DIY (develop it yourself)

Periods of stagnation in property markets often compel investors to consider more aggressive strategies. The current slowdown, along with higher interest rates, has left many seasoned investors pondering their next move.

Given that Australia’s housing supply is already at critically low levels, with the Housing Industry of Australia estimating that 500,000 new dwellings will be required to accommodate our growing population in the next five years, there is no doubt the cost of new homes will rise in the future. (See today’s feature by Christopher Joye, House price surge is building.)

Adding to existing supply constraints is the fact that large developers are reluctant to get their hands dirty because higher interest rates and softer values are making large-scale projects less feasible. HIA data for June showed that building approvals weakened to their lowest level since the end of 2006, with a seventh consecutive decline suggesting a significant slowdown in residential construction for the remainder of the year.

Along with a 5% nose-dive in construction finance for May, the HIA reported that “on a seasonally adjusted basis, total building approvals fell by 0.7% in June, following a drop of 7.8% in May. The number of detached house approvals was down by 0.8%. Approvals for the more volatile multi-unit segment eased by 0.5% following a 20% drop the previous month.”

Source: Housing Industry Association

For the cashed-up entrepreneurial investor, a viable option might be to undertake their own development: to acquire a residential redevelopment site while conditions are soft, with a view to completion in 18 months to two years when the market is likely to be more robust and interest rates may be lower.

Of course any investment activity that has the potential to generate a greater profit in a shorter time frame comes with associated additional risk. And although the ongoing housing shortage might provide compelling motivation for some investors to consider a redevelopment, under no circumstances should you jump in without testing the waters and carrying out extensive preliminary legwork. The first step is to surround yourself with a team of experts to work synergistically to help you maximise your profit margins.

Acquiring the team

The key to assembling the best team is to cover all major areas of expertise required for a redevelopment. Your specialist lineup should include an independent property adviser, accountant, a financier, solicitor, an architect whose experience is compatible with the location, style and scope of the intended development, and a reputable local real estate agent for the re-sale phase.

Having selected the appropriate team, your first step will be to assess your financial capacity. Then convene a meeting with the entire team to discuss the available options within your financial range, including the extent of the project you wish to undertake, which could be anything from a straightforward cosmetic renovation to a full scale multi-dwelling development.

Feasibility studies

To ensure a professional and profitable development, it’s imperative to undertake a feasibility study that analyses the viability of the project, from site acquisition through to resale. It’s advisable to use a fairly standard profit benchmark of about 20% in excess of all costs and contingencies for a project to be considered feasible.

In almost two decades of property advisory experience I have observed that the lack of attention given to the financial feasibility of a proposed project is the main reason investors lose money on a redevelopment.

Here are the key feasibility considerations for a redevelopment involving demolition of an existing building and construction of two new dwellings. If your project involves less or more, simply adjust the items accordingly – and please don’t rely on this composite! Undertake your own feasibility study specific to your intended project.

Construction
Demolition of existing structures.
Two dwellings @ $XXX,000 each (based on construction cost of $XX,000 per square metre).
Driveway and garages.
Landscaping and fencing as required.
Total construction.

Interior finishes
Flooring, such as carpets, polished floorboards, lino, tiles.
Window finishes, i.e. blinds, curtains, etc.
Interior and exterior painting, timber and metal fixtures as required.
Light fittings.
Total interior finishes.

Professional and other fees
Stamp duty on purchase.
Architect and project management.
Surveyor.
Solicitor/conveyancing/subdivision and resale (initial site acquisition and resale).
Real estate agent’s commission on resale.
Municipal permits.
Marketing completed project
Total professional and other fees.
= Subtotal-construction, finishes and fees.

Finance
Total borrowings.
Bank fees.
Interest rate @ X% pa over 24 months, including settlement contingency.
Additional contingency sum.
= Total cost of project.

Resale details
Two new dwellings with a conservative market value of:
(dwelling one).
(dwelling two).
(In a tandem development, front units are generally assumed to realise a higher sale price because their street frontage theoretically confers greater appeal).
Total projected gross realisation.

Less
Percentage profit (loss) 20%.
Total cost of project.
= Balance.
Final analysis: Is this project feasible based on the benchmark 20% profit requirement? Yes/No.

Site selection

Right now, time is on your side, so take a few months to assess your preferred market. Stick to areas with a proven history of strong capital growth, such as the inner suburbs of major cities, bayside, or large, easily accessible regional centres. The location should feature established infrastructure, including public transport, healthcare, retail and educational facilities. If you’re contemplating a multi-dwelling subdivision, dual street frontage provides optimal access with the bonus of street appeal for each dwelling.

It’s worth considering an undervalued or under-capitalised site in a previously designated light industrial or commercial area, rezoned for residential use and undergoing gentrification. This should pave the way for strong demand within your target time frame. Several of these locations are still emerging across the nation, such as in select pockets of Melbourne’s inner north and western suburbs.

Similarly, consider sites with permits already in place or even a project that has been shelved. Avoid a site that is architecturally significant or in a heritage area with a period building that, if demolished, could raise objections from local residents. Before committing, always seek the guidance of your team in determining whether your idea is likely to succeed.

Ask your property adviser for guidance in site selection and negotiation, because saving as much as possible on the purchase price will significantly reduce risk and maximise your net profit.

Style of development

Now it’s time to consider the architectural and stylistic elements. Take note of pre-existing streetscapes, and in particular any new developments coming on the market. Inspect as many properties as possible to ensure you are conversant with the design, styling, materials, workmanship and buyer responses to projects in your target area. Focus exclusively on developments that reflect realistic construction and resale budgets for your purposes.

