Double Rental Return

This week I was really excited to find a fabulous property that we could add value to.  Add value?…in what way I hear you say.  Perhaps you are thinking through renovation…new kitchen, new bathroom, paint throughout, perhaps a deck out the back or even maybe add another bedroom?  Yes, this kind of work would usually add value to a property.  But actually, I was thinking along other lines and two words had sprung to mind….GRANNY FLAT.

By adding a granny flat to this property, we could literally double the rental return. This four bedroom house, in a Hunter Region of NSW town, was renting at $260 per week.  But as soon as I saw it, I knew it could achieve much more. It is a large block, over 1000sqm with dual access.  By building a 60sqm, two bedroom granny flat on the property it could be rented for around $280 per week on its own, just for the flat.  But it does get better….the house is way under rented.  You see, I’m finding right now that as rental markets have continued to tighten over the past few years, there are some owners and managing agents who haven’t bothered to increase rents. This house was being rented by a long term tenant and quite frankly, she is on a very good wicket!  The market rent in this town for a four bedroom house is actually up to $350 per week.  So the house is under rented by a whopping $90 per week.

So if we spruce up the house a little, and this one only needs a paint and new carpet, we can increase the rent to $350 per week.  The purchase price is $250,000 and we may spend $8,000 of a cosmetic reno, so already that’s gives us a 7% gross yield. Not a bad return when the average yield for houses in Sydney, for instance is 4.18%.

The granny flat will cost us $94,000 to build, this includes the design and complying development application fees. It also includes separate service connections for the flat so that we can rent it to a different tenant to the house if we need to. Remember, the flat will rent for $280 per week.  If we add the cost of the flat to the purchase price of the house plus the small renovation costs, and include purchasing costs of stamp duty, legal fees, reports etc then we end up with a gross yield of around 9%.

Did I already mention that the average rental yield on houses in Sydney is around 4.18%?  We are finding more and more clients are looking for cashflow positive investments and these projects also deliver some decent depreciation.  Property Bloom manages the entire process right up to finding tenants and negotiating management fee discounts for our client with local agents. There is a massive demand for the new and low maintenance flats in the Hunter Region right now.

Ok here is the twist. If you have a Self Managed Super Fund or are thinking of setting one up, you may be able to do all this from within your fund. On 14 September 2011 the ATO released draft Ruling SMSFR 2011/D1 clarifying its views on key issues surrounding borrowing arrangements (Limited Recourse) as they apply to Self Managed Super Funds (‘SMSF’), allowing fund monies to be used to renovate property.

Importantly the ATO has given clarity to concerns of fund trustee’s in regards to repairs, renovations and improvements to properties held in SMSF’s under Limited Recourse borrowing arrangements. It is clear these can now be done within such arrangements. Borrowed monies cannot be used in all cases for such work; however other monies within the SMSF can be utilized.

This information comes from Nic Ellis, Director of The 2020 Group, who tells me he’s had more enquiry than ever on this topic.  People want to utilize their Super to not just invest in property but to renovate and add value.  With such a volatile global situation and stock market, Australians want more security around their retirement funds.  Nick says he’s happy to see the draft Ruling as it falls in line with his company’s interpretation. The SMSF Limited Recourse borrowing for purchase of property has seen significant growth in recent years and this draft ruling will help turbo charge this sector of the market.

However, the area remains complex and care needs to be taken to ensure expert advice, appropriate structures and experienced administration of this process.

Jo Chivers   http://www.propertybloom.com.au/

Break It Up Baby

I met with Danielle this week for a coffee. Danielle is a part time town planner and full time to mum to three kids.  I’d met Danielle when she’d asked me about helping her with a medium density development. Then, through some unfortunate circumstances Danielle found herself a single mum.  She couldn’t finance a larger development.  But she used her experience and prowess in understanding the planning process to make herself a cool $70,000 profit from a simple two lot subdivision.

Danielle purchased a large lot in a new release of a big, well known development in the Hunter Region of NSW.  My first reaction was you can’t buy a lot in a new release and then subdivide it as there are restrictions under the 88B Instrument in the contract.  A Section 88B Instrument is the part of a deposited plan which upon registration can put certain restrictions on the land. 

You would assume a large developer would protect the right for someone to come in and then subdivide their lots especially in a new, upmarket release.  But Danielle went through the massive contract with a fine tooth comb and with her ability to read the LEP and DCP and understand what council would allow, and what she was legally permitted to do, she went for it.

