out to the veranda via a sliding door.  With the technology available to us today, you can easily make one bedroom double as a media room. What tenant wouldn’t want that?  So cut out expensive hallways and dinosaur rooms and offer your tenants very modern, useful and attractive homes.

Also, you can save a ton of money by building the units to suit the environment.  In hotter areas like Queensland, for example, there’s no need to build expensive two story homes with the bedrooms upstairs.  One-story homes are cooler, preferable to tenants, and are much less expensive to build and maintain.  Again, you’re saving money, offering value that no one else is, and reaping the positive results.

Finish smart

One final thing to remember is to be smart about the finishes you put in.  Depending upon the area, luxury finishes may or may not be of value.  In most cases, luxury finishes on the floors, high-grade bathroom fixtures and expensive lighting do not return value in terms of the rents generated.  They’re just not that much of a factor for tenants.

More important factors than the finishes are how you build the homes, their design and functionality, and the location.  By following the strategies outlined above, you will see your development projects making you money right from the start, and that’s what it’s all about!