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
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
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