Profit from Property: Your Step-by-Step Guide to Successful Real Estate Development

By Philip Thomas

Profit from Property is the must-have guide for anyone who wants to make money out of property development.

Expert author Philip Thomas will show you step by step how to develop property the smart way—from purchasing the best development opportunity, to financing the development, through to completion and disposal of the property. His fool-proof system will have you buying, managing, developing and selling property like an expert, whether you're a first-time developer or an experienced investor wanting to make more out of your portfolio.

Inside you’ll discover:

• money-making strategies for residential, commercial and industrial properties
• handy tips and case studies that will save you time, cash and stress
• a proven development model that you can start using immediately with results
• how to become a successful property developer without a huge amount of cash behind you.

The best time to get into property is now. Read this book today and start profiting from property tomorrow!

• Language: English
• Publisher: Wiley
• Release date: Jul 28, 2011
• ISBN: 9781742469485

Book preview

Part I: Understanding property development

Property development can be a daunting challenge — so much to learn, so much to know, so much risk, so much effort. However, it really follows some basic principles that can apply to many different businesses. When you get your head around those principles, the whole process isn’t so daunting. Before I take you into the hands-on stages and action steps of the development process, in this part I outline some of those basic principles as they apply to property development.

You get to look at what actually constitutes property development (and what doesn’t) and just what makes real estate a valuable wealth-creation tool. You get to know the roles in property development — who does what and when — and the value of putting together a top-notch development team. Next I compare the different property types so you can see what might suit you — residential, commerical or industrial. I also take you through the principles of market analysis — the importance of supply and demand! Finally I give you a rundown of the different options of financing your venture.

Now you have no excuse — dive in and start getting your vision for property development humming.

Chapter 1: Real estate development 101

This first chapter sets the scene and covers some of those basic questions you were perhaps too embarrassed to ask. For all my 25 years in the industry, I’m still surprised at how often people misunderstand the basics of property development. This chapter is here to make sure you aren’t one of them.

Real estate development defined

Succinctly, property development can be defined as the process of doing structural work to change the use or intensity of land or buildings.

Here are some more detailed aspects of development:

• Real estate development requires the control of land or buildings (or both), followed by the coordination of people, resources, materials and finance in a series of processes.

• The processes can involve commercial, industrial, residential or infrastructure property and assets.

• The development is planned to meet the requirements and needs of a specific target market, end user or customer.

• The purpose of development is to add value equal to or greater than the cost of the development.

• The intention of the developer is most often to make a profit, though some develop for their own use and enjoyment and others develop not-for-profit; that is, for philanthropic or humanitarian reasons.

• On completion the product developed is usually sold, leased or held as an investment.

Real estate development can include:

• alterations and additions to land and existing buildings to improve their use or increase their value

• demolition of existing buildings and structures followed by the construction of new buildings and structures

• subdivision (or breaking up) of existing buildings or structures to increase density or usage, lower the purchasing threshold or provide additional benefits to the existing or future occupants

• subdivision (or breaking up) of land to increase its density and usage

• consolidation (or joining together) of two or more lots of land or buildings to achieve a more intensive, better or different use

• changing an existing property’s zoning density or usage from residential, commercial or industrial use to an alternative or mixed use.

Whatever you do, the key component in value creation is change: changing from ‘what it is’ to ‘what it could be’. A classic example of creating value through change and how successful property development is genuinely accessible to all is brilliantly demonstrated by one of my clients — Jamie.

Case study: Jamie’s story

Jamie was a small and wiry young man. When he first walked into our offices he was so quiet no-one even noticed him enter. From the far end of the room I eventually heard a quiet, ‘Ahem … Bought a place and hope to subdivide’.

I looked up and there he was … hands thrust deeply into baggy pockets, peering in from just outside the open door. He seemed incredibly nervous. I asked Jamie to come in and explain a little more about his situation.

