Property Developers Vs Average Investors - Why they do what they do?

[CairnsInvestor]

Why is it that property developers have very few normal residential IPs; yet control/own large commercial/industrial portfolios and/or multiple development sites; Vs the average investor who invests primarily in your typical residential IPs. Note: For this thread - "Normal residential IP" is units, houses, duplexes, etc etc returning 4-5% average yield pa. plus 7-10% capital growth.

Now I know that the higher the risk, usually the higher return/profit margin, etc, so a property developer makes around 25-30% or more profit margin on their projects. The property developers that I know of (not personally) own very few typical residential IPs, & continually buy development sites & commercial IPs, large tracts of land, etc.

So if property developers can make year-in year-out returns of 25-30%; I guess they think why bother investing in typical residential rental IPs that only return 4-5% + capital growth; when I can make 25-30% +; is this correct? It seems like they just continually develop properties, continually buying & selling, & not really holding onto anything for the long term anyway. Another property developer I know just buys large tracts of land, gets DA, then onsells as a parcel or sub-divides land into smaller pieces & then onsells to unit developers.

Comments?

 

[steveadl]

I'm sure Daz and Ausprop will elaborate - but I think once you reach a certain point in both knowledge and wealth, small residential deals aren't worth the hassle to a lot of people anymore. Even from a pure logistics point of view, it's more of a headache.

If they have say $5M capital/equity available that they want to throw around - why bother with 12-15 houses, each with their own tenants and problems, when you could just buy/develop a nice big commercial property with one tenant who you never hear from?

Residential is good for starting out and building some equity, but a lot of people progress from that when circumstances allow.

 

[oc1]

I was discussing the very same thing with a friend last night, a friend who i'm helping get started. I never really thought about it before. 10% of what I own can be considered "property investing" in the traditional sense. The rest is held for a period of time and turned over. I guess when done this way you have more control over the outcome and not relying on the market to deliver the return. If you do do your homework properly the returns on average are better. Having said that I believe it's important to have your Buy-n-hold(pray) ticking along in the background. This will then feed you when you call it a day or slow down considerably. I know of a couple who sell just about everything they have built/subdivided. Another mate I know is now just starting to keep some of the projects he's involved in. I know I would cringe at the idea alone of whacking 20% deposit for a say $400,000 resi property and waiting. But that is passive compared to an active approached.
The other thing you have to remember is that it becomes a job in itself. Actually, if done properly, it is a business first. The beauty is you can keep some of what you produce which then becomes investing. So the best of both worlds.

 

[JoannaK]

Well, I don't know about other developers, but I certainly do have "normal" ip's (units)that I've retained after developing the buildings. This is why I develop properties...so I can build a substantial portfolio.

In fact, 70% of my portfolio is made up of "normal" ip's, but interestingly they provide only about 35% of my rental income!

The balance of my portfolio is commercial/retail property.

I can't imagine not keeping at least one in each development I do, whether it's a commercial unit or residential unit. My husband developed property for many years before we met, and he always sold everything! He never thought of keeping anything!!We sat down once and worked out what he would be worth conservatively if he'd have kept only 1 of each of the many developments he'd done, and it was staggering to the point of depressing for him.

I think I would be very foolish if I didn't include "normal" ips in my portfolio. They, and the returns they provide, are the bread and butter. In my opinion, the commercial is the cream (very delicious cream may I add!).

Each sector has it's pro's and con's, but admittedly, residential is a total pain in the rear end (both to develop and to hold), and I would rather commercial any day (both to develop and hold), but I believe that I need the residential component of my portfolio. It acts as a kind of stabiliser.

 

[ianvestor]

If they have say $5M capital/equity available that they want to throw around - why bother with 12-15 houses, each with their own tenants and problems, when you could just buy a nice big commercial property with one tenant who you never hear from?

I think this sounds like the most likely answer. Similarly, most people with $500k to spend buy a house, not two small units.

 

[aaarghhh]

Each sector has it's pro's and con's, but admittedly, residential is a total pain in the rear end (both to develop and to hold)....

Hello JoannaK

In your opinion what is it about resi developing that is a total pain in the rear end?

