• Sat. Apr 20th, 2024

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Questions for first-time small-scale property developers

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By Ritchie Clapson CEng MIStructE, co-founder of propertyCEO

Historically, people have viewed property development as the domain of the wealthy, the brave or even the foolhardy. But the last few years have seen a significant shift in people’s perspectives.

There have been two key drivers.

Firstly, traditional buy-to-let property investing has become far less attractive due to increased taxation and heavier regulation. Property investment can still be highly lucrative, but the balance has shifted towards the development end of the spectrum and away from the rental sector. This move has seen many landlords look at development as a parallel investment strategy that can generate significant amounts of cash in the relatively short term.

Secondly, we’ve seen a considerable push from the government to encourage small developers to convert unused commercial properties using permitted development rights (PDRs). The UK has abundant unused commercial space—enough to build 1.2million new homes, according to countryside charity CPRE—and no town is immune from the blight of empty shops or redundant office space. On top of this, there has also been the realisation by many people that development doesn’t need to mean building an entire housing estate – you can make substantial profits from simply converting a single building.

So, what exactly is ‘small-scale property development’? Typically, we’re looking at converting a commercial building such as an office, shop, or light industrial unit into residential flats. It could be as simple as converting a small office building or the upstairs storage areas in a shop. You’re likely to be building between four and 20 units, and you’ll typically be looking to target a profit of between £100,000 and £500,000 per project, with each project lasting 12-24 months or so. You could also include a new build in the definition, but this means going down the planning permission route, which is far riskier than using PDRs to convert a building.

So, if small-scale property development is the current property investment strategy of choice, what are the key questions that get asked by those thinking of dipping their toes in the water?

Here are the top five:

  1. How much money do I need to develop property?

This comes as the biggest revelation for most people. Because it takes a fair amount of cash to convert a property, most people think it must require a larger personal investment than a buy-to-