There was one hiccup when the town planner managing her DA started to question the DA.  But as she’d had no opposition from the vendor, the original developer or her neighbours, she was able to talk her way around this.  Once approved, she paid for the necessary works and then soon sold off both smaller lots and made her profit.  Go girl!  So I thought I’d explain to you more detail about subdivision. Because although it worked out well for Danielle, it can be costly and not so rewarding if not managed the right way.

Subdivision is one of the many strategies you can use to develop property.  It involves converting one piece of land OR existing dwellings into several. 

Raw land subdivision entails legally and physically converting raw, undeveloped land into developed land so that one or more buildings - residential, commercial or industrial - can be constructed.  As you will be changing the lands usage and appearance for example perhaps from a rural rezoned paddock into a residential land subdivision, you’ll also be building the infrastructure required such as roads, paths, drainage systems, water, sewerage and perhaps even public utilities such as a park. 

You can also subdivide developed land (much more easily) by simply splitting a block in half.

Subdivision of existing buildings is the conversion of a single title to multiple titles. For instance, a block of 10 units on a single s title - often referred to as units ‘in one line’ – can be converted into individual titles such a strata title. This is a great way to add value to the properties and allows you to sell them off individually.

Subdivision is a great development strategy for the current market conditions.  It gives you flexibility to play is safe and sell off a newly created piece of land to reduce your loan, or to hold and add value to the property by registering the new lots and holding or further developing them.

The objective here is to have a creative outlook while searching for potential subdivision sites as it is this creativity that can determine the success of the development.

So when would you subdivide?

An investor might buy a dwelling that is on a large piece of land, where they can renovate a house and then subdivide or perhaps you are a homeowner living on a potential development site where subdivision may be permissible. The site will however, need to meet council regulations.  The first question you need to ask council is ‘what is the minimum lot size?’  You can find this out from your council’s Development Control Plan for Subdivision and their guidelines.  The minimum lot size will vary from council to council and from different zonings. For instance, the residential minimum lot size will be smaller than the rural zoned land size.  One council I work with has a residential minimum lot size is 450sqm.  So we can subdivide a 900sqm corner block into two lots. However, if we had a 900sqm piece of land that was not on a corner, then we could not subdivide this, as we also need to allow for a driveway to access the back lot and the area needed for the driveway is in addition to the minimum 450sqm.  So we would need a block of land approximately 1100sqm in size to be able to subdivide and allow for our access handle.   

Another type of property to look for is land with two street frontages, so if it is 900sqm in size and the minimum lot size is 450sqm you can literally cut it in half and each lot will have its own street frontage.

Different types of Subdivision

When looking to develop with subdivision, it’s important you understand the different types of subdivisions. Getting professional advice will help you to make the best decision for your site and also which potential purchase will make the process through council the smoothest.

Strata Subdivision – Dividing a property into separate units, apartments or villas.  Strata is land title based on the horizontal division of air space and may involve common areas shared by each title holder and usually managed by a strata manager.

Torrens Subdivision – Dividing one land lot into two or more separate land titles. This form of subdivision gives the owner complete autonomy with their land as they don’t have to answer to the strata manager or adhere to certain strata rules and regulations.

Community Subdivision – A development with common property such as roads may be used by all residents.

The Figures

When budgeting for your subdivision you’ll need to start with a realistic target for how much the completed development will be worth, and then subtract costs to calculate profitability. It’s important to run a feasibility analysis on the subdivision (covered in detail in last weeks article) including possible costs for stamp duty, legal fees, surveyor services, council application and developer charges, civil works and service connections such as gas electricity and water.

Make sure you also discuss your subdivision strategy with an accountant and understand the possible tax and GST implications if you are planning to sell.  You will also need to estimate your holding costs such as interest on your loan and rates.  This can be a real drain on finances if the process drags out and you are not getting any income from the land to help offset your holding costs, so time is literally money in this type of development.  Try negotiating long settlement periods with permission to lodge a DA from the vendor or buy under an Option.

Location

Getting the location right can either make or break your development success. Research is prevalent here to ensure you are building a property where people in that area want to live. You have to totally remove yourself from the development as you won’t be living in it, your target market will be.

Inner cities are limited with the availability of land so in this case strata division is being created through developments.  Looking up to two hours outside the city allows you to be more creative in your development plus you can usually create a Torrens subdivision. There may also be more room for growth in the outskirts especially if there is some infrastructure taking place in that area.

