What does profit margin tell you in a development feasibility study? Not much?

[evan1875]

Many newbies like me are getting into developing and profit margin is always talked about a lot. Most will say to us noobs, aim to have a minimum margin of 20%.

I am trying to rationalise what 'profit margin' actually tells the investor who undertakes the development.

Does it tell you how much money you will make? It is a percentage so indirectly. But many people prefer to think in terms of actual dollars.

Does it tell you about how much risk you face? Not entirely. There are market risks. Cost risks. Council risks etc.

All we can say is if we have two sites in the same area, having the same likelihood of desired outcome at the council within a defined period of time (say 6 or 12 months), the development with a higher % margin is safer.

If Proposal A is a multiunit project which starts at the raw site stage, the margin is 20-22%. Proposal B is a duplex on a splitter block which does not require council planning approval, the margin is only 13-14%. I think one must seriously consider choosing B over A.

Does it tell you about how profitable the development is? Once again not the whole picture.

I remember a few years ago when I was just getting interested in development. An uninhabitable property on 1000sqm corner block was auctioned and sold for a jaw dropping price (at the time). 3 years went by and nothing happened. Now almost 5 years down the track the person who bought it managed to build 8 units on it. Good outcome if it was achieved within 12 months at the council. The margin here is much higher than 20%, probably 50%. But it took 5 years to get there.

I think the internal rate of return is a much better way of calculating profitability. For a X amount of capital tied into a development for Y amount of time, the return is Z% per year on X. Then you can compare it with other options of putting such X capital to use, such as shares, bonds, cash, etc.

Margins are still important though. 20% makes the bank feel warm and fuzzy, and let you have their money

 

[westminster]

You're correct in that it is not a standalone figure to be considered.

As you have mentioned there is also
- ROI
- simplicity to access finance - ie commercial vs resi, high LVR etc
- complexity of project which can often increase time taken
- market volatility (some areas are more volatile)
- opportunity cost

 

[TMNT]

an interesting question for you

would you prefe to earn

$100k at 30% return

or

$700k at 15% return?

 

[D.T.]

an interesting question for you

would you prefe to earn

$100k at 30% return

or

$700k at 15% return?

Over the same time frame?

 

[Scott No Mates]

The most detailed method to use is the a discounted cash flow & net present value . The tools are already in excel & Google will guide you. Anything less is a punt.

 

[MTR]

Many newbies like me are getting into developing and profit margin is always talked about a lot. Most will say to us noobs, aim to have a minimum margin of 20%.

I am trying to rationalise what 'profit margin' actually tells the investor who undertakes the development.

Does it tell you how much money you will make? It is a percentage so indirectly. But many people prefer to think in terms of actual dollars.

Does it tell you about how much risk you face? Not entirely. There are market risks. Cost risks. Council risks etc. I would like more % than this, but not always possible with my developments.

All we can say is if we have two sites in the same area, having the same likelihood of desired outcome at the council within a defined period of time (say 6 or 12 months), the development with a higher % margin is safer.

If Proposal A is a multiunit project which starts at the raw site stage, the margin is 20-22%. Proposal B is a duplex on a splitter block which does not require council planning approval, the margin is only 13-14%. I think one must seriously consider choosing B over A.

Does it tell you about how profitable the development is? Once again not the whole picture.

I remember a few years ago when I was just getting interested in development. An uninhabitable property on 1000sqm corner block was auctioned and sold for a jaw dropping price (at the time). 3 years went by and nothing happened. Now almost 5 years down the track the person who bought it managed to build 8 units on it. Good outcome if it was achieved within 12 months at the council. The margin here is much higher than 20%, probably 50%. But it took 5 years to get there.

I think the internal rate of return is a much better way of calculating profitability. For a X amount of capital tied into a development for Y amount of time, the return is Z% per year on X. Then you can compare it with other options of putting such X capital to use, such as shares, bonds, cash, etc.

Margins are still important though. 20% makes the bank feel warm and fuzzy, and let you have their money

I think you have raised some good points.

At the end of the day, you can only work the numbers on what you know today once you have considered all the risks.

There are also other ways I look at ROI and profits, if you have enough equity/cash flow you can increase the profits by increasing the number of projects, ie 2 developments @ 20% each, perhaps smaller projects, less risk, shorter timeframe/turnover.

