Development feasibility

Discussion in 'Adding Value' started by emjay68, 20th Mar, 2013.

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  1. emjay68

    emjay68 Member

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    Hi all,

    I have an overall goal. It's basically to find a property (vacant land or house), demolish, subdivide in half, and build 2 houses. I want to know if my thinking for funding this project is correct. I'll use rounded numbers and make it very very basic to make things simple.

    Say i purchase a run down property for 250k with a 50k deposit. I demolish it (15k) and subdivide it (25k). So my loan would be 200k and i have already spent 40k out of my own pocket to subdivide it. Then i build house #1 on the first half of the block using a loan extension which costs 200k. This increases my total loan to 400k. Then i get the entire 2 blocks valued and it comes back at:

    - 350k for house #1
    - 150k for the vacant half of the block

    This gives the assets a total value of 500k giving an equity of (500k minus loan balance of 400k) = 100k.

    Now, obviously, i can't use that equity to build house #2 because it's simply not enough. Would i be able to do another loan extension of say 100k so that i'll have a total of 200k (equity + loan extension) to work with? This would therefore increase the total loan to 400+100 = 500k.

    Say i was able to do this and house #2 gets valued at 350k as well. This would give a total value of 700k for the 2 new houses. So now the equity is 200k. Is that then usable to buy the next property?

    Is my thinking correct?? Or am i dreaming? Is this how investors end up getting many properties over time?

    Thanks, and apologies if this has been answered already.
     
  2. Shahin_Afarin

    Shahin_Afarin Finance Broker

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    Thinking is fine as is the strategy - one of the big variable is the DA to subdivide. In Sydney metro the councils vary greatly as does wht you are able to do within those councils.

    I would start engaging a townplanner.

    Regards

    Shahin
     
  3. Aaron_C

    Aaron_C Finance Broker

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    You will get a construction loan to build the houses. That's how you do it.
     
  4. emjay68

    emjay68 Member

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    Thanks TFS. I'll definitely get in touch with the townplanner when i do find the property i want.
     
  5. emjay68

    emjay68 Member

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    Aaron, would the contruction loan be for both houses all at once? Or each house separately? i.e. in between subdivisions?

    If it was for both houses, i doubt i'd be able to afford the entire loan. And you wouldn't be able to leverage the equity from the subdivided land would you?
     
  6. westminster

    westminster P Plate Developer

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    First thing you have to consider very carefully is that you are planning on demolishing the house which the bank is using as part of their security.

    So if all the sums work out make sure you ask the bank to go along with the plan.

    To borrow the rest of the money (and probably prior to demolishing) you will get quotes from builders and choose one. Then get a building contract 'subject to finance' then seek your construction finance. The bank will value it on the land + the construction of the 2 houses. If the LVR is acceptable to them then they will lend you the money.

    You shouldn't need to do one house then the other unless you really want to. You will need to be able to service the loan though.

    During the construction the bank will dole out payments to the builder as they get to various stages. As the bank gives out money your mortgage will increase until the end when it will be at 100% of the rate they agreed to lend you. These draw downs on the loan help make the construction period holding costs a little bit more manageable.
     
  7. emjay68

    emjay68 Member

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    I'll most definitely let them know!

    So if the bank values it on the land and the construction of the 2 houses, does that mean the unsubdivided land with the original house? So the value would be original purchase price (250k) + price of 2 houses (200k) = 650k? I'd be very uncomfortable having to borrow that much at once. And after the 2 houses are built, and they are revalued to say 350k each, that would mean i would only have 50k in equity instead of the 200k i initially calculated.

    The reason why i thought to build the houses one after the other was to leverage the equity gained AFTER subdividing the land, therefore allowing me to build the 2nd house.

    Or have i completely misunderstood the whole concept of development?

    I see. That will definitely help holding costs for sure. Thanks for the info.
     
  8. westminster

    westminster P Plate Developer

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    Equity can be used as security for a loan but you would still be borrowing $200k more the first and next build.

    If you were using a Line of Credit on the equity you would be borrowing $100k from the first build (for example) and then another $100k for the construction. It still equals a $200k loan

    So your sums are a little skewed.

    Total cost $600k in loans + holding costs + $40k subdiv costs for a $700k valuation is not something I'd do - nor would the bank probably let you as the LVR is probably too high.

    Sorry!
     
  9. HD_ACE

    HD_ACE Game-Changer

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    why not go for a retain and build site? either battle axe or two street front corner block.
    This way you have income coming in from the original house, no demo costs and no security issues with bank.
    subdivide and revalue with a construction loan againts the vacant block to build? sell or keep one or keep two. Reno on the original house for extra equity. Can even do it with a triplex block. As long as the house is positioned correctly.


    Could be a much more simpler start into development.

    hope this helps cheers
     
  10. emjay68

    emjay68 Member

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    I apologize but i still dont follow. I understand that i would be borrowing 200k for the first and second builds. Which is why i thought that if i only build 1 house to start off with (which would probably take as long as the subdivision to be approved), then i can use the equity from the subdivided land and build the second one afterwards. If i tell the bank that i initially just want to build 1 house to start off with and leave the other half of the block vacant, this would work right? And then later on once the first house is finished, i'll go back to the bank and tell them "i've decided i want to build another house, can you re-value the new house + the vacant land and see if i have enough equity to build another?".