Choosing the Right Property

•         The first item you need to properly assess a potential subdivision site is a survey. It’s amazing how many contracts I review that do not have a survey.  So you may need to pay for this before exchanging as you need to be sure of the land size and whether there are any easements affecting it. 
•          The next item I always ask for is the sewer diagram. You need to know where the sewer is located and if it is actually feasible based on the slope of the land, to cost effectively extend it to service a new lot.  
•      You need to check the slope of the site for drainage issues.
•           Check the aspect of the site and think ahead of where any new dwellings will sit to take advantage of the aspect.
•            Research the zoning regulations and read council’s subdivision guidelines.
•           Compare market value – is vacant land in demand?
•           Check service connections – is there sewer available in the area, is there an electricity source close by?
•           Corner blocks are good for your first subdivision.
•           Structure of Property – this is important if you are developing a strata division as the building will need to be structurally sound to handle the requirements such as firewalls between units.
•           Have your solicitor check for restrictive covenants or easements. You may find land in a new estate has a covenant over it that does not allow for further subdivision.

DA Approval

Getting a surveyor to manage your subdivision DA can save you a lot of time.  If you’re researching a new area, the first place to start would be the local surveyor. They can give you advice on the subdivision process and cost indications. You need to use a surveyor to prepare your subdivision plan.

Once you have abided by the councils regulations, it is then the residents you may need to win over. Generally if the land you’re subdividing meets zoning requirements and you comply to the subdivision Development Control Plan then there should be little your neighbours can do about your subdivision, however it is always a nice gesture to talk to them personally about your plans.  

I always look at the best way to subdivide as part of our development process, the way that will be most cost effective and not hold up the development process and we have found in many instances it may not be the most obvious way.  What may look like a simple subdivision can turn into months and months of complicated work.  The service connections, plumbing and civil works alone can really blow out a budget, so it’s important to understand the entire process before you embark on your first subdivision.  I’d recommend you start with a simple two lot subdivision.

There are many more things to consider when planning a land or building subdivision, so make sure you engage professionals to assist you if you’re a beginner.  A development project manager will be able to work with you on every stage of the process and you’ll be amazed at how much you learn along the way and like Danielle, you could find yourself making a nice profit for your efforts.

How to determine if a development site is Feasible

You’ve found what you think is a brilliant development site.  Now it’s time to jump on that roller coaster and start the ride of your life as you commence the analysis process.  Will the project be feasible?  What is feasible anyway?  

Let’s find out.  Feasible is really another word for “is it going to be financially worth it for you to spend your time, energy, money, blood, sweat and tears developing this site?”

Some advice I can give you about property investing and anyone in property will also tell you, to stay emotionally unattached to the property, as this is where bad decisions can be made. I have seen it many times and this is where it can all come undone.

Firstly, it’s important to determine your development strategy and your investing criteria prior to looking for a development site.  Your strategy may include:

-          Land Subdivision

-          Renovate an existing dwelling

-          Dual occupancy or low density development

-          Renovate an existing dwelling and build new villas/units also on the land

-          Medium density development

-          All of the above

Your budget will help to determine your development strategy. A simple land subdivision will be less costly (but not necessarily quicker) than a larger villa/unit development for instance.

As part of your strategy, you will need to think about what profit margin you would feel comfortable making from a development.   You may have heard about the ‘20% profit margin’ rule for developers?   Once all development costs are taken from the potential sale result of the properties, (when selling the properties) there will be a 20% profit margin.  Personally, I don’t always work back from a certain profit margin as I find this restrictive. 

Most of my clients are looking to boost their portfolios and hold the new properties long term, so we also need to meet other criteria.  By other criteria, I mean rental returns on completion.  For instance, if a client wants to create a positively geared development the end gross yield will need to be around 10% and we will actively search for development sites in very strong rental areas of the Hunter to meet this objective.  Other criteria will include the amount of equity we can create from the project.  We strive to create over $100k in equity after our project management fee. 

To determine the feasibility of a site, you will need to:

-          Talk to an accountant who specialises in property and one who preferably develops property themselves as they can advise you on the best structure to purchase under and explain the tax implications when developing such as GST and CGT. 

-          Meet with a financial lender or a Bank to determine your budget and the best loan structure for your development.  It’s important to choose a lender that offers construction loans and find out what their lending criteria is around this i.e. not all residential lenders will lend to you for a four unit site for instance.  Check interest rates on these loans.

-          Meet with solicitor to determine their costs. They will check for restrictive covenants or easements that may affect the land. They will also make sure services are available and connected especially if you are developing in a new area as well as finalising the deal for you.

