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November 11, 2015

Winning property development isn’t luck – it’s strategy

By JAMES ELLIOTT

If a development is going to go wrong, the vast majority of the time it’s a disaster before a single sod of earth is touched.

Over a series of articles, we’re going to take a detailed look at the real world strategies we use to create profitable small developments for our clients every time. I won’t share with you any theoretical ideas or concepts that are untested. Anything you learn from this series is a strategy we use to ensure we get results.

When asked what my best tip is for anyone considering doing a development, I always say, “Know exactly what you’re getting into”. You need to know every single detail before you start a project so you know there won’t be any surprises. Talk to anyone who has lost money on a project, and I bet they’ll talk about the things that surprised them and the things they “didn’t see coming”.

When you know exactly what you’re getting into, there are very rarely going to be major surprises that’ll hurt your project. Additionally, if you’ve done accurate (and rational) due diligence, your project should almost never go into the red and lose you money.

As we say to our clients all the time, “It’s not luck, it’s strategy”.

Here are the main strategies we use that we’ll be digging deeper into over the coming articles.

Fixed price build contract
You must have a locked-in build price with no variations allowable in the contract. It’s always the variations that blow out the cost of your build. There are some seemingly innocuous clauses in a “standard” build contract which, upon close examination, mean you can have a limited idea of how much your build is ultimately going to cost you.

If a development is going to go wrong, the vast majority of the time it’s a disaster before a single sod of earth is touched.
Turnkey finish
Whenever you hear a builder say “turnkey”, take that as a reminder to start asking a lot of questions. Some builders play pretty fast and loose with their definition of “turnkey” and you need to watch out. For our clients, “turnkey” has to mean “ready to rent”. The builder can hand the keys to the agent who can immediately lease the property – no last-minute, unexpected surprise expenses (not to mention the weeks of lost rent) like blinds, lawns, paths, clothes lines, etc.

Guaranteed build period
Every week a build falls behind is obviously an additional week of interest you have to pay. But the real costs are actually much worse than this when you consider what Warren Buffett calls the “opportunity cost” of what you miss out on. You can’t forget to factor in the weeks of rent you lost as well as the tax deductions you didn’t receive from the depreciations in that time. On a small development, lost rent and depreciations can be pushing upwards of $2,000 a week, so this is a significant risk that we want to eliminate.

But this raises the next important consideration.

Liquidated damages
This is essentially the penalty builders will pay when they go over their guaranteed build time. Many industry build contracts have this set at $50 per day. That sounds pretty reasonable at first glance, but when you crunch the numbers, that’s only $18,250 a year. On a $700,000 build that’s a tiny 2.6 per cent penalty for going a whole 12 months overdue – hardly a big motivator, is it? Your interest bill on a project of this size will be at least $70,000 a year, so no prizes for guessing who’s going to bleed to death first in a situation like this. That’s why it’s critical to have significant liquidated damages to keep your builders highly motivated.

No provisional sums or prime cost items
Ultimately these are two fancy terms for “we had a guess at the cost because we didn’t really know them at the time… and we reserve the right to change the price later on”. This sorely misses our philosophy of knowing exactly what you’re getting into. Of course, if you’re doing a renovation on your own home, this makes sense to include. You may not have decided on the taps you want to use yet, so you factor some “wriggle room” into your contract to allow for it. However, when you’re building for profit, in order to create some known equity in a property, this is an unacceptable risk. We need to know every detail, every cost, before a sod of earth is turned.

Obviously there are nuances to each of these points and that’s exactly what we’ll be exploring over the next few articles.

About James Elliott

James Elliott is the principal of InvestorDeveloper.com.au, specialists in small development projects. He has managed projects throughout Australia and in the UK, ranging from small duplexes and restoration of ancient castles through to luxury, high-rise apartment buildings.