We spoke briefly about the house Jamie had bought, his dreams and his aspirations. There was nothing remarkable about Jamie that first day he walked into our office. He had a normal post office job, a normal income, drove a normal car and lived a normal, quiet life. What separated him from others, however, was that he wanted more! Jamie recognised that no-one else was going to secure his financial future. His post office job was okay, but it was never going to make him financially secure and, with no rich parents, wealthy uncles or fairy godmothers, he’d realised that his financial future was up to him.

Like millions of people before him, Jamie wanted to own his own home. He couldn’t afford a house in the location he wanted, but he needed to make a start and had bought a house on a 1050 square metre block in the southern suburbs.

You could just imagine the conversation between Jamie and his enthusiastic real estate agent …

‘What do you think, son — it’s a little beauty, isn’t it?’

‘This is it?’

‘A family haven or an investor’s delight, mate!’

‘Is it?’

‘See the potential? You can hear the kids playing on the lawn.’

‘But there is no lawn; it’s just sand.’

‘You add the lawn, mate. You add the lawn. Just imagine it.’

‘It’s hard to imagine. It’s very sandy.’

‘It’s the perfect renovator’s dream, son, just perfect.’

‘Is it?’

‘Yes, and the block’s so big. You could build a golf course or put an Olympic-size swimming pool out the back. Just imagine that. Or you could chop the property in half: then you’ve got two blocks for the price of one! That’s where the money is, mate!’

Whatever the conversation, Jamie agreed, and it was his first purchase. He wanted to split the block in two and sell off the rear lot, then live in the existing cottage at the front with an affordable mortgage. He approached my team to find out what was possible and how to do it.

It was clear that if the existing cottage had to be demolished to enable the subdivision, Jamie wouldn’t be able to afford the subdivision and construction of two new dwellings. So I went with him to visit the property.

The cottage had been a dream home when it had been built more than 50 years before. Since then, the dream and the cottage had faded. It sat near the front of the property, powder-blue and boxy, held just off the dusty ground by grey-black timber stumps with rusted metal caps. The roof was dull terracotta and weather-beaten. It looked tired and heavy, pressing down on the building below as though it was about to return to the earth it had come from. The dilapidated white post-and-rail fence that weaved across the front was losing the battle to contain a row of weed-infested roses. A concrete speckled path that had once been green ran to the front door, stretched out over the dirt like a broken tape.

Enough room had been allowed down the side of the cottage to park the family sedan, which had probably also been powder blue and boxy. The backyard was large, hot and dusty; a private desert of dark sand scattered with thin leafless shrubs, old jars and some partly buried car parts. The only green was the buffalo grass growing tall in clumps in the shade of the speckled corrugated fences. It certainly was a renovator’s dream.

Still, while its residential zoning at the time wouldn’t permit a straight subdivision, Jamie’s property had all the ingredients for a strata subdivision. And, because the cottage was at the front of the property, with more than 3.5 metres of access down the side, it was possible to keep the original building intact and do a vacant-lot subdivision at the rear. Also, while the cottage was in truly ‘original’ condition, it appeared solid and structurally sound.

Jamie was obviously stressed about his purchase and whether he’d made the right decision. Once we had gone over the potential of the property he seemed relieved and excited, like a starving man who’d won a meat tray at the local club.

By the time the subdivision plans were prepared, submitted and approved, five months had passed.

Jamie tidied up the cottage with paint, repairs, polished floorboards, new turf, and rear and side fencing. He decided to sell the renovated cottage and keep the vacant lot at the rear. When he put the cottage on the market, it sold quickly for 20 per cent less than he’d paid for the entire site. He was now holding the rear lot debt-free: his dreams of homeownership and financial freedom were coming to life, and so was he.

Within six weeks of the sale of the cottage, Jamie had secured a second block and was doing the same thing again. After 14 months, he had two vacant strata lots of just over 500 square metres each, with virtually no debt. He was gaining momentum. He kept buying lots that could be subdivided and began constructing homes on the first two vacant lots. Just over two years later, he was earning more from his part-time development work than he was from his full-time job.

