Due diligence...the key to a successful development

[Sailesh Channan]

I operate a business in Brisbane that provides a development advisory service to investors. Our fees are mostly based on the profit of the project. Therefore we make a profit only if you do.

Currently we are involved in several duplex projects in the Redcliffe area.

The following is a run down on the due diligence procedure we went through prior to purchase:

Even though the blocks were zoned res b and I have a town planner/project manager in my team with 30 years of experience in lodging applications. To ensure that we can achieve our targets we first had meetings with the council town planners on the viability of the development

Prior to recommending the properties I spent months analysing the market in order to determine the supply and demand factors of the various types of properties.

The next step was finding a builder who could build at a good price. After looking at several builders I was lucky to find a local builder who only did work for developers. After checking out his work I was surprised he could get the work done for a turnkey price of around $720 per sq/m. (I am currently doing a slider in Morningside for myself and here the new house is costing me $920 per sq/m)

Now that we have a good build price the next step was to finalise the feasibility with some resales of duplexes in the area. Most agents in the area were quoting around $300 000 per duplex however, I did not feel comfortable with quoting such a high figure so I settled for $275 000.

Oh...and the last thing was negotiating on the land. I was able to organise a $10 000 rebate on the land at settlement time.

Overall this is a straight forward project and we have budgeted 8 months to finalisation. I am confident that we should finish sooner.

Most of our clients will end up keeping thier duplexes and will end up with around $100 000 in equity and a positive cash flow.

I hope this synopsis will help budding developers.

Regards

Sailesh Channan

www.developersedge.com.au

1300 73 5934

 

[willair]

Sailesh .C.
just a simple question,how many sq/m are in the total living
areas in these duplexs,and what is the total land area?
$720.per sq/m to $920 why the difference?
can you give a breakdown how you gain 100k in equity.
good luck
willair.

 

[Sailesh Channan]

Hello Willair

The house that I am building in Morningside is on a small lot. The high price is probably related to supply and demand issues once again. Not many builders are willing to build or specilise in building in the inner suburbs. Therefore you are limited in choice with builders. In fact most other builders will quote you over $1000 per sq/m. I must admit the 5 bedroom 300sq/m house in Morningside in a double storey house as well which adds to cost.

On the other hand the duplex is a basic low set brick and tile home which this builder specilises in. In his words..." I will not build a double storey...too many hassels".

With the duplexes the land is under contract for $187 550 and the duplexes have a total floor area of 291.8 sq/m

On a 600 sq/m block we are allowed a gross floor area of 50%.

The numbers are as follows:

Land.....................$187 550
Building..................$214 600 (actually $735/sq/m not $720 as stated earlier)
Purch costs............$ 10 000
Development costs..$ 31 000
Interest.................$ 9 500
Contingency...........$ 4 450
Total.....................$457 100

Resale values @ $275 000 each...............$550 000
Nett Equity in todays market.....................$92 900

Based on 5% growth the profit will be........$110 236

These figures have been based on equity achieved on very conservative resales estimates.

If you are looking to sell then you will have to factor in selling costs( through conjunction we should be able to refund you half the agents commission and reduce your selling costs) and taxes.

Expected rental is between $240 and $280 per week for each duplex according to most agents in the area.

Our fees are covered in the development costs.

Regards

Sailesh

 

[duncan_m]

I operate a business in Brisbane that provides a development advisory service to investors.

Hi Sailesh,

I wonder if you can provide any insight into what Due Diligence an Investor should do when looking to select a Development Adviser.

 

[Sailesh Channan]

Duncan

There are very few advisory company that provide a full service ie; source properties,carry our feasibilities, due diligence and project manage.

One of the first things to look at is the development experience that the team brings. An experienced project manager will be able to look at a site and assess the potential problems very quickly. He or she will also have established contacts with local council which will mean quicker answers from the council.

However this alone does not make the project immune from failure.

The key is looking at each project presented to you on its own merits and assess its viability yourself. We at Developers Edge merely present properties to our clients to consider as potential purchase. We provide a detailed report which includes builders quotes, development costs, holding costs and resale estimates from several real estate agents including comparable resale addresses where possible.

What you have to realise is that you are the developer looking for better returns from real estate. This activity carries a higher risk than usual and there is always the risk of loosing.

However, a well researched development reduces this risk. Your development risk is further reduced if you choose a simple project...like we have with these duplexes. Once you start developing splitters,sliders,townhouses and units your risk increases as the complexity of the development increases.

Regards

Sailesh

www.developersedge.com.au

1300 73 5934

 

[Lplate]

Duplexes: being visual, can you help me out with some scanned plans or photos and maybe a list of finishes? $735 m2 sounds competitive.