Of course its just dependent on so many factors, finance just to mention one, comfort zone etc.

MTR

 

[Blacky]

Its only one metric, and as you say if used in isolation to everything else is pretty meaningless.

But that doesn't mean its not a very useful metric to use to help measure the viability and risk profile of a project.

Blacky

 

[evan1875]

an interesting question for you

would you prefe to earn

$100k at 30% return

or

$700k at 15% return?

100K at 30% return means a total development cost 330K
700K at 15% return means a total development cost 4.6M

Assuming that you put in 30% of TDC of you own money.

To earn 100K at 30% you put in 110K (91% return on equity)
To earn 700K at 15% you put in 1.38M (51% return on equity)

Assume both are over the same timeframe then the 30% margin one

 

[evan1875]

The most detailed method to use is the a discounted cash flow & net present value . The tools are already in excel & Google will guide you. Anything less is a punt.

Hi Scott,

Will look these up

Thanks

 

[Rockstar]

Also need to consider how much time YOU put into the project. You have to pay yourself for your time. A newbie can spend a lot of time on initial ventures because of lack of experience. Whether it is time in planning, accessing finance, finding a builder or time on site project managing. As the others say there are a lot of factors to consider but if you are seriously considering sticking it out for multiple projects you will find, like any other skill, you will become more savvy and more efficient as your experience grows.

I have reached the stage now that my business has become full time property development although I do hold onto some of the new homes as and when I can afford it. I'm still not sure how much profit I make because I can't be bothered working out how much I want to be paid.
eg: I build a dual occ within 1 yr with total costs of 500k and total sales of 700k.
My income is 200k for the yr. How much is profit? Maybe I don't make any profit - only income?
The following year I build another dual occ with costs of 500k and sales of 750k. Do I make 50k profit and 200k income or do I make 250k income and no profit? Whether I call it income or profit I still pay tax on it.
Having said all of this it does depend on your business structure. My wife and I are in a partnership and there is no company set up so we don't receive a wage as such.

Anyway, with development, I would keep it simple to start with unless you have deep pockets and can afford some expensive lessons or have someone very experienced to guide you through a more complex project. It's pretty scary in the beginning where even a simple dual occ project can cost around 500k+ in my area - much more in parts of the bigger cities.

 

[evan1875]

Also need to consider how much time YOU put into the project. You have to pay yourself for your time. A newbie can spend a lot of time on initial ventures because of lack of experience. Whether it is time in planning, accessing finance, finding a builder or time on site project managing. As the others say there are a lot of factors to consider but if you are seriously considering sticking it out for multiple projects you will find, like any other skill, you will become more savvy and more efficient as your experience grows.

I have reached the stage now that my business has become full time property development although I do hold onto some of the new homes as and when I can afford it. I'm still not sure how much profit I make because I can't be bothered working out how much I want to be paid.
eg: I build a dual occ within 1 yr with total costs of 500k and total sales of 700k.
My income is 200k for the yr. How much is profit? Maybe I don't make any profit - only income?
The following year I build another dual occ with costs of 500k and sales of 750k. Do I make 50k profit and 200k income or do I make 250k income and no profit? Whether I call it income or profit I still pay tax on it.
Having said all of this it does depend on your business structure. My wife and I are in a partnership and there is no company set up so we don't receive a wage as such.

Anyway, with development, I would keep it simple to start with unless you have deep pockets and can afford some expensive lessons or have someone very experienced to guide you through a more complex project. It's pretty scary in the beginning where even a simple dual occ project can cost around 500k+ in my area - much more in parts of the bigger cities.

Hey Rockstar,

First of all your duplex build thread are inspirational. Thank you for sharing.

Are you at the stage where you have truly found your niche and feasibility becomes not as critical? I have seen people who has done a few similar developments in an area and inherently knows that $X per site 'works'. Rinse and repeat. I am not so sure if they still linger over a spreadsheet for hours at the site acquisition stage.

 

[Rockstar]

Hey Rockstar,

First of all your duplex build thread are inspirational. Thank you for sharing.

Are you at the stage where you have truly found your niche and feasibility becomes not as critical? I have seen people who has done a few similar developments in an area and inherently knows that $X per site 'works'. Rinse and repeat. I am not so sure if they still linger over a spreadsheet for hours at the site acquisition stage.