After three years, Jamie’s net worth had skyrocketed. His outlook, confidence and attitude towards life had also changed substantially. He walked away from his job to pursue developing full-time. He’d discovered that he was a real estate developer, and he has never looked back.

With his initial property, Jamie added value first when he subdivided, going from a single residential lot to a two-lot strata. He added value again through a basic makeover of the cottage; the makeover created the least wealth of all his changes, but added substantially more appeal to both of the new strata lots. The final value-add was the construction of a new home on the rear of the property. In most cases, people would rather walk into a new home than build their dream home themselves.

What real estate development is not

Buying a commercial, industrial or residential property and repainting it, landscaping the garden or installing a new kitchen, bathroom, roof or driveway is not property development. These are cosmetic changes, not structural changes and, while they may add value, they are not considered development.

Neither is buying and holding property in the hope of capital growth. In this case the investor’s only influence on the future return is in selecting a suitable, well-placed property and a good tenant. Property development is an active investment: the developer takes charge of her future return by selecting a well-placed property, then modifying it for optimal use, aesthetic value and maximum return. Development applies leverage to the asset. The more desirable the property is to those who can afford it, the better the return on the investment in terms of both capital growth and rental income.

The key component of profitable development is cost-effective value-adding; that is, increasing a property’s return in rental yield or capital gain above the cost of the value-add. Cost-effective value-adding can also be done by community housing services, local, state and federal governments and other not-for-profit developers. However, the focus for a not-for-profit group is on creating value for a community group or department, rather than on increasing rents or capital values.

A very powerful wealth-creation vehicle

Although you can acquire money in many ways, there are only five ways to create real wealth:

• win it

• marry someone who has it

• inherit it

• create a successful business

• invest.

You can discount the first two ways immediately; they happen rarely, are unreliable and can’t be controlled. The next option, inheritance, is a way of acquiring wealth, especially for baby-boomers with hard-working, dedicated parents who accumulated savings or assets. Transforming an inheritance to create real wealth requires shrewd investment and appropriate leverage.

One serious way to create wealth is to build a successful business — tap into the entrepreneurial drive that takes the seed of a business idea, plants it in fertile ground and reaps the rewards. On paper, the path to business success looks simple enough. Yet, in reality, the mix of skills and competitiveness required, not to mention the sheer determination and perseverance you need, is quite rare. The statistics paint a bleak picture of business start-ups: few even make it through the first three to five years of operation. Fewer still produce the stellar growth and wealth that we read about in business magazines or splashed across the world’s media.

Most people who go into business for themselves do so because they want to escape the nine-to-five ratrace, are fed up with having a boss or have been made redundant. They dream of a better life, more time to spend with loved ones, more money and more freedom to do what they choose. Going into business seems like a logical step towards that future. More often than not, though, reality begins to bite and the dream enterprise slowly evaporates into a day-to-day, hand-to-mouth grind and a struggle for survival. A business is only really a wealth-creation vehicle if it will still make you money if you leave it for a month. If it would fall in a heap without you, then you haven’t been liberated by the business but imprisoned by it.

Sooner or later, most people conclude that it’s not how much money you make that creates wealth; it’s how much you keep and what you do with that money. In short, you have to invest your money to create long-term wealth. Even someone like Sir Richard Branson, who has built successful business after successful business, doesn’t hold his wealth in a single business or a single piece of real estate. Many individuals of high net worth leverage their wealth through property development and hold that wealth in a variety of investments.

It is the leverage of investments that creates and builds real long-term wealth. The best and by far the most accessible way of creating financial independence is through smart investments. There are two main areas to invest in:

• successful and growing businesses (sharemarket)

• real estate.

Investing in the sharemarket

You could take your hard-earned cash and invest it in other businesses that are already successful. You could choose one with a strong track record of earnings growth or a business model that promises big future growth and returns. Stock market investing can be a great way to build wealth — but how do you know you’re selecting the right businesses, with the right management team, in the right market, in the right business cycle? You don’t. You can’t.