 

[always_learning]

Doesnt this belong in Caveat Emptor?

Beating the business drum if you ask me. I got this service I sell let me explain!

...Rebates after settlement; is that legal?

Fee is dependant on profitablity of the completed project, sounds a good idea...but I see some landmines of potential problems.

 

[Sunstone]

Dear Sailesh,

I recall when I met yourself at a function you were with "Investment House". What is your current relationship with Investment House and is "Developers Edge" in direct competition to "Investment House"?

If you left Investment House what were your reasons for doing so?

Cheers,

Sunstone.

 

[duncan_m]

Your development risk is further reduced if you choose a simple project...like we have with these duplexes. Once you start developing splitters,sliders,townhouses and units your risk increases as the complexity of the development increases.

Hi again,

Your site seems a bit devoid of content in the 'track-record' area. What are some projects you've recently managed to a successful conclusion?

 

[Sailesh Channan]

Sunstone

I will send you a PM as to my reasons for leaving Investment House

Regards

Sailesh

 

[Sailesh Channan]

Always learning

After reading recent threads on how some investors have got bogged down with council issued. I thought I might share some of the processed we go through in order to educate investors before purchaseing as site.

Over the last few years I have witnessed many investors rushing in without proper due diligence only to get burnt.

If you can spot land mines then that shows you have learnt something from your experience and this forum. Please feel free to share this with everyone.

Regards

Sailesh

 

[Sailesh Channan]

Hi again,

Your site seems a bit devoid of content in the 'track-record' area. What are some projects you've recently managed to a successful conclusion?

Duncan

Developers Edge was recently established and we are still in the process of establishing a track record.

However, in my previous employment I gained a lot of experience and was associated with around 40 projects.

The townplanner/ project manager that I have in my team has over 30 years of experience in this industry and he has also been actively developing in this time. He ran his own successful surveying/ town planning business with 25 employees until 4 years ago whch he sold to go into semi retirement. He is now consulting to my business and we can all benefit from his vast experience.

Regards

Sailesh

 

[willair]

Sailesh.C.
Thanks for personal time to draft that post
imho,i think you are in line with the rental return
in that area,but once you add the 20% extra
costs that always seem to come along near the end of any
project then i dont see any money in these deals.
just dont take what i say the wrong way once the money is
in your hands after any deal then everything before hand
is only talk..
good luck..

 

[quiggles]

First, let me thank Sailesh for a well spelled out proposal that enables sensible questions to be asked. If it wasn't first posted in Caveat Emptor, well, we live and learn.

My understanding was the the principal risk management tool for developments is the profit margin. There's a small (1%) contingency, but 30% is viewed as reasonably secure and 20% downright skinny. Less than that is a worry from my perspective.

Secondly, my view of cashflow positive is a simple test. If you can cover all your interest costs (assuming 100% borrowings) and your maintenance (hopefully low) and including tax benefits then you are cashflow positive. Caveat, the first year, with the huge number of one-off writeoffs doesn't count.

Mine is not the only definition of CF+ by any means but i don't think the development would actually make it for me.

Happy to hear responses, and please note, I have never been involved in a development, so I don't pretend to expertise.

 

[Sailesh Channan]

Sailesh.C.
Thanks for personal time to draft that post
imho,i think you are in line with the rental return
in that area,but once you add the 20% extra
costs that always seem to come along near the end of any
project then i dont see any money in these deals.
just dont take what i say the wrong way once the money is
in your hands after any deal then everything before hand
is only talk..
good luck..

Willair

Can you please elaborate to what these extra costs would be.

As I mentioned earlier that these properties have been purchased by investors who will be keeping it for investment purposes. They are looking at the bottom line where the property has cost them $457 000 and has an income of $500 per week.

All the purchase costs and development costs such as council fees, consultant fees have been costed and accounted for.

We are yet to go unconditional on these purchases so please let me know what we are missing.

Regards

Sailesh

 

[willair]

We are yet to go unconditional on these purchases so please let me know what we are missing.

Sailesh C,
Just checked my ABR/alcohol to blood ratio/ after
looking at the take off costs again,property in those
areas have reached the top level heights ,and if you are lucky
enough to purchase a cheap block,then eventually you may miss all
the crosscurrents with the uncertain property horizon,but you may see a different picture.
good luck
willair..

 

[kissfan]

Most of our clients will end up keeping thier duplexes and will end up with around $100 000 in equity and a positive cash flow.

Hi Sailesh.