Thanks Evan,

That's right, I don't linger over any spreadsheets. I know the planning code and the market price for my product well enough to decide very quickly whether there is plenty of money to be made. I also know how long the project will take for purchasing, planning, construction and strata subdividing. All roughly 1 yr in my area as long as you don't buy a tricky block!
My latest purchase is a medium density site for 210k. Construction of 3 houses will be around 500k. Other costs of around 90k. All up around 800k. Final value should be around 1.2 mill. You don't need to look at spreadsheets when you have confidence in these rough figures but I do have 8yrs of experience behind me to make these quick assessments.

 

[MJD]

this is just off topic, may I ask someone with developing experience that how much did you pay for engineer for documentation the working plans for building approval submission for 4 unit /or 8 units
thanks in advance
MJd

 

[Ace in the Hole]

Thanks Evan,

That's right, I don't linger over any spreadsheets. I know the planning code and the market price for my product well enough to decide very quickly whether there is plenty of money to be made. I also know how long the project will take for purchasing, planning, construction and strata subdividing. All roughly 1 yr in my area as long as you don't buy a tricky block!
My latest purchase is a medium density site for 210k. Construction of 3 houses will be around 500k. Other costs of around 90k. All up around 800k. Final value should be around 1.2 mill. You don't need to look at spreadsheets when you have confidence in these rough figures but I do have 8yrs of experience behind me to make these quick assessments.

I like the way you work.
No messing around with detailed analysis, just go on rough figures and feel, based on experience.
I follow a similar style and it works out very well.

 

[Brady]

That syle would have to come with some decent experience, a client of mine who's a builder/developer operates similar way. Usually most are just beer coaster calculations as knows there's enough fat and has the skills to overcome the hurdles.

Be nice to get to that point.

 

[oc1]

That syle would have to come with some decent experience, a client of mine who's a builder/developer operates similar way. Usually most are just beer coaster calculations as knows there's enough fat and has the skills to overcome the hurdles.

Be nice to get to that point.

It is nice, but everyone needs to start somewhere. Full due diligence is best followed by a cookie cutter approach if you are on a winning development strategy/formula.

 

[Ace in the Hole]

That syle would have to come with some decent experience, a client of mine who's a builder/developer operates similar way. Usually most are just beer coaster calculations as knows there's enough fat and has the skills to overcome the hurdles.

Be nice to get to that point.

Or a higher risk taker/high risk profile.
I've operated this way with everything from day one.
You get a general for risk vs reward for all events after a while.

 

[Mamaof3]

an interesting question for you

would you prefe to earn

$100k at 30% return

or

$700k at 15% return?

This is very true....we don't only look at the 20% margin...this is only a rough guide. We look at other factors such as the ease of the deal overall, whether its easy to get x number of homes on there and be pretty much fully compliant with all the council requirements, if it is very straightforward with minimal risk that a contingency might need to be taken into account (other than the risk of the resale price of the new homes might drop) then we'd consider less than 20% but having said that, 20% is a good guide that allows for those unexpected issues to come up and if they do, then you've got that buffer before you start losing money on the deal. We always aim for 30% + margins but that being said, we're talking bigger sites so bigger risk hence we demand a higher return to safeguard ourselves.

Good question you raise though.

 

[Rockstar]

That syle would have to come with some decent experience,

If you're fortunate enough to have a mentor with experience then you can fast track this stage.
I am advising my chippie/builder at present. He has built 8 houses for me and is currently working on another duplex of ours. He is about to settle on a triplex site which is his first development. I can confidently say he will earn at least 200k for a duplex approval. If he can get DA approval for a triplex he should earn around 300k.

I didn't have a mentor but was fortunate to do very well on my first duplex. We earned around 190k without too much involvement since it was a fixed price contract with a project builder. My second duplex was great experience. Again it was a fixed price contract but I was on site during much of the build and learnt all about the building process. The 3rd duplex I was hands on and the experience was even deeper. Now I just project manage everything and the whole process is pretty smooth.

 

[Hodge]

Rockstar, how would you go about finding a mentor? I am guessing it's not a role developers / builders advertise? I have thought about approaching developers regarding a mentoring role but then think why would they bother?

I've read books on developing, etc but sometimes you need real life experience to learn the ropes.