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January 14, 2015

Property Development 101 – Part Six

By PETER KOULIZOS

So, you want to be a property developer. This can be a great way to make money, if you know what you’re doing. The property development process can be a long and complex one. The more you’ve planned and thought about your project, the more likely you are to succeed. Remember the old saying, “A failure to plan is just a plan to fail”.  

This Property Development 101 series won’t be able to teach you everything there is to know about property development. For this you’d need to read many editions of this e-newsletter, books, enrol in courses and /or have years of experience. However, if you read each instalment, you’ll learn about the fundamentals of property development and it will make you aware of what questions you need to ask so that you can make an educated and informed decision.
In the Property Development 101 series, I’ll be outlining the major steps involved in property development. These include:

  • Setting your goals
  • Research
  • How to find development sites
  • Choosing the best site
  • Drawings
  • Feasibility studies
  • Working with council
  • Selecting a builder
  • Finance
  • Project management
  • Real estate agent/property manager
  • Tax

In the first instalment, I outlined some strategies in relation to goal setting and research.

In the second instalment, I detailed some methods on searching for developing sites and then some considerations when selecting the best site to develop.

In the third instalment, I provided an insight into the design and drawings for a development.

In the fourth instalment, I looked at one of the most critical components of property development; the feasibility study.

In the fifth instalment, I considered what you need to do when working with the local council/shire to obtain approval for your development.

In part six of the Property Development 101 series, I’ll be addressing a number of issues you need to consider when selecting a builder for your project.

Overview

Building your development will probably be the most expensive component of your project. You could save money by sub-contracting the building work but if you’re not experienced in building, construction or development, I’d strongly advise against this. Your best option is to find an appropriate builder. By this I mean finding a licensed builder who has experience in building investment properties in the local area that are similar to what you wish to build and is recommended by others who have used their services.

The right builder

If you do a search on the internet, you’ll find countless builders that operate in your city or state. These will range from builders who may do just a few projects a year to multinational companies that construct hundreds of homes annually. So, which builder is best for your project? There are a number of strategies you can use to help select the right one.
Ask others who have built for their recommendations. In my opinion, referrals are the most important indicator in the builder selection process. If you don’t know many people who have built, drive around the area you wish to develop in and take note of the builders who are active there.
Once you have the names of four or five builders, contact them and ask if you can inspect some of their projects. The larger builders will probably have display homes you can check out whereas smaller builders should at least give you the addresses of completed projects or projects under construction that you can drive past.
Your final decision should be based on referrals, experience in building similar developments in your area and a “gut feel”. If a builder doesn’t seem right for you because they don’t return your calls promptly, doesn’t take you seriously, they aren’t helpful or you just don’t feel comfortable with them, look for another builder.

The right building contract
Most residential building contracts are ready-made documents prepared by the Master Builders Association (MBA), Housing Industry Association (HIA) or in some cases, the builder has their own contract. Whichever contract you have, make sure you READ IT VERY CAREFULLY before you sign as “the devil is in the detail”.
When it comes to residential building, there are generally three different types of contracts:

  • Cost plus.
  • Construction management.
  • Fixed price.

Cost plus contract
In a cost plus contract, the client (you) will pay for all the costs of construction plus a margin on top of the construction cost. This margin is the builder’s payment for his management of the project and is usually 10 to 15 per cent of the total construction cost. I personally don’t like this type of contract as it places all the risk with you, the client. Let me explain. Assume that you’re building four townhouses and you agree with the builder that his margin is 10 per cent. If the construction cost of the four townhouses is forecast to be $1 million, the builder will charge you an extra $100,000 for managing the project. However, if costs blow out, the builder’s margin also increases as it’s based on the increased cost, not the original $1m. If the cost of construction increases to, say, $1.2m, the builder’s margin is $120,000 (10 per cent of $1,200,000). Not only do you have to find an extra $200,000 for increased construction costs but you also have to pay the builder an extra $20,000!

Construction management contract
This is similar to a cost plus contract but the builder’s margin is fixed. If we use the example above, the builder’s margin on the forecast construction cost of $1m is $100,000. If construction costs blow out to $1.2m, the builder’s margin remains fixed at $100,000. I think this is a better style of contract than cost plus as at least the builder’s margin is fixed. However, I think the best type of building contract is a fixed price contract.

Fixed price contract
As the name suggests, the price is fixed. If the forecast build cost (including the cost of construction and the builder’s margin) is $1.1m that is all you’ll pay. Even if costs blow out to $1.2m, all you’ll pay is $1.1m.
This is a much safer option for you as the risk is with the builder.
Some builders also offer a fixed price/fixed time contract. With this sort of contract, the price AND construction period is fixed. This is great for you as time is money in property development and any overruns in time will cost you extra in bank interest if you’ve borrowed money for the project.
No matter which contract you opt for, READ IT VERY CAREFULLY. If you don’t know how to read a building contract, ask a property/construction lawyer to read it for you, especially the fine print.
Property development can be a very risky business. You can minimise your risk by selecting the right builder and signing the right kind of contract.

About Peter Koulizos

Peter Koulizos is a lecturer and the author of “Top Australian Suburbs”.