Did you realise that just days before the 2001 collapse of Enron, 11 out of 16 Wall Street analysts covering Enron were still recommending the stock to investors as a ‘buy’, or ‘strong buy’. They weren’t lying — they were basing their assessments on the information they had been given by Enron, which had allegedly made US$100 billion a year earlier.

In principle, investing in the stock market should be straightforward. You merely need to work out what investment legends such as Warren Buffett, Peter Lynch and John Neff do, and copy them! But, as Yogi Berra, baseball coaching legend, once said, ‘In theory there is no difference between theory and practice. In practice there is’. It sounds really easy on paper, like many wealth-creation ideas; that’s why so many people get burnt by get-rich-quick schemes. And, certainly, some investors do very well in the stock market. But investing in businesses leaves success and your wealth creation up to people you don’t even know. Without significant shareholdings, a single investor has little or no influence on a company’s performance. There is absolutely no opportunity to add value to a stock market investment unless you are a major shareholder. Most people just have to buy and hope!

Although it’s possible to leverage your investments in the stock market through margin loans, it is perceived as far riskier than borrowing against property. A margin loan allows you to borrow money to buy shares, but the banks consider this a more volatile investment because the sharemarket moves faster than the property market. As such, banks lend less for shares than they do for real estate. Margin loans are much harder to secure, especially in an economic downturn. Lenders are also very restrictive regarding the areas and companies you can invest in and the amount you can borrow, and the loan can be called in (meaning you have to repay a part or all of it) at short notice. Loans can be called in for property but that happens far less frequently.

In addition, investing in businesses can be volatile in the short term. Value is subjective — news, speculation, market sentiment, fear and greed can drive a price up one day and trash it the next. What’s considered a successful business today isn’t necessarily what was considered successful yesterday, or what will be considered successful in the future.

When something major such as September 11 happens, billions of dollars are wiped off the value of global markets, and yet most of the businesses affected then didn’t change one iota. They were still well-run successful businesses supplying strong demand. While it was a tragedy, September 11 did not change the businesses; it scared people — and that fear changed the perceived value of the businesses. It’s true that you don’t lose anything until you sell a stock, but, still, market fluctuations can mean your theoretical net worth can be decimated overnight and there is nothing you can do about it.

Why investing in real estate is better

The other alternative is to invest your hard-earned cash in real estate: the houses that we live in, the places where we work, the places where the goods and services that we buy are assembled, stored or made. Real estate is the foundation of our society. It’s a finite commodity, so, as population expands, real estate values increase in most cases. We are, after all, not making more land! (True, developers did reclaim part of the ocean off the coast of Dubai and create an archipelago of 300 islands in the shape of the world’s landmasses; Singapore has also reclaimed land from the ocean to expand the nation’s buildable area. However, this sort of program is extremely expensive and rare.)

In the long term, real estate values have appreciated in the major growth centres in line with consistently performing business investment. Well-located, income-producing real estate is an outstanding long-term investment. Long-term capital appreciation, combined with inflation-adjusted rental returns, make real estate an attractive asset. You can also easily leverage real estate: when you have some real estate, you can use it to secure finance for more land to create an even greater return. In most cases, you still need a 20 per cent deposit to secure property but that means that banks and financial institutions are happy to lend you the other 80 per cent of the value of the asset, providing you have security and can demonstrate serviceability (you have the cash flow to repay it). In sharemarket investing the banks will rarely lend you more than 70 per cent of the asset value, leaving you to find an at least 30 per cent deposit to buy the shares. Plus, the banks will usually impose certain restrictions on what shares you can buy with that investment.

Unlike shares, real estate is tangible and its use can change many times. Just take a walk down your local retail street and think back to all the businesses that have come and gone in a particular building! The building remains ripe for adaptation and development long after a business has closed its doors. Good income-producing real estate in good locations will be around long into the future.

By adding value early in an investment, net worth can be exponentially increased. I’ve been involved in real estate development for a long time, so obviously I love property. If you talk to a stock market investor, they may passionately argue for investment in securities. For me, it comes down to control. I love property because I can see it, touch it and, best of all, I can change it. I can impact its value by what I do. I don’t have to sit on the sidelines and hope other people are doing a good job.