    I agree, i would not be able to do this and i wasn't planning to. Which is why i thought the strategy of building the houses separately and leveraging the equity gained in between builds would help me out.
     
  11. vaughan

    vaughan Member

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    I think what Westminster is suggesting is that there isn't money in the whole deal to make it worth doing, the bank will realise this and likely not lend the money.

    Your figures are this (total money spent, not just borrowed)

    Buy house and land $250k + stamp duty + costs = $270k
    Demolish + subdivide = $40k
    Build two new houses = $400k
    Total costs = $710k

    Valuation for houses at end = $750k

    That $40k "profit" will be eaten up by holding costs, selling costs and capital gains tax. Interest on $600k loan at 7% is $42k per year.

    Even if you built the houses one at a time, the end result is still the same set of numbers: there isn't any profit in the deal.

    You'd be better doing what HD_ACE suggested and look for a property where you can keep (and ideally reno) the existing place and build another out the back or side. The rent coming in will help ease the holding costs.

    To get a deal like this working you'll have to:

    minimise buy costs
    minimise build costs
    minimise holding costs
    maximise selling price

    As you can see, there are 3 places you need to keep costs in check, but only one opportunity to make money.
     
  12. emjay68

    emjay68 Member

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    There isn't money in the whole deal for whom though? Me or the bank? What's it to the bank if there's no money in it? If i can pay them back the loan, isn't that all they should be concerned about?

    Who's concern is this total cost of 710k? Mine or the banks? If i paid 50k for the deposit and 40k for the demo + subdivision out of my own pocket, isn't the total cost FOR THE BANK really 620k?

    I still dont understand why the loan is so high. You'll have to bear with me because i still dont have a firm grasp on equity and how to use it. In my example, i said that i would initially borrow 200k right? Then i would borrow another 200k to build the first house bringing the total loan to 400k. When it comes time to build the second house, are you saying that if i use the equity of 100k + a loan extension of another 100k, that the total loan would be 600k and not 500k? If so, i dont understand why. Isn't the equity essentially "intangible cash" that's basically yours? Forgive me if i have completely misunderstood this whole concept.

    Who's profit though? Mine or the banks?

    That is an option and i have been looking for those properties as well.

    I agree. And again, if i can afford it, why wont the bank lend me the money?
     
    Last edited: 21st Mar, 2013
  13. Rockstar

    Rockstar Member

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    Brokers may clarify but my construction/devt loans to date have been max 80% of construction costs.

    Once you have the land with a loan you have to ask the banks permission to make any additions/alterations, subdivide or demolition. They will have to approve the whole plan to demolish and build - whether in stages or all together.

    Good to go for an appointment with your loans manager or a broker to check if you have the capacity to achieve all of this. Serviceability/ holding costs will be scrutinised if you are demolishing.

    Lender will likely want you to

    1. Buy the property
    2. Get DA approval and building/demolition contracts prepared
    3. Give authority to proceed once final valuations have been checked
     
  14. sanj

    sanj Member

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    emjay - can i ask why you appear keen to go ahead with a development that has no profit in it?
     
  15. westminster

    westminster P Plate Developer

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    Equity is intangible cash in a way. The bank will loan against it but you can't 'withraw' equity. If the house goes up in value then you can't take it out but you can use it as security against a loan for more money.

    So that is why the total loan is 600k.

    The bank cares little amount the profit of the deal but does need to cover it's own risk. So if it is working on an 80% LVR and the loan is $600k then the value of the property has to be $720k
     
  16. emjay68

    emjay68 Member

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    Thanks for the advice Rockstar. I have heard similar advice from others as well with regards to letting the bank know of my intentions. I will be talking to brokers with regards to my capacity. Thanks.
     
  17. emjay68

    emjay68 Member

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    Is an immediate profit usually required to justify an endeavour such as this? My intention was to make the first house as my PPOR and the other as a rental. If i can afford it, why not? I want to set myself up in the long term and create equity. Isn't this what investing is all about?
     
  18. sanj

    sanj Member

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    Yes, an immediate profit is absolutely required because you are developing, not investing. With developing comes risks and you need profit to justify the risks. If youre going into it with no profit on the table what happens when something goes wrong, as it inevitably does? You will end up paying more for 2 homes wholesale, with all the effort that has gone into it, than you would've paid retail buying it on the market.


    For the love of god pls dont go into a development with 0 profit. it is absolute madness.
     
  19. emjay68

    emjay68 Member

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    I see. Thanks for the clarification westminster.
     
  20. emjay68

    emjay68 Member

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    I'm so confused. What is the difference between a development and an investment? Aren't they pretty much the same thing? Developing just involves the act of constructing the buildings - i'm still essentially investing for their construction and thus future capital growth/profit. I'm not looking to sell these properties after they're built. I'm going to keep them both - live in one and rent out the other.

    I don't see what the difference of this is to simply buying a house and living in it. Say i buy a house and live in it. Forget about my strategy of subdividing and building. I'll simply live in it as my PPOR. Is there going to be an immediate profit? No. Will there be a profit in the future? Maybe, depends on rate of capital growth right? Why does there need to be an immediate profit if i were to hold on?

    I think you've read my scenario in a light that assumes i'll be selling them immediately. I wont be, i'll be keeping them.
     
    Last edited: 21st Mar, 2013