Australian Residential Property Development for Investors. Forlee Ron

products are of the utmost importance. Deliver these and you will enhance your reputation as a credible and trustworthy developer.

Due diligence

      Before launching a new development, successful developers always undertake a thorough due diligence process on the project. This process will identify the potential risks and determine what strategies may need to be adopted in order to mitigate these risks. The successful developer will evaluate the development by preparing a detailed feasibility study to determine if the project has the ability to meet the targeted return. They will perform a sensitivity analysis by testing a number of possible scenarios to determine their impact on the profitability of the project. The developer should also understand other influencing factors, such as local government regulations and restrictions, local tax issues, and planning and environmental issues, and be satisfied they can be effectively managed.

Luck or persistence

      In property development, luck has little or nothing to do with long-term success. Of the developers I know, very few believe that luck plays more than a very minor role in their success. One novice developer I spoke with recognised after reading my two earlier books that even though he had made money on his first project, he would lose money on his next if he followed the same principles. Opportunities present themselves to us all from time to time; some we grasp but others we overlook. Successful developers are no different. They have lucky breaks and disappointments just like everyone else. The difference is that more often than not they are working consistently and conscientiously towards a defined goal. Their ‘lucky breaks' are more likely to be opportunities that they have engineered in one way or another. In climbing the ladder of financial success, all developers have made mistakes and had setbacks along the way, but they keep going. Persistence is one of the key qualities shared by these developers.

Location and timing

      The successful developer also has a very good understanding and knowledge of (a) location and (b) timing.

      Location

      We have all heard it many times: ‘Location, Location, Location' or ‘Position, Position, Position'. Of course, what is a good location for one type of property use may be entirely unsuitable for another. For example, a high traffic area may be ideal for a commercial property that would benefit from the marketing exposure but much less attractive for housing. A good location is part of a cohesive structure that takes into account a combination of amenities and services such as shopping, recreation, quality housing, efficient traffic network, education facilities and efficient council services.

      Timing

      Another critical factor is ‘Timing, Timing, Timing'. Most failed developments have not been in tune with the economic cycle. The developer has not read the market correctly and has introduced the product when there is an oversupply and demand has waned, creating a drop in prices and resulting in a severe financial loss for the developer. Supply and demand together with price fluctuations affect all investment markets. Poor developers tend to believe that when markets are buoyant and prices are rising, these conditions will go on forever. Unfortunately this is not the case, and many developers come unstuck by failing to understand the property market cycle, explained later in this chapter.

Setting goals

      At the start of a new project successful property developers establish their objectives, including both short- and long-term goals. These objectives fall into the two broad categories of financial and social. They consider any significant challenges and related risks they may encounter in pursuing these objectives. Each project type, whether residential or commercial development, has its own set of unique requirements for operational and financial success. For example, developing and managing a shopping centre is different from developing an apartment block.

      Financial goals

      The successful developer determines how much profit should be made relative to the risk of the development. Both long- and short-term financial goals should be analysed. This analysis is based on the developer's current financial position – that is, their current cash flow and net worth – and the targeted long-term profit. A developer in need of cash may want to take a quick profit and move on to the next development. If a particular project is likely to have an extended pre-development stage owing to complicated zoning, environmental or community issues, it is best to recognise that money will be tied up in legal and consultants' services. If a lending institution does not finance speculative projects, then other ventures should be considered. When an objective has been selected, the developer should review their position once more and consider alternative options before making financial commitments.

      Social goals

      Social goals relate to the local area and the surrounding community in general. Before starting the development, the unique challenges associated with a particular location should be considered carefully. If the developer is selfish and believes only in taking from, but not contributing to, the community, the environment and community will suffer. In the long term, this may contribute to the destruction of what was a strong market, which in turn will affect the developer's objectives and reputation negatively. Developers should always consider contributing to the community and environment. These social objectives mean designing a project that blends into the social and historical setting of the community. They include being sensitive to surrounding neighbourhoods, well-planned traffic flows, and retaining or replacing any trees or vegetation destroyed during construction. They also involve using building materials and designs that are sympathetic to the surrounding area and local customs and are environmentally friendly.

      Understanding the market

      For a property developer, understanding the market is vital for good decision making. With the significant capital involved in a project and the long development process any error of judgement could lead to financial ruin. From the inception of the project through the site selection, planning, building design, financing and construction, the developer should be considering every aspect of the market requirements. By understanding the following points, a developer will be better placed for the market being targeted.

Supply and demand

      History has shown that property markets are cyclical in nature. When compared with the erratic performance of the stock market, property trends are more predictable, which makes the forecasting of property supply and demand conditions a lot easier. However, property cycles differ between property types and locations. For example, housing markets tend to relate more closely to the overall growth of the economy and of the local population, while the office market relates more closely to business activity.

      Property markets are often considered in terms of the balance between supply and demand, also known as a state of equilibrium, in which the volume of buildings under construction should equal the volume of buildings in demand. Unfortunately, markets cannot maintain stability for any period of time owing to their cyclical nature. It is therefore important to understand where a market stands in relation to its equilibrium state in order to assess future demand. An awareness of these variations in property cycles can be a valuable guide for developers. Reading business articles and talking to people in the real estate industry are ways of maintaining awareness of where the market is sitting.

Evaluation of future demand

      As mentioned, demand factors can vary from one property type to another. For example, the level of employment in the area is of primary importance for office and industrial properties, whereas residential demand relies on population growth. An analysis of the office space vacancy rate, employment distribution (as derived from government forecasts and data collected by the Australian Bureau of Statistics), building approvals, buildings under construction and the quantity of similar types of projects in the planning stages can all assist in determining demand.