In the end, it comes down to personal preference. As you’re reading this book, I’m assuming you prefer real estate. The best way to create long-term wealth, financial security and ultimately freedom with real estate is to invest, and then leverage that investment by proactively adding value through development.

So, to recap, real estate is often a better long-term investment than shares because of the following factors:

• The power of leverage when looking at cash-on-cash return and internal rate of return (see chapter 5 for more on finance). Financial institutions will lend up to 80 per cent property for as opposed to 70 per cent or less when buying shares. This means you can access the investment with less of your own cash.

• Achieving a superior capital gain (increasing net worth) or above-average rental income (cash flow) isn’t difficult, by selecting property in areas of above-average national and regional growth and/or investing in growth sectors (see chapter 4 for information on market analysis).

• In most areas, real estate is more stable than shares because it isn’t as liquid. Shares can be bought and sold in a heartbeat and that liquidity means that fear and greed can cause havoc in the market. Real estate doesn’t change hands so fast and is not therefore subject to the same volatility.

• The investor is in control with real estate, whereas others are in control with publicly listed companies.

• Tax and depreciation advantages make real estate attractive.

• The ability to value-add through controlled real estate development and property investment is unsurpassed.

Real estate and value

If you want to be a successful property developer, you must understand value. Figure 1.1 (overleaf) shows you the three aspects of value for property investors:

• Rental income (cash flow) is the money you receive from letting a tenant enjoy your property over a period of time. High-income-producing properties are often termed ‘cash flow positive’ as they produce more cash than the total expenses required to hold the property.

• Capital growth (net worth) is the amount land and buildings increase in value over time. Usually there is a trade-off between high capital growth and high rental income returns, though this depends on the sector and the quality of asset.

• Tax benefits are the value you or your company receives as a result of holding real estate. This includes all deductions for real estate-related costs, including interest, bank and agent fees, building and equipment depreciation, and all maintenance costs.

Figure 1.1: value for real estate investors

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In order to achieve these objectives, you must understand how to add value to the development in a cost-effective and efficient manner. What’s the point of extending the family home if you then have to sell it because you can’t afford the increased mortgage repayments? Why would you bother building a block of residential units only to find, on completion, that you can’t sell them at a profit? Why go through the process of subdividing land only to find there’s no demand for the new lots at the proposed price? The key to making developments profitable, enjoyable and beneficial is a thorough understanding of value.

Tangible value

Once, when I was in Sri Lanka, I was shown a series of beautiful sapphires and rubies by a local merchant with a very big smile, brilliant white teeth and fast hands. He worked with confidence, like a card dealer in a top-flight casino.

‘You like beautiful big stone? We have beautiful big stone; best in the whole wide world. Oh, now these ones are very good. But look here, these ones are very, very good. And these are very, very, very good. Which ones do you like?’

I looked with interest at the big, bright, expensive gems spread out in front of me. The merchant assured me that his prices were far lower than anywhere else in the world. ‘Very, very, very cheap price for you; which ones do you like?’

I didn’t know much about sapphires and rubies, but I knew that diamonds had a high perceived value due to carefully controlled, coordinated supply and effective centralised marketing. I also knew that, along with most people, I would have difficulty distinguishing between a diamond from Tiffany & Co. and costume jewellery. But Tiffany & Co. could be trusted. Could this gem dealer in a back street of Galle be trusted to the same extent? Perhaps he was knowledgeable and honest, but I had no way of knowing. Fortunately, unlike gemstones, many key aspects of real estate are obvious.

Yes, some things in real estate may be unknown, such as tenancy issues, vacancy rates, future uses, planning and development potential and difficult-to-identify structural defects. However, unlike gemstones from unknown traders, most things to do with property are obvious — once you know the trade secrets. A property either has direct access to a harbour or a major port or it doesn’t; it’s either located within a major retail centre or it’s not; it’s