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Introduction
Ask a room full of aspiring developers what is stopping them and you will hear a hundred different worries. Underneath, it is almost always one of five sticking points.
In this episode Bob Andersen and Hilary Saxton unpack all five: how much equity you actually need (with a simple rule of thumb), why development finance is nothing like the retail finance you are used to, how to choose your patch, why the profit is decided at the start, and why you do not need to know everything, you just need the right people around you.
It is all plain English and real numbers, including the leverage example that shows how putting in one fifth of the costs can turn a 20 percent project margin into a 100 percent return on your money.
What you’ll learn
- How much equity you actually need, and the one-fifth to one-sixth of GRV rule of thumb
- Leverage explained simply, and why financiers put in most of the money
- Development finance vs retail finance, and why your local bank is not the lender
- Why serviceability does not apply, and what capitalised interest means for you
- How to choose your patch and become the local expert
- Why the profit is decided at the start, with an accurate feasibility
- How to build your team so you do not have to know it all
Episode highlights
- 2:30 “We only work with experienced developers” – clearing up the myth
- 3:05 Sticking point 1: how much equity do you actually need?
- 5:41 The power of leverage, and the 100 percent return example
- 6:05 The GRV rule of thumb: one fifth to one sixth of end value
- 8:29 Where the equity can come from if it is not in your bank account
- 9:39 Sticking point 2: development finance vs retail finance
- 12:05 Why non-banks fund the vast majority of small projects
- 13:34 No serviceability test, and interest capitalised into the loan
- 16:14 Sticking point 3: how do I choose a patch?
- 19:01 Sticking point 4: the profit is decided at the start
- 20:55 Sticking point 5: you do not need to know everything
- 26:37 The October workshop on the Gold Coast
Episode transcript
Read the transcript (edited for readability)
Introduction
Hello and welcome to the Property Mastermind Podcast, episode 269. Today we are talking about the areas new property developers get stuck. There are a number, but there are five big ones we are unpacking today.
First, clearing something up
Hilary: Something interesting happened this week. After our masterclass, somebody almost did not sign up with us because they thought we only work with experienced developers. Let’s clarify that straight off the bat.
Bob: No, we do not. We teach people how to do property development, and most people who work with us are starting on their first project. A one into two, splitting a property and putting two houses on it, a duplex, sometimes three. That is probably 80 percent of mentoring students.
1. How much equity do you actually need?
Bob: It will come as no surprise that financiers do not finance 100 percent of your costs. Just like when you bought a house you paid a deposit, in property development we put money in too, we just call it equity. The good news is the financier puts in most of it. As an indication, think of the total costs of your project, the total development costs or TDC: the land, construction, consultant fees, finance, marketing, everything. You put in on average about 20 percent of that, and the financier puts in the other 80.
Hilary: And that is leverage. Unpack that, because the words can get confusing.
Bob: Say a project costs a million dollars. We put in 200,000, the financier puts in 800,000, and our profit might be 200,000. We put in 200,000 and made 200,000, that is 100 percent on our money. If you had funded the whole million yourself, the same profit would be 20 percent on your money. That is the power of leverage.
The GRV rule of thumb
Bob: Another acronym: GRV, gross realisation value. It is what you will sell your project for. Say two townhouses at 1.5 million each, the GRV is 3 million. The equity you would put into a project like that is between about a fifth and a sixth of the GRV. One sixth of 3 million is 500,000, one fifth is 600,000. So somewhere between 500,000 and 600,000 of equity builds the whole project, and the finance does the rest.
Hilary: And you can look at it either way: if I have 500,000, what size project could I do? Or, if I want to do a 3 million dollar project, how much do I need? Now, before you think “I will never have that”, there are so many ways to come up with it. Drawing equity from something you already own. Doing it with somebody else, you bring the knowledge, they bring the money. Everyone puts a little bit in. You could even create a small syndicate.
2. Development finance is nothing like retail finance
Bob: The banks you see at the shopping centre are retail banks. Retail banks want 20 year home loans, that is where they make their money. They do not want to finance an 18 month development. Their commercial arms exist, but many have minimum loans of 8 or 10 million, so our size of project is too small for them.
Bob: That leaves the commercial non-banks, and they would fund 95 plus percent of all small development projects. So when you do property development, you will most likely use a non-bank, and it is commercial finance, not retail finance.
Hilary: And here is the big difference people do not understand. With a retail loan you have to prove serviceability, that you can pay the interest out of your income. In commercial development finance, you do not.
Bob: It is what we call an asset lend. They are really looking at the project, less so the individual. And the interest is capitalised into the loan, the financier actually lends you the interest so you can pay them the interest. A lot of people have held back from property development because they thought they were tapped out on serviceability, not realising it is irrelevant here. Retail finance brokers are great for retail finance, but this is different.
3. How do I choose a patch?
Bob: You want an area you can dig deep on. It might be one or two suburbs, or a council area. You need to become the local expert, because you will have to make commercially sound decisions, often fairly quickly, and you can do that when you have deep local knowledge. You get to understand the zoning you need for your project type, what size and width of lot you need, and which sharp real estate agents are worth talking to.
Hilary: And if nothing is coming up there, you move to the next patch, but you do not lose that knowledge. You also learn what information matters, and that transfers straight to the next area.
4. The profit is decided at the start
Bob: Property development is all about numbers, and that is what a feasibility is. In its simplest form: your income, less your costs, equals your profit. You do the feasibility so you do not get emotional. You might love the idea of a deal, too bad, if the numbers do not work, move on. And the feasibility ties back to the valuation and to obtaining finance, it is all interrelated. You have to prove sufficient profit for you, and for the financier to fund the project.
Hilary: So it is not how anyone feels on the day. Get the numbers right and everything flows from them. No emotion, just the numbers.
5. You do not need to know everything
Hilary: You leverage the financier’s money, and you also leverage other people’s knowledge. You do not need to be an architect or a builder. You need to know the right people.
Bob: This is the team you put together. The architect is a key consultant, when you are getting your development permit and building permit, everything revolves around them, alongside the town planner. Engineers get engaged along the way. And the builder: we do not engage the tradespeople, the builder does. Whether it is townhouses or something bigger, you talk to one person, the builder, and they organise every trade on site. You do not have to be a builder, most developers are not, and never want to be. Your job is conducting the orchestra, not playing every instrument.
Wrapping up
Hilary: So the five: how much equity you actually need, development finance versus retail finance, choosing your patch, the profit being decided at the start, and having the right people around you rather than knowing everything. Everyday people do property development, mums, dads, nannas and grandads. In fact today somebody joined our mentoring program who is a mum on maternity leave.
Hilary: And while we are on it, our three day workshop is coming up on the 9th, 10th and 11th of October, and this year we are adding joint ventures and creative strategies, different ways of using your money and other people’s money to put deals together when you do not quite have enough. Which was that very first sticking point. There is a link below if you would like to have a chat about coming along. Catch you next week.