What margin for development potential?

From: Nigel W

Here's a curly one for all the old hands:

What sort of premium are developers prepared to pay today to secure/control a property with a big upside POTENTIAL?

I guess what I'm asking is: what ballpark/rule of thumb type figure would a developer start from to figure out whether they are willing to buy now, on the expectation that they will be able to rezone etc, build and profitably sell?

Say a fair market price is $200K for a property. The developer thinks he can say move the house and put another on it, or put up 4 townhouses etc. Working backwards from a potential sale price of the finished properties (whatever form that may take) of say $500K, that leaves gross profit of $300K.

Out of that $300K must of course come all the multitude of costs of actual development, debt servicing, council approvals etc etc. One of the developer's expenses is securing the property. (let's ignore JV's and options for the moment)

If the owner in fact wants $250K for it rather than the $200K which it's "worth", is there enough fat left in the deal for the developer to proceed?

I guess the missing factor, which will help in deducing the answer to my question, is what net profit margin do developers work on? Is it 20% nett, 15%? 30%? Or is it purely determined by the market?

I suspect that I'm glossing over a huge number of important feasability study type issues here but I'm just trying to get a general feel for the expected returns.

thanks in advance for your responses

ps. before you deluge me with well intentioned "do your due dili" concerns - thanks. But I understand that development can be dangerous to your financial health!
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Reply: 1
From: Michael Yardney

When I first started developing property in the mid 1980's I learned a lot from a successful property developer who taught me that you must make at least 20% margin on your development cost to make a project worth looking at.
That means that if a project costs you say $1,000,000 including all the costs to develop it including sale costs etc., you need to make $200K. This is not because developers are greedy - it's because there are always so many unknown and uncontrollable costs that you need to allow a decent margin to cover them.
A few points;-
1. This developer went bankrupt because he did not stick to his rule.
2. this does not take into account the time involved in the process and therefore is a little simplistic but at least it is a guideline
3. Most developers go broke because they do not do their sums correctly - they leave things out or the market turns against them.
Currently we are seeing lots of inexperienced investors trying to become developers. I wish them well, but know a few will fall by the wayside because they haven't done their "due diligence" as you call it.
That said -development can be very lucrative.
Michael Yardney
Metropole Properties
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Reply: 1.1
From: Paul Zagoridis

Ahhh memories.

Late 1991 a 26 year old Dreamspinner, full of vim and vinegar, decided to bet the farm on becoming a developer. He'd built an impressive investment portfolio and thought himself a "Master Of The Universe" (pronounce the caps). Plus an uncle was an architect and commercial developer.

"No federal Labor government would allow first mortgage rates to hit 18%", he declared.

[insert your preferred image of disaster]

Older, bruised and hopefully wiser I have two truisms

1. Everybody always thinks the other guy is making more money. Normally he ain't.

2. Don't bet on "what should be", deal with "what is".

20% profit doesn't allow for many mistakes, a 10% cost overrun and a 10% time delay wipe that out fast.

I think many newbies rushing into developing today will feed the mortgagee-in-possessions tomorrow.

Paul Zag
Oz Film Biz is at
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Reply: 1.1.1
From: Nigel W

Thank you Michael and Paul for excellent responses.

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