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.
What drives you to be a developer - Money or design?
Deciding why you want to be a property developer (or what skills you have that mean you might be any good) is a step many jump over. The appeal of finding an old wreck and turning it into a stunning home is the belief many have of what property development is. The truth is that development is about making profit in a safe and risk-assessed manner. Having an ability to spot that wreck will make you no money (and very likely lose you lots) but assessing potential profit after costs on an average house will give a chance of success. As such, getting into this business without a love of spreadsheets is dangerous.
"Would you like the idea of flying to Milan to identify a new piece of furniture for your new development? Or would you prefer to crunch spreadsheets?"
This question can be the crux in determining whether you lose money (big-time), drawn even or make serious dollars. To make money (more specifically a minimum profit, which is the primary intention of any business), property developers must be totally focused on numbers, and this is where the sqft.capital modelling tool becomes invaluable.
Numbers means a constant projection of every deal that changes daily with fluctuations in costs, timescales, debt, projected GDV etc. Your head needs to own these numbers because no one else will, and in doing so - YOU MUST NOT BE UNREASONABLY OPTIMISTIC. This sounds like huge pessimism but this mistake puts more developers into trouble more than any other.
Forget market fluctuation, the mortgage market, the toilet arriving on site being the wrong shade of white, time delays, blah-blah-blah. Developers who carry too much optimism (and you can see them coming), will get caught out - usually either very early on or shortly after a big win. This statement did not require a 4-year stint in Rocket Science at Cambridge for the author – nor can he claim exclusivity on it. It actually belongs to the bible of property development.
An abundance in optimism means a developer may hope some costs won’t be what they actually will, some costs will not apply (“we don’t have to pay VAT, we’ll give him cash in hand" = alarm bells). This is usually summarised by an expectation to break every price ceiling in the vicinity and re-write the rulebook on selling the most expensive property on the street. A more secure key to success is paddling on the pessimistic side of realism.
A classic example of when this comes into play is as follows; the market is healthy, every new property for sale on XYZ Street sells for more than the last one (note, danger, more on that later). It is derelict, un-inhabited for 40 years and still has an outside thunder-box. Without question, this could do with some cosmetic enhancement. Sadly, there are no awards for identifying this pearl of business acumen - because the other 50 people that have seen this place are of the same belief. Still, because of the interest, the property goes to “sealed bids” (i.e. everyone puts in their best and best and final bid and a buyer - hopefully the best buyer, not the best offer - wins the deal). Sealed bids should ring another alarm bell - you are unlikely to make any profit in a competitive bidding environment such as this. The excitement ensures that many sealed envelopes arrive, eclipsing the asking price. This is what the selling agent wanted, and many bidders feel the need to enter a figure that competes with, or worse still, is the highest.
The “successful” bidder may win the battle to agree the purchase but they have suffered huge defeat in the war on profit and are about to get conquered by the army of their own over-optimism. In summary, profit is made at the time of purchase, not the sale – as such, a “successful” offer will only be that if it is the calculated figure that the bidder wishes to pay in order to realise a profit later on sale.
In such instances, an end-user will typically triumph because they have a longer-term perspective as opposed to the developer’s short-term profit focus. In order to make money in this business, a prosperous speculator must be willing to walk away from way more opportunities than they win - because a short term loss is a long term gain whereas a short-term gain (battle) can be the end of a developer’s career (war). When a developer learns to laugh at the bid that beat theirs, they can objectively perceive success on their horizon. Success will come, maintaining persistence is vital.
It is a situation that a buyer will fail to convince many an estate agent on; a successful property deal might involve acquiring an immaculately presented property, with no need for work whatsoever. Why? Because if the seller of that property needs out quickly (perhaps for cash reasons) – a “deal” presents itself in potential purchasing a below-market asset, only to resell at a higher market price in time – this is called arbitrage. This is not a common situation but displays the point plainly - what a developer buys is less important than what they pay. As soon as this mindset adjusts thinking in terms of deals, the opportunity for profit arises, or what can legitimately be called success.
Returning to the title here - money or design, we have covered the importance of a focus on numbers and the need for lack of over-optimism. The other closet skeleton to sidestep or at least be aware of is too much focus on the ability to have a vision. Remember the question about going to Milan? If this seemed an alluring lifestyle, bad news - there could be a danger of creating a hobby rather than a business.
If the developer has eye for design and an excitement about the aesthetics of finished product - this could be a huge asset in their career. If however, it manages to dominate the focus of figures – an end result could easily be the most beautiful house on the street. And a loss of £200,000. Or more.
If this is an attractive reality, please stop reading and walk away.
It is an unfortunate belief that possessing the skill to create a beautiful product is more important than profit - specifically a percentage return on costs. “Budget" should be a word that you sneak away to the Cotswolds for a dirty weekend with – appreciate it and let it break your marriage with the concept of having a vision.
A developer’s ability to recognise this in others will pay dividends, literally, though in the longer term. Some buyers actually do have the money to lose, though they will convince themselves that because they sold higher than they bought, they have made a profit. Their blind optimism is ignoring costs, or maybe just popping them in a drawer to look at later. And locking it.
Don’t do this for a hobby unless you are Montgomery Brewster.