For example, don’t build an unsympathetic cutting-edge development in a conservative suburb. These may look fabulous in funky inner city locales, but they won’t be appreciated by residents in traditional suburbs filled with period homes.

Consider the demographics of the location. An affluent buyer in an exclusive suburb would expect to see state-of-the-art European appliances and high-level finishes, whereas purchasers in a less prestigious area will have less lavish requirements.

One more thing

Your team should meet about once a month to ensure that everything is on track and to undertake more detailed forward planning.

Property Q&A

This week’s questions cover:

• Are car parks necessary?
• Buying in Sydney’s middle ring.
• The importance of age.
• Replacing investment properties.

Car parks

You say never buy a unit without car parking. We know that public transport usage is soaring, and there is a move away from cars, especially in the inner city and particularly among young people: the same areas and demographic you concentrate on. Times are changing; can you see a day when you drop your rule about car parking?

At face value, soaring fuel costs and a growing awareness of the environmental impact of cars could conceivably mean fewer cars, but it’s unlikely that a sufficient number of cars will be eliminated to render car parking an expendable investment criterion. Even if this did occur, with smaller dwellings becoming more popular, the additional storage capacity offered by car spaces and lock up garages will prove invaluable even for those who opt to be car-free. You only have to look to Europe and the US to see how much of a premium is attached to the extra space. Ultimately, it’s having the choice to park a car, store bicycles or ski gear or bulk-buy non-perishable food that is the real attraction rather than car parking per se.

Sydney’s middle ring

I am a first-time investor thinking of buying a two-bedroom unit in a middle-ring Sydney suburb. I have noted both good and bad points about the area, and wanted to ask your opinion about whether it is a good place to invest.

The area features excellent public transport, health care, roads, infrastructure and services and schools. There are two major shopping centres. However, there have been many empty shopfronts along the main street and above the train station in recent years. I am also concerned that changes to the local banking facilities will reduce staff numbers and service standards, which would have disastrous consequences for local commerce, which depends on local workforce numbers.

In principle, I have no issue with Sydney’s middle ring. All asset classes go through cyclical ups and downs and because property is a long-term investment the softer times should be mitigated by good growth as the cycle turns up. If you are buying an apartment, be sure it dates between 1930s and mid-1970s, is in a quiet locality near to all the good points you mention and away from the less favourable ones; all areas will have their good and bad characteristics! Your apartment should be in a small, low-rise block of up to 20 apartments and have dedicated off-street parking. Be sure that the position in the block confers abundant natural light and a pleasant outlook. If your budget limits you to middle suburbs at this point, I suggest you begin reducing debt ASAP so that you can use the building equity to move closer in when you next invest. As far as CBD units are concerned, as long as you invest in the correct areas and in small, established, low-rise buildings, CBD apartments are most unlikely to affect your investment as this is a different sector of the market.

The age of property

Other variables aside, how important is the age of a property? I am afraid that old properties will not appeal to coming generations of renters, and will need more upkeep and capital improvements. I avoid brand new properties because of what you’ve said about them, but what about newish properties? These have depreciation benefits, and are also likely to be more in demand for many decades to come. I would love to hear your view.

Chronological age is less important than structural condition and timeless appeal. When I assess property my checklist goes something like this: Is it the right location? Is the architecture classic/timeless and unlikely to become obsolete? Is the building structurally sound? Will the investment be reasonably tax effective?

You’ll notice I’ve placed the tax issue last: it should never be a key driver for property investors. But if all the other boxes are ticked and a recent renovation or new building of a classic style means that’s a tick too, then fine. Whilst I tend to favour Victorian, Edwardian and 1920s to 1940s houses because they do have timeless appeal across a wide variety of demographics, if there are structural problems I immediately eliminate that property.

Changing investments

I have three investment townhouses in Sydney’s east with a total value of about $2.5 million, all rented at $650–700 a week. I am, however, considering selling all and buying a knockdown in Sydney’s leafy northern suburbs and building a new house. I would need all the equity in the townhouses to do this. I realise the “do nothing” approach will realise great capital growth over the next 10 years or so. However comparing the returns on the northern suburbs option is a bit harder: the developed land/house value should be greater than the sum of its parts. Given that this would be a primary residence rather than an investment and therefore not attract CGT, are you able to assess the wisdom of doing this now?

Today’s column should provide some assistance in assessing whether this is a viable option and how to go about it. However, because your primary purpose is lifestyle rather than investment, I suggest that within reason, you concentrate on that rather than making a significant profit as long as you intend to stay put for at least seven to 10 years. Even so, be aware that you will pay a premium for a home that is both brand new and custom-made. Don’t automatically assume that your new asset will initially be valued at “more than the sum of its parts” by the wider market!

I am a little concerned that you will be selling all your investment properties and effectively placing all your equity into a home. This is generally not a sound strategy and I would suggest you consider whether some of your current diversification position can be maintained before proceeding. You may be wise to consider an existing property that will meet your lifestyle needs even if it needs to be moderately renovated.

Note: We make every attempt to provide answers to readers’ questions, however answers are of a general nature only. Subscribers should seek independent professional advice for more in-depth information that is specific to their situation.

Monique Wakelin is co-founder of Wakelin Property Advisory, a Melbourne-based independent property acquisition and advisory company, and co-author of Streets Ahead: How to Make Money from Residential Property.

Do you have a property question for Monique Wakelin? Send an email to monique@eurekareport.com.au.