Aaron

 

[JoannaK]

a few quickies off the top of my head:

1) design guidelines much more stringent (BCA) for residential

2) more components required in a residential development, eg: 5 level building containing a total of 20 resi apartments needs 20 kitchens, 40 bathroom, 40 wardrobes etc V commercial 5 level building, needs 5 kitchenettes, 5 bathrooms, etc

3) warranty requirements are massive for residential property, and there are no "defects" in commercial property

4) with commercial (as Dazzling has pointed out several times) the tenant coughs up for pretty much everything

 

[grossreal]

hi aaarghhh
1. needing presales to develop resi
2. tennants and not having the ability to evict for non payment of rent
3. not having cpi or annual increases in rent
4. having to deal with body corporates that are made up by people that are not business minded
5. having to deal with owner of ajoining property that don't give a s--t to put a finer point on it
6. returns are lower on sales then comm
7. cost of construct is higher and so is risk
all of the above are the difference between comm and resi construction.
and as for holding yes from a tax point of view its better to hold but you then leverage off the hold units into some thing else.
and steveadl
if you have 25 mil I have a 17ha prime site sydney with 22 da's on it

 

[steveadl]

hi aaarghhh
1. needing presales to develop resi
.....
if you have 25 mil I have a 17ha prime site sydney with 22 da's on it

GR, not quite up to the 17ha site yet!

Quick question though, when I read about some of the commercial office developments in the city - they say that "such and such project will be delayed/put off because the expected tenant dropped out."

So is this more a business choice than a requirement? ie. as you said resi needs presales.

 

[Ausprop]

first couple of posts pretty much nailed it... why sit around hoping for a 10% cap gain and put up with tenants and negative cashflow when you can rip your 20%+ equity out and double it? As you double your wealth repeatedly you find the resi IPs to be a small part of a bigger picture, to the point where you say stuff it they are now too small to worry about it. finally, why bother developing a poduct that you can't affod to hold? it just creates churn and burn which state and federal goernments feed off. developing resi is painful, tying to anticipate what colour curtains someone will like or is the 3rd bedroom too narow?! give me square metreage rates as a valuation basis any day (as opposed to comparing what Granny May sold her 2x1 cottage for 6 months ago).

 

[boods99]

GR, not quite up to the 17ha site yet!

Quick question though, when I read about some of the commercial office developments in the city - they say that "such and such project will be delayed/put off because the expected tenant dropped out."

So is this more a business choice than a requirement? ie. as you said resi needs presales.

This is usually a requirement of the financier, to have a signed lease. It minimises the banks risk. They can also derive the finished value by applying a cap rate to the income to give a value. (one of the ways a building can be valued)
Having said this...all deals are not the same and are treated differently by different banks...

Boods

 

[Aaron Sice]

most of the developers i do business with have a minimum 20% ROI.

they have larger than normal due diligence periods (up to 12 months) for a $10k cash non-refundable deposit - so they don't cop $100k worth of holding costs while working out DAs, engineer's etc if they bought outright.

so they can basically control a property's profit without purchasing it, almost like an option but not quite because of the $10k deposit.

most sellers are happy with his arrangement as they don;t target land for sale. they enquire as whether "this stretch" of land is possibly available for sale, if it is, how much. would they take a non-refundable deposit on buying the land for a 12month DD period, and if the DA is good and we still don't decide to go ahead you can keep DA to add value to your land.

so it's a win-win situation.

 

[grossreal]

hi steveadl
yes tennants dropping out does cause a delay but comm is usually sold before you start to the value of the loan anyway and comm is easier to sell to say a superfund etc.
the lending criteria for comm and resi is very different and there is alot of work before constructing comm as it does need alot of work with real estate to make sure that a you can sell it b the market can take that quanity.
and I thought I had a sale on the 25mil
and
Blue Card to do a deposit like you say would be a huge risk and I for one would not do it for a couple of reasons.
one an option can be sold and you have security over the land
a deposit the owner could increase the price and you don't have security they can give you the right to do the da but it would be to risky for me and a da on a multi costs about 350 to 400k to get out of da so thats alot of money.
yes a holding deposit is alot cheaper but there is no protection for the da person the owner can just say they don't want to sell.
a deposit does not force the person to sell or it would be an exchanged and then you are tied up can't have your cake and eat it.
the cost of the da is alot more then the holding fees and option is the only way to secure your position unless you want to take the risk but everyone has a different risk profile but for me 10 down and 350 out with the chance of losing the 10 and the 350 or 115 down and 350 and getting the site
I would take the 115 down in an option.
you can do a management contract
but thats very different and a bit longer to explain

 

[boods99]

Adding to grossreal...
If you get DA for the site, the owner can turn around and say they dont want to sell now...however the DA is still attached to the site, therefore giving it to the owner for free...I would have thought an option would be a lot safer for the purchaser...


