Residential property development can be very profitable, however equally costly if not approached with vigilance.
Taking the first step
Residential property development can be very profitable, however equally costly if not approached with vigilance. In this blog series over the coming weeks, we reveal our 15 key lessons that are the result of experiences in the recent past. These lessons have been learned the hard way, sharing our experiences so you don’t have to make these same mistakes. Hard work, determination and the sqft.capital deal modelling tool coupled with these rules to live by will lead to that long and profitable property development career you dreamt of.
Measuring Performance – actual numbers or with the help from rising markets?
Many believe that they cannot fail at property development and associate the business with huge riches and a great lifestyle. What is not always seen is that money is easily made in a rising market – if you buy for £300,000 and sell for £400,000 with £100,000 costs, you have made no profit; but if the market goes up 10% in that time, you’ve made £40,000. The truth is, you haven’t made any profit – the market did. In the same instance, if the market went down (which it does!) 10% in that time, you have lost £40,000 – if you can even sell the property. Profits must be projected at the start of a project so even if the market drops 10%, you should at least draw even or make a reduced profit. A safe margin is 20% - not many people will risk their cash on a high-risk project for less than this. Remember, 20% is the profit on ALL costs.
Success here is making money whether the market goes up, down on is static. To ensure this, we have developed the and this is where the sqft.capital modelling tool becomes invaluable., it is invaluable when underwriting your development opportunities.
A common trap that awaits many the hopeful developer, like the proverbial slice of moldy cheddar to the opportunistic rodent, is that of comparison - comparison to others who are perceived to be “in the game”. A useful phrase to keep in mind regarding longevity of performance; in an airfield bar, there are old pilots and there are bold pilots but there are no old, bold pilots.
Taken quite literally, there are those that promote their performance, believing it to be all of their own insight - and there are those who have been doing it for some time, quietly sipping their reward in the corner, away from the champagne spraying, Johnny-come-developers. Experienced-knowledge doesn’t need to stand on a podium for they know how much a fall from it can hurt and have seen one or two. In very few industries is there such a blatant opportunity to accidentally perform and become a prophet of the industry from one’s supposed performance - this is similar to waltzing in a minefield. Tick, tick, tick, boom.
Buy at the right time (the “right" time being controlled by more factors than we could possibly to be aware of), sit back (sweat a little but keep a handkerchief close at hand), let the rising market do its work, and congratulations - sell for a “profit”, more of which we will explore later. This very same story could be relayed in the reflection of itself as it has been done to countless many over the last 70 years.
Comparison to others is not what this business entails, if that is your wish, then good luck. If serious success (by which we mean both monetary in terms of rate of return and quality of life) truly is your goal, your focus must be on your own performance. If starting from scratch - which is entirely possible - recognise that there are no short-cuts but the sooner you understand how to rig the game in your favour, the sooner you will understand the game and see the tide change into your conservative favour.
The short-term (and it always will be less than 10 years, commonly 5) property investor will likely have no experience in a "bad run of luck” - which is a necessity in their success. It may be wise to not just accept but also embrace the fact that most (all) developers make mistakes; so many mistakes. These mistakes however are vital to future know your end game but expect, or even anticipate that people, greed, markets, fluctuations, headlines, people and greed(again) will always take a slice of your potential performance. The strongest out there will take each mistake as a lesson and learn from it - sometimes an expensive one but a lesson that will likely not happen again in their career.
One of the biggest direction changes in the my own outlook came when a person previously respected for some time with a (supposed - never saw proof) successful history of property development once admitted he had never failed at anything in his life. In one instance, a great deal of respect for this individual evaporated and shortly afterwards he committed a monumental failure that cost hundreds of thousands to those involved. No doubt he tells others to this day that his failure record is still zero. Though a bitter pill to swallow but it led to one of life’s best lessons in trusting others without conviction; I.e., don’t.
If one is able to go into this market with eyes wide open for those who have had “success” in terms of bought at x and sold for y, certain similarities will become apparent. A common one is that of the ease at which individual success apparently has arisen.
The hardest part of this entire game is getting off zero - it may take some years. The second hardest part is staying above zero through discipline and repetition. Many successes will have not actually started at zero but had a less than visible hand-up (or hand out more specifically), from others. When selling a property for a profit, the focus is always on what was supposedly made - not on what was gifted to start with.
The easier part of this game is understanding leverage - if you have x amount, leverage it up, develop and sell for y. It is no longer possible to leverage from zero any more, thanks to a little correction in the global debt markets around 2008 when less than honourable members of the financial industry were incentivised to make huge profit by offering leverage to those with no capital or knowledge of debt which created an enormous bubble that popped, very badly for some.
Returning to the main point of awareness of others and the signs of future success; by always focusing on our end game, seeing others spraying the proverbial champagne, be sure that they may not have had the end game in mind at the start of their investment and such an investment may have had easy backing. This is not success - it is blind luck. True success can be seen way down the line (if greed has not taken over) and can be clearly shown in future performance being linear or exponential.
Linear vs. Exponential growth
Linear growth is characterised by 1, 2, 3, 4……, an example being that an initial profit of £50,000 becomes £60,000 after the next deal and maybe £75,000 on the next deal. If linear growth is the focus of our success, the property market and time will take care of this - so long as we are prepared for re-corrections over time, which will happen.
In property investing, triumph is not characterised by allowing market growth to create profit. Real success is measured in exponential performance - quite simply 1, 2, 4, 8, 16.... This ROUGHLY means doubling funds on each deal. While this is a perfect world example, hopefully it shows that real success means beating (not riding) the market through considered and well researched acquisitions, leading to conventional and de-risked arbitrage.
Just to revisit the second hardest thing in property investing (staying above zero); should a developer experience the Midas touch and see their portfolio develop exponential growth, incredible discipline will likely be required to retain a considered approach. Very few people in the global world of investment have achieved this - think Warren Buffett, Carl Icahn, George Soros, but they have done so to create unimaginable wealth. Still, this is a nice problem to have, so long as it is noted.
A fantastic story of such exponential success was an individual (who was self made) who amassed a fortune of some $750m in Las Vegas real estate. His supposed Midas touch landed him negative $400m due to excessive leveraging and something of a market correction in supply and demand. How the mighty fall. Big story, hopefully an illustrative one.
Conclusively, a developer must play their own game, know their goals and not attempt to replicate others and their ticker-tape parade of success every time the market goes up. Congratulate them on their winnings and be aware of what may topple them or the fact that the market has allowed them linear success – and retain focus on the fundamentals, buy well and know the variables. A commonality in the “profit” accrued by some is that it very rarely accounts for what may have been in the bank to start with, the actual costs involved (i.e. debt/mortgage costs, inflation, VAT, fees, sales costs…) and the time taken to return the profit. A 20% profit over 2 years is actually a 10% profit in the real world, and less than 7% over 3 years. Take away a rising market and the actual profit (Return On Investment) becomes eroded.