-          Read the local Development Control Plan (DCP) and Local Environment Plan (LEP) and speak with your council’s town planner to find out DA and CC (Construction Certificate) costs. Get friendly with the Town Planner to find out which developments they want to see in the area as this could save you time and money by getting it right the first time.

-          Meet with an architect and builder to determine what you can build on the site.  Some builders offer standard designs which will save you design fees.  If they do this, then they will be familiar with the local planning requirements.  If you are not happy with a standard design, engage a local architect to design specifically for the site. Get a quote.

-          A surveyor will give you advice on the subdivision process. They’ll prepare your subdivision plan and estimate costs relating to the subdivision including sewer extension and service connection costs.  

-          Once you have a concept design and before you lodge your DA, meet with builders to determine construction costs. Try to get 3 quotes and make sure they offer you a Fixed Price Contract.

-          Talk to real estate agents to determine the value of your development and rental returns on completion as this will have huge impact on the success of the feasibility.

-          Research other costs such as Stamp Duty, reports, Insurance and Interest payments.

The aim is to keep the above costs to a minimum so you will receive a higher profit margin. All this information can be kept in a spread sheet or there are software programs to help you with this process.

Below is a quick one page analysis I do to determine if a development is going to be feasible. In this case the client is keeping the three properties we have created from one.

Purchase price three bed house on 1012sqm of land: $210,000
Estimated set up costs, stamp duty, legals, pest & building reports, survey: $8,500
Estimated renovation cost: $8,000
Build cost for a two bedroom duplex (2 x villas) to be built behind existing house: $353,000
Contingency:  $20,000
Note: build costs includes all council, subdivision and other fees & charges. I always ask my builder to wrap all development costs into their contracts so my clients can maximise their lending.

Total development cost to create three properties from one in Hunter Region of NSW:  $599,500

Estimated end values:

Renovated three bed house on 400sqm:  $220,000

Two bed villas $260,000 each:  $520,000

Total end values:  $740,000

Potential gross equity to be created: $140,500

note lending costs are not included at this stage: 

Estimated rental returns:

Renovated house $300 per week

Two bed villas @ $280 per week each:  $560 per week

Total rental return: $860 per week or $44,720pa

Gross yield on completion of development: 7.5%

Gross Rental Yield – How it works
One of the first calculations you will need to understand if you intend renting the properties on completion is the Gross Rental Yield (GRY). To calculate the GRY you need the annual rent and the total cost of the development. If we use the above example:

Annual rent: $860 per week x 52 = $47,720pa
Total development costs: $599,500
Gross yield: $47,720 divided by $44,720 =  7.5%

The yield on the above example of 7.5% is ideal at the moment as anything over 7% is considered to be a strong yield.  Some of our developments are creating up to a 10% gross yield.  

Once you have obtained the estimates for your development and the figures are looking good, you have some actual estimates to go back and speak to your lender about and ensure you can finance the project. There are various finance options so seek professional advice on the best one for your situation.  Then before you purchase, ensure you have discussed the best legal entity to be purchasing under for your individual circumstances with your accountant.

When your finance is preapproved, you can then start to negotiate the purchase. Always ensure you have a preapproval before making an offer so you can move quickly to exchange. This is a good negotiation tool.  Ask for a longer settlement and a lower deposit which will reduce your holding costs.

There are many more things to consider for your site selection, so it’s important you do your due diligence.  In the development game, time is money. So you will need to learn to assess a potential site very quickly. One way to fast track the analysis process is to engage other professionals to do this important work for you.  If it is your first development then work with an experienced project manager so you can learn from them as you progress through the complicated and challenging journey of your property development.  Enjoy the ride!

Happy International Women’s Day!

Today I’m using the occasion of International Women’s Day to reflect.  I thought about my role as a wife, mother, daughter and what I was doing to try and make a difference in my life and hopefully others.

There are two words that describe why I do what I do; Financial Freedom. My driving desires to build my investment property portfolio and also Property Bloom; my property development project management business is financial freedom.  Not just for myself but for my family.  This drive has come from watching my parents in their retirement.  Whilst they are living in a beautiful part of NSW and own their own home, they are on the old age pension and really struggling to pay bills. There is no spare cash for a holiday or to reward themselves for working so hard all their life, but they are still happy.

I want something different for my retirement and I worked out ten years ago after picking up the book Rich Dad, Poor Dad that unless I take full responsibility for my future and management of my own investments then I’d be in the same boat.

I also wanted to her other inspiring stories so I asked my female staff and clients what it meant to be financially independent.