Edit...I think I may have just repeated what grossreal wrote...

 

[INVSTOR]

I think once you reach a certain point in both knowledge and wealth, small residential deals aren't worth the hassle to a lot of people anymore.

I don't agree. I think everyone has there own niche. I don't think it would suit me to go industrial but resi has worked for me. I haven't worked since I was 25 and hubby could easily retire by 40. I have excellent tenants in all properties and the worst problem I've encountered is mould in the bathroom. I've also had 100% occupancy in all the properties.

 

[WASP]

hi aaarghhh
1. needing presales to develop resi
2. tennants and not having the ability to evict for non payment of rent
3. not having cpi or annual increases in rent
4. having to deal with body corporates that are made up by people that are not business minded
5. having to deal with owner of ajoining property that don't give a s--t to put a finer point on it
6. returns are lower on sales then comm
7. cost of construct is higher and so is risk
all of the above are the difference between comm and resi construction.
and as for holding yes from a tax point of view its better to hold but you then leverage off the hold units into some thing else.
and steveadl
if you have 25 mil I have a 17ha prime site sydney with 22 da's on it

How abouts I give you one of those $1 Option thingy's that are being promoted of late

 

[steveadl]

I don't agree. I think everyone has there own niche. I don't think it would suit me to go industrial but resi has worked for me. I haven't worked since I was 25 and hubby could easily retire by 40. I have excellent tenants in all properties and the worst problem I've encountered is mould in the bathroom. I've also had 100% occupancy in all the properties.

Of course there will be many exceptions, but I think it's fairly safe to generalise that the bigger the investor/funds become - the biger the projects they get involved in will be.

Of all the property people on the BRW 200 list - I can't remember any off hand (although it's been a while since I've read it) that still go around and buy indivdual houses/units with their funds. They buy CBD buildings, or develop 200 hectares of residential land etc. How time consuming would it be for Harry Triguboff to spend $150M on individual houses as opposed to developing a new Sydney apartment tower?

 

[Mark C]

CI,

Thanks for the PM invitation.

For me it comes down to return for my time with what knowledge I have accumulated. My life is all about returns on outlay and being efficient with everything I do. I guess when I apply this to my own investing strategy I find more efficiency and return for time in large development sites.

20%+ returns are mandatory to seek finance on developments, the result is a vast increase in short/middle term cash flow. Buy and hold negative gearing investing is still apart of my strategy although I build & hold instead, if finances would allow I would rather not sell anything.

I remember reading an article in BRW about Harry Triguboff owning 1,200 units in Sydney. Can you imagine a 10% year for poor old Harry?

Buy and hold dose work, it got me started in the first place. Developing is just a faster way of getting where I want to be plus it suits my personality.

Mark

 

[INVSTOR]

For me it comes down to return for my time with what knowledge I have accumulated. My life is all about returns on outlay and being efficient with everything I do. I guess when I apply this to my own investing strategy I find more efficiency and return for time in large development sites.

20%+ returns are mandatory to seek finance on developments, the result is a vast increase in short/middle term cash flow. Buy and hold negative gearing investing is still apart of my strategy although I build & hold instead, if finances would allow I would rather not sell anything.

I remember reading an article in BRW about Harry Triguboff owning 1,200 units in Sydney. Can you imagine a 10% year for poor old Harry?

Buy and hold dose work, it got me started in the first place. Developing is just a faster way of getting where I want to be plus it suits my personality.

Mark

I totally agree with your strategy Mark C. Developing my blocks into units and villa's will be the next step, and I'll be holding onto as many as I can.

 

[alexlee]

There's also the question of what you want. I don't want to be a Triguboff or Grollo. Because I don't want to be tied to a business full time, even a successful one. People like that do it because they love the developing: the building, seeing something they buit, the fame, and of course the money.

If you want to build a 10, 20 million dollar net worth, I think it's fine just to go with small developments, and buy and hold.

I also question the title of the thread: property developers vs average investors. Do you make a distinction between 'average' developers (just a small development of a couple of townhouses, as opposed to Meriton) and 'extraordinary' investors (buying a whole office building, whatever)?
Alex