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Is development the right strategy for you?

Friday, 6th Apr 2018

Many property enthusiasts consider development the “sexy” side of property investment. The glamour of high returns combined with the creation of a physical building may sound appealing, but it’s important you are fully aware of the inherent risks this strategy brings.

The returns developers chase in today’s market are an internal rate of return of approximately 15% + per annum. These returns can yield profit margins in the millions for certain development sites. While these strong returns may sound incredibly appealing, there is a significant added risk. Such risks include:

  • Property market fluctuations: the market may not hold true in terms of value for the end product, which may be different to the pre-feasibility price expectations.
  • Your builder may encounter unexpected problems during the build which escalate costs creating financial burdens, or the builder themselves may reach financial hardship threatening their capacity to finish the project.
  • Setbacks in terms of planning and design can add to costs and stretch timelines.
  • Increased supply through completion of similar developments may create a more competitive market, putting downwards pressure on prices.
  • Overpaying for the site and under planning for costs creates an unfeasible project.

It is a common misconception that most property developers walk away with a lucrative profit margin. This can certainly be the case with well planned and executed developments, however, without proper research and development analysis things can also go spectacularly wrong. Plenty of unsuspecting investors end up in financial distress in the form of capital losses and cash flow issues.

Ultimately, development is a more volatile strategy which means it is of greater importance that you are in a secure financial position. You need to be able to afford any issues that may arise through cost escalation or timeframe extensions, which increase holding costs. It wouldn’t be the first time an inexperienced developer gets into the unfortunate position of having to sell a very attractive development site, due to their financial inability to hold/develop the asset.

If you are considering whether property development is a suitable option for you, start by carefully considering whether you are in a positon to take on the elevated risks. You must have the capabilities to afford the initial large capital outlay as well as be able to service the loan during the times of peak debt.

Finally, development has very lumpy capital transactions which can cause strain on cash flow. The strategic developer will not place the majority of their money within a single development, as it heightens the risk drastically.

Are you suited to development?

If you are at the start of your wealth building journey, you are probably better suited to purchase growth assets, or development sites with the aim to develop in the future. The capital growth achieved in these assets will help finance the developments down the track.

Generally, development won’t be part of your investment strategy until you are further along in your journey. In today’s market with its stringent finance requirements, it is typically reserved for more experienced property investors with an appetite for risk, the serviceability to pay for the development and the cash to obtain the site.

If you would like to find out whether development is right for you, request a no-obligation consultation with our team. We will obtain an understanding of your situation and will be able to advise you on whether development is the right strategy for you.