05 Oct How profitable is property development?
I’m often asked the question, particularly from non-property people, how profitable is property development.
When it comes to making money from property, one strategy stands head and shoulders above all others – property development. That said, there are risks and those need to be understood and mitigated as well as possible.
I don’t consider renovating as property development. For me it starts with a two lot subdivision. The reason is we aren’t just adding value we are creating more ie. One lot becomes two lots.
So how much could you potentially make from a one into two lot subdivision? The big variation is location which has a large effect on pricing. A two lot subdivision at Potts Point would be worth more than a two lot subdivision in Birdsville.
Also, the industry standard profit margin for small projects is lower than for larger projects. This margin is calculated as the profit as a percentage of the total costs. The margin on a four townhouse project might become acceptable from 18% – 20% upwards but on a two lot subdivision it might become acceptable from 12% – 14% upwards.
The reason is that the smaller project is quicker to develop with less financial risk. On the small project it might be considerably faster to get a development approval and the only construction could be as little as connecting new services. Also, borrowings are less in dollar terms and cheaper finance is available.
With the larger project the development approval typically takes longer, the construction takes longer, the financial risk is higher, and finance is more expensive.
Here is a quick thumb rule for calculating the projected profit on a project showing a 20% margin on cost. If you know what the product (lot, townhouse or apartment) would sell for multiply that selling price by 16.67%. For example, a townhouse that would sell for $800,000 should show a development profit of $133,000.
When you consider that you can gear the borrowings 4 times (25% equity, 75% debt), that gives you an 80% return on funds invested. It’s not hard to see why property development reigns supreme in the wealth creation property world.