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.
Starting Out as a Developer - how to get going
The “where do I start” question is one that is likely to hit all potential property developers - though this may be affected by the cash at your disposal, your experience (particularly in business), your appetite and your existing skill set. The more you know, the more likely you will succeed so it's worth getting experience in various areas such as business, buying/selling properties, accounting, bank funding, equity investment and construction. A lot will be learned in the process but an ex-estate agent who understands bank funding will be far more successful than a graduate with a geography degree.
In order to make some progress, the following knowledge / skills should help, in order of importance:
What is going on in the economy globally, nationally and locally? What factors affect housing supply and demand and is a specific location experiencing more of the former or the latter - is it a buyers or a sellers market? What are the historical trends of the housing market in an area? Who is buying what - i.e. what is the typical buyer profile (nationality, age, funds source, climbing / downsizing) and importantly - what is in most demand? For example, if 2-bedroom flats are selling more than anything else in a locality, for say £500-700,000 – it may be unwise to build a £3,000,000, 5-bedroom house. Though we can be very proud of creating something huge, beautiful and weekend-supplement porn-worthy, it usually comes with some ego - and there is little room for ego in this sector. Ego will create something visually beautiful to be proud of, but if that ends you up £200,000 in loss – this is not a property development but more a hobby in funds disposal. Property development is about turning for a profit - so why make it harder than it needs to be? Why not take that big house and split it into 3 two-bedroom flats? The finish can be cheaper, the price per square foot is likely higher and the product is in the area of highest demand. Simple but missed by many. A final note on market knowledge that I was once told by one of the most successful property magnates in London if not the world; avoid journalism, especially weekend-supplements. All property journalists are trading on second-hand information that contains data that can be six months old, and the job of the journalist is not to maintain humanity - it is to sell papers. Nothing deprives a reader more of his £1 than a headline that advises that, since yesterday, Armageddon has occurred, and the house market is crashing. Tomorrow however, this story will not grace the front page but may have a sidepiece in the journalistic graveyard of page 6. Crashes in property very rarely actually happen overnight, because the assets are illiquid - and assets lose value based on human sentiment (how we feel, what we need), not new CEOs, emissions data or social media.
All good developers spend hours in front of spreadsheets and modelling on the sqft.capital deal modelling tool – this business is about MONEY. Well modelled costs, returns, profits and percentages are the difference between making a profit and going bankrupt. This attention to detail will be welcome when the market drops – which it will at some point. The tide will retreat and you don’t want to be wearing the Emperor’s new clothes. Once we know a demand is present for a sale, it is vital to be able to confirm internally and to funders that the model works in providing a reasonable Return On Investment (ROI). Floor layouts, paint colours and scatter cushions are not of any relevance now - unless you want to look an idiot to your lenders. Your model should display a competent understanding of excel to show you have considered all cost factors (acquisition, development, debt and disposal - more later) as well as a realistic Gross Development Value (GDV). Detail is the key here because most debt lenders will agree “in principle” to lend millions from one spreadsheet, so long as it shows a sufficient ROI and protection of their funds. The reason for banks’ prompt agreement to lend (in principle) is that their due diligence measures (quantity surveyor, valuer, lawyers - all at the developer’s cost) will confirm whether or not the projection is viable or mystical. They will lose nothing except the few minutes to decipher your spreadsheet. As such, a spreadsheet should be easy to read, progressive (start to finish like a balance sheet) and clearly show the magic profit number at the end, without the need for excel(lent) engineering. And for the love-of-God, the appraisal must include a realistic time period for acquisition, development and disposal, with a comfortable contingency. 7% interest is not 7% of interest over 2 years, it is per annum. Finally, the promoter (developer) must know their numbers inside out as all professionals involved will dissect these. If the promoter cannot back-up their projection with absolute certainty – the deal is off to the graveyard. In starting out a career however, don’t be concerned about getting it a little wrong – it is far better to have 3 models pulled apart that don’t quite work so when the fourth comes along, previous shortfalls are obvious. Many will make mistakes and these are vital in order to progress – don’t be afraid to ask advice from debt lenders, it is usually very welcomely given by those with experience because though this deal might not work for them, they hope to lend at some point to all budding developers. Quite frankly, they have a balance sheet causing ‘cash drag’ – it is not earning a return sat in the till – they want to lend their cash.