Can you please explain how this deal is cash flow positive. On a loan of $457K, repayments (at 7% I/O) are approx 32K P/A. If rent/s is $260 per week (average) then 2x260=520, 520x52(assuming rented for 52 weeks)=$27K. This is before management fees, rates, insurance etc. I think this is what Quiggles and Willair were getting at. If depreciation turns these deals positive, at what year will they cease being positive.

Regards
Marty

 

[Sailesh Channan]

Hello everyone

This thread has started some healthy discussions which is great to see. I started this thread to make investors aware of the need for proper due diligence prior to purchase.

Being my first thread I may have given my business a bit of a plug which is my mistake.

You can all relax because most the suitible duplex blocks have been sold. All that is left are blocks with easements and unsuitable size.

I hope that the following information will cover some of the questions with reguards to the due diligence we undertook.

The location

Redcliffe is a peninsula and therefore land is fast running out. Recent repotrs from residex and other research organisations have highlighted this as an area that investors should invest in.

My research on types of dwellings in the area saw a deficiency with duplexes. In fact if you did a search for such properties in the area you will find there are no mote that one or two for sale at any given time. This compared to dozens of units, townhouses and houses in my opinion represents a good opportunity for duplexes.

My research also showed that there is a need for cheaper accommodation as new homes in this estate is selling for $350k to $390k. Duplexes will benefit people looking at lower cost and maintainamce properties.

The major market for these duplexes are retirees. As the baby boomers move towards retirement this market will dominate property trends. In this case we are seeing retirees headed to locations close to the water. These blocks are located 1.5km to the water...within walking distance. Most retirees prefer low maintinance single level accommodation. This market has not been catered for by the majority of developers.

So, while I understand there is uncertainty in the property market with looming rising interest rates,etc. I feel that if your property is unique and there is ongoing demand and a lack of supply your property will stand a better chance of survival.

The Development

This is not a complex land subdivision or multi unit development with multiple risk factors.

This development is as simple as buying a vacant block of land and building a house. First home buyers do this all the time and do they put aside $130 000 in contingency incase things go wrong?

The land has the correct dimensions and the correct zoning to build a duplex. We have even met with council to confirm our plans. We have a quote from a builder which will go to fixed price once we have completed a soil test and engineer designed footings.

We are building on a reletively flat block on natural ground.


The Dwelling
The construction of this low set duplex is very simple. It is a brick and tile construction and nothing complex. The builder that I am using has built many such dewllings for other developers and knows the need to finish the job on time.

Therefore, this is a reletively low risk low cost development. However is does not mean that you abandon the need for proper due diligence.

I think all investors need to carry out proper due diligence to minimise risk. I generally would stay away from difficult sites. Some examples of difficult sites are:

Sloping blocks.
These blocks will lead to increased construction costs. In some cases I have seen retaining costs of around $60k. If the blocks are sloping towards the back you need to ensure you have access to storm water and sewer.

Overland water flow
This can be a major issue and can dramatically limit the type of dwelling.

Easements
Leads to increased construction costs if you have to build over them.

Zoning
There are many battles lost over this. Before you purchase it is important to ensure that the property you are purchaseing meets tha local council guidelines. Some areas have strong lobby groups that oppose developments that fall outside the guidelines.

These are just some of the areas that you need to look into prior to purchase.

Larger developers work on a win loss ratio and are prepared to take more risk for greater gain. They will take on the unknown and challenge the council to seek rezoning etc. These developers will therefore need large contengencies in thier due diligence because they do not know what the final outcome will be.

I hope this has been useful to some.

Regards

Sailesh

 

[Sailesh Channan]

Hi Sailesh.

Can you please explain how this deal is cash flow positive. On a loan of $457K, repayments (at 7% I/O) are approx 32K P/A. If rent/s is $260 per week (average) then 2x260=520, 520x52(assuming rented for 52 weeks)=$27K. This is before management fees, rates, insurance etc. I think this is what Quiggles and Willair were getting at. If depreciation turns these deals positive, at what year will they cease being positive.

Regards
Marty

Marty

Thank you for your calculations. The property does rely on depreciations which should be good on these types of dewllings to return a positive cash flow. Rentals if kept in line with inflation should keep growing and eventually compensate the lack of depreciations after the first few years.

My belief with property investment is that while cash flow is important in a property the key reason for purchaseing should always be the capital growth aspect. I would gladly sacrifice $5k in costs if I were to make $50k in a high growth area.

These properties are in a fast growing area and only 1.5km to the water. Therefore the future growth prospects are good.

Regards

Sailesh

 

[Klausb]

financial details please

Sailesh,

the information you have provided is very interesting, but it would be helpful if you could share the depreciation tax deductions etc that is making this property positive after these deductions.

thanks.