Here’s Kylie’s story...I remember sitting down with my Nan many years ago and she was telling me how she had always had, what she referred to as a “cunning kick”. Her cunning kick consisted of a couple of hundred dollars, which back then was a lot of money. She had it hidden in an envelope stashed at the back of the hall closet so no one, not even my Pop, could find it.

Later on in years, this amount grew to a thousand dollars, then two thousand dollars. She felt so confident that she had this safety net for her “just in case”. When we would visit, she would go to the envelope and give my sister and I twenty, sometimes fifty dollars. It was obvious to us it made her feel good that she could do this for us.

Later on in life when they were on the pension, my Nan would go shopping and buy nice things for herself. She would come home and secretly change the price tags on clothes, jewellery or anything she had bought for herself telling my Pop she paid less than half the price she actually did pay for it.  My Pop never found out. Seeing my Nan in this situation, I soon realised I wanted something different.  

Here’s Joanne’s story....Financial Freedom means I have the choice to live where I want, somewhere that brings peace and joy to me just by waking up...Being surrounded in Beauty. 

 Grow organic foods on my land to keep me healthy into old age.  Have time to exercise and stretch.

Travel if I want to both overseas and closer to home to experience more of the world and the people in it.

To really enjoy the beauty of nature by spending more time in it not rushing by it.

Having time to spend with family and friends, taking my niece and nephew on adventures.

Knowing that I can choose to work whenever I want to keep me stimulated and challenged and choose to not work when it is time to rest, meditate or play in the garden.

Having the ability to say yes more often "yes I would love to go hang gliding!" 

Being self reliant empowered, in control of my own life and destiny.

Here’s Sandi’s story...

Financial Freedom to me means a few things. Firstly it means that if anything ever happened to me or I ended up on my own, my family would be OK without me financially or I would be OK financially if on my own. That gives me piece of mind.

Then I suppose from a more selfish point of view, financial freedom would be to have our investments working for us: not us working for them. That’s the ideal position I’d like to get into. To have more time for the family and also importantly, for myself (I’ve learnt that this week from ending up with pneumonia from over doing it!!).

What is your plan to financial freedom?  Perhaps a good question to ask yourself today, even if you are not a woman. 

www.propertybloom.com.au

http://www.internationalwomensday.com/

Milking the Property Development Process

Last week my senior project manager used an interesting story to illustrate an important lesson in patience when developing property.   

Rich is a country lad brought up on a farm in rural NZ...no it wasn’t a sheep station. Lucky for me, he decided to ‘cross the ditch’ and settle in Australia to make his fortune in developing property in the Hunter Region of NSW. He was working with one of my builders when I discovered his expertise. It was some time later that we ended up working together.

Rich’s story message was simple – “Pushing too hard at the wrong time can cause problems rather than solutions.”  

The message came about whilst discussing how we could fast track lodgement of a particular Development Application.  As project managers I knew we were doing all we could.  I also knew that the other people involved; our builder and engineering consultants, were too.  We wanted to illustrate this to our client.  And then Rich sat down with a steaming cuppa in his hand and spun me a yarn.

I thought I’d share his tale with you because it really made sense, even to a city gal like me.  Hope you enjoy it as much as I did...

Rich:  On the farm we never had a dog to chase the cows into the milking shed. But our neighbours did and they were always in a hurry to get the milking done for the day. One day I asked Dad; “Why don’t we have a dog to chase the cows like our neighbours?”

He responded by saying,  “Son, when a dog chases cows, by the time they arrive at the milking shed, they’re all nervous and tense because that dog has been snapping at their heels, barking and generally causing them grief.  Because of this, those cows never milk for long and as a consequence, they don’t produce much milk.”

Rich explained that what those stressed out cows did was to produce a lot of crap.  The cow manure mounted up quickly and ended up covering the shed while they stood waiting to be milked.

The neighbours with dogs always finished milking earlier than us, but spent more time cleaning up their milking shed at the end.  They produced very little milk.

When it was all washed up and done, we always finished around the same time as the neighbours. Although our cows milked longer, we had less to clean up and we always produced a lot more milk.

Going back to our property development situation, the bottom line is if we do things properly and not rush the procurement stage of the process, the delivery and close out will move along smoothly and end up producing a better, more profitable ‘on time’ result.

My take out of Rich’s yarn:  There are times for snappy dogs, but use them sparingly and intelligently.

Property Bloom understands the need for speed, as do our builders.  At the end of the day we all want to complete the project quickly.  But what we really want to ensure is a development that is delivered efficiently, on budget - and hopefully with very little crap to clean up at the end!