When starting out, it’s vital to concentrate on one area and own it. If concentrating on more than one, market knowledge will be diluted and therefore too weak to spot profit. View, view and view more – see 10+ properties per week. Don’t go to auctions - they are rooms full of drooling idiots who miss the objective of finding a deal, even when surrounded by others who get bursts of endorphins every time they raise their hand. In any area, many developers will be passively active but those that scour a specific area for every single property passing through the market are typically very few. Why? Because many developers are lazy and rely on their past experience - they expect to get the call when the deal of the century arrives. Even if they know all local estate agents well, they probably will get this call along with 20 others - and before you know it? Yep, we’re going to sealed bids to see who has the lack of foresight to bid in a fiercely competitive environment. Know thine area, search portals weekly and get to know every single estate agent in the area, call them weekly. Some you will build good rapports with, as all agents secretly want to be developers, while others will forget who you are before the receiver touches down - until you call them every week for 2 months. If you are getting into developing from an early age (school, university), without capital and don’t have too much pride to swallow, the best move you can possibly make is to get a job as an estate agent in your specific area. Nothing will teach you more about the stock in the area, what is in demand, who the buyers are, the legal process of a purchase and so on. Yes, you will not earn big money - though many and agent has hit six-figure take-homes with 12-24 months - sadly though creeping into this level of income leaves you little room for any exponential or even linear growth in income - earnings are capped because one person can only sell so many houses per year. Saying that, £100,000 per year is one hell of an income and will afford an extremely comfortable lifestyle (as to whether any of this will be saved, it is doubtful as we typically adjust our lifestyle our income level). This does come at the expense of the most important commodity, our time; success in estate agency will mean 5/6-day weeks and at least 10+ hour days to see a significant income. Making money in property takes time – don’t be in a rush, it will only cause you to make mistakes that can be painful.
It may sound strange to have funding in fourth place of priorities. The reason it is here in penultimate place is that so much of the above must be learned, forgotten and experienced before developers actually need any money to execute a deal. This should not be of concern, it is so important in the early time to build relationships with both debt lenders and equity lenders. We will go into more of each later but start doing some research and meet as many people as you possible can. Equity lenders are usually individuals who have a level of disposable income that they want deployed in higher-risk investments - of which property is one, and who like the idea of being invested in property and it is tangible unlike stocks and shares. They will not have, or want to have, their noses at the coal face of the property market so will welcome a young person with enthusiasm to do the running and deal finding. Meet as many potential equity lenders as possible because, as soon as you find a deal - all of those people who were desperate to invest will suddenly be busy, less than interested or have funds committed elsewhere. Both debt, mezzanine and equity lender are easy to find with sqft.capital, we can provide indicative terms and discuss;
- What their APR is (basically cost % per annum of their money).
- Their “in” fees (usually 1-2% of loan).
- Their “out” fees (usually a % of the loan or the GDV, if applicable).
- Their security requirements.
- The track history they look for.
- Whether they require Personal Guarantees from you.
- What their minimum deal size is.
Surprising to some but this sits right at the bottom. You are planning to be a developer, not a builder. Money is not made in any significant amount by taking courses in plumbing, electrics or brick laying. Without question, they are all skills that are useful to be aware of in order to spot when (not if) a contractor is serving up dubious excuses about progress or delays. Know enough on these subjects but do not be an expert - typically, 80% of most trades can be learned by reading up and looking around sites asking questions. That final 20% of knowledge is what makes you a contractor for a living and will definitely cap your income - one man can only lay so many bricks a day. This may seem harsh but it is a fact of business - labour is labour and it has a maximum rate of output, hence why it is a predictable cost to a developer. Above all, know some contractors, see their work and build a rapport - if they like you, you may get a favour or two some day, which will be worth its weight in mortar. Meet lots, see their work, ask questions and buy them a beer - do not take liberties from any though - they work incredibly hard to make a living and it is one profession that is expected so much for free from – having owned a construction firm for 6 years and being delighted to be free form it, I know this. When a project does land, everything will move so quickly, you cannot afford to start looking for labour then.