Should you sell or hold your development?
For many property investors, the appeal of property development is the promise of creating enormous capital gain in a short space of time. Most people assume that to make money out of property development you need to sell the properties you develop. Is this a common misconception?
The decision of whether you should sell or hold the properties you develop depends on a number of things, including your financial position, the market conditions and the type of development you are undertaking. But primarily it comes down to your objective in doing the development in the first place. Some property developers aim to increase rental returns, while others seek to make a cash profit or simply increase and unleash their equity. Developing property can also be a way of obtaining new property at wholesale prices. It’s important that you are clear on your objective prior to starting a development as it can influence many aspects of the development.
People often sell properties they have developed because they think they have to sell to make money or “realise the profit”. However, by refinancing you can still access the equity you have created. Why might this be a better option than selling? It comes down to the risks and costs associated with developing to sell. Developing to sell requires expert market timing to get the property cycle right. Plus, if you sell properties that you have developed you will likely have to pay Sales Agents Fees and Marketing (3-4%), GST on the Profit Margin (2% if a 20% margin), and Income Tax (as much as 9% if a 20% profit margin).
It’s clear that if you develop and sell, transaction costs will eat away at your profit. For that reason, I believe developing to sell should not be the first choice in every instance. You could be far better off by hundreds of thousands of dollars by holding the properties. Many of the most successful property developers, such as Frank Lowy (developer worth $6 billion who has built a worldwide shopping centre empire) rarely sell.
So when should you develop and hold? The simple answer is when it is feasible. Depending on the type of development you do, you will generate either additional rental income over and above the interest costs OR you will generate additional equity. But preferably you will do both.
So when is the best time to develop & sell? Being a successful property trader requires focus, commitment and a lot of time. You need to do much more market analysis and it is inherently more risky as you are timing the market. To justify continual buying and selling, you need to generate high returns to warrant the transaction costs (agent fees, stamp duty, income taxes). You also have to be prepared to “landbank”, which is common amongst developers, who may hold land for 10 or more years.
Depending on the project there may be an opportunity to develop and hold some of the project (e.g. 3 units of 6) and sell the rest to pay down some debt. Professional developers can make a lot of money developing and selling, but it is a full time profession. Most developers still hold some part of their portfolios for long term investment.