Property investment and property development are instruments for passive income, however, property developing has a different concept to property investing.
Property investment offers the funds needed for either short or long term passive investment, which entails purchasing an already constructed property in order to generate income by renting it out or selling it for a profit. Proof that you can pay and service the loan is required when applying a bank loan for long-term property investing.
Property development begins with understanding the project and negotiating terms that include the structural project’s planning and development process before the project can create income. You should have a knack in searching for the best property deals, be innovative when producing new solutions to development problems, and basically have a technique in ways to fund a development project. It is a short-term venture in which a considerable profit can be made within that period.
What approaches can be taken to start property development?
There’s no right or wrong way on how to develop real estate properties, but it would be better and advantageous on your part if you started from investing properties. Property development has a lot more steps undertaken in the process and other resources considered with the asset.
Well-established property developers are professionals that invest in big time projects and they typically started with getting the education to pursue that career. But there are a lot of other people who chose to be property developers as a sideline and some don’t even have a degree related to it, the projects they handle are small-scale and managed usually by themselves or with a modest team. Often times property developers invest on development projects even if they are incapable to pay off the full capital at the start and there are many ways to initiate your property development.
So what strategies can be used to develop property when you don’t have enough money for it?
Approach 1 – Bank loans for property development
Banks have more stricter terms regarding what the loan is used for. The bank would analyse the feasibility and profitability of the potential commercial property development. The same goes if the loan is for residential property development, however the bank would depend your capability to service the loan for a residential property development and eventual holding of that property. The interest rate for this type of loan is smaller, but the bank has a hold of that property so the developer can’t demolish the building and simply construct a better one without the knowledge and permission from the bank.
Approach 2 – Vendor + bank loan
Bank loans can cover for a certain percentage of your development project, and they don’t cover the deposit of the property. Average percentage of a bank loan can be at 60-70% and the highest a bank could offer is 80% of the property’s purchase price. When funds are really tight, you can do vendor financing where you can arrange a private loan agreement with the property development vendor so they can lend you the money for the deposit of the property itself. The private loan via vendor finance is on a nominal interest rate and the vendor rate can be higher than the rates charged in traditional banks.
“Get your Access to our Fully Customisable Investment Property Research and Analytics Tool Now!”
Although this sounds easy to do, this approach comes with a major risk. Banks may not consider approving your loan or they will have to investigate and make you prove your credibility. Having two parties involved (the bank and the vendor), may also increase the difficulty of managing the property development because they put a lien on the property.
Approach 3 – Real estate option agreement
The real estate option contract is an agreement between the landowner and the developer for a possible transaction regarding a property in which the buyer has the only right to purchase the property for a certain period of time. This means that the seller can’t put the property on the open market and they can’t accept or entertain any bid offers. Properties that are available for option contracts provide the investor some security since they are less risky and demand less capital investment. The option agreement is the buyer’s right to purchase the property development, but it doesn’t mean they’re obliged to purchase it until the end of the contract.
The downside to an option agreement property is that you are not allowed to make any changes to the property. You may have the right to the property, but you do not have any permission to replace or redesign anything unless stated by the landowner. But the upside of the option agreement is that you are actually adding the value as you keep paying for the rights of the property. Although there’s no guarantee of you buying the property, the landowner still benefits from the option agreement. Even if they weren’t able to sell the property, you helped the landowner uplift its value without costing them anything.
Approach 4 – Property developing through project management with owner
There are property developments that were on sale in the market for quite some time, instances like these can’t be avoided. These underlying issues will never be brought up by the real estate agent when they want to sell the property in whatever way possible. You can engage with the agent and their client (e.g. owner) to work together and develop the property so they can bring up the value and increase its selling price. This collaboration setup can also present you positive cash flow.
Check out our “Flipping Houses: How to do a Proper Feasibility Study to Ensure Profitability“
This approach may be time consuming when there is somone who becomes the middleman between you and the one who makes the call regarding the property development. Agents hired by the owner would always prioritise working favours for the best interest of the owner and the agent as well.
Approach 5 – Property developing through project management with investor
When you’re low on funds, you can rely on other investors. It may be hard to find investors right at the get go, so first consider your connections and your community if they have the same intentions as you would have. You have to make sure that the development project has a relatively good profit margin and has space for continuous improvement because private investors are willing to provide funds as long as they can highly benefit from it.
You can receive an introduction fee for finding the project as well as presenting it to the investor, and you can negotiate with the investor about deals for a forward funding of the development project. The introduction fee is based from a portion of the property’s purchase price which can depend on what type of property it is (e.g. residential or commercial).
Approach 6 – Active joint venture with property investor and property developer
This is similar to the fourth approach, but this is when these two types of people have worked hand in hand as a team to discover property developments and invest in them. All the members of team normally work together to investigate, examine and decide on the property development project/s. An investor who may not have the skill and connections a developer may have can always rely on the developer who may not have as much funds but have the expertise and skill to execute the development.
Check out our “How Building Design Can Double or Triple the Cost of Building a House“
What are some tips to take note of when doing property development?
- Money is always the reason for an interest in property development, but one tip to actually get your investor onboard with your plans – genuine enthusiasm. Make the investor excited and get their interest, hopefully matches with their preferences as well.
- Investors are more open to providing the property developer a forward fund if there is transparency of details regarding the property, and the turnover of the property development is easier on their part.
- When working with approaches 3 and 4, you’ve become more of a project manager than a project developer. You can either charge based on the percentage of profit margin or a time rate basis (hour, day, weekly, etc.). Just remember that property management in certain Australia states requires the proper education and license to start and continue this practice.
- There’s also risk working with a property investor you personally know (e.g. a family member, a best friend, or previous coworker), the sense of familiarity between you can make you both more lax with each other especially when there is a lack of written contract agreement. Irregular payments, lackadaisical updates and the like don’t always happen on most cases, but there is a chance of it happening.
- Interest rates may vary when borrowing directly from an individual’s private money. Since this individual lent you their money, they have the power to dictate how much you have to compensate them. Althought unlikely, if the invidivudal asked for a very low interest rate, the borrower (property developer in this case) would normally gift tokens to the lender.
- Property developers must always take initiative to keep adding property value and solving any possible problem that can occur during the development process and less supervision from the investor. The investor is working with the developer because they don’t need to worry about the arduous task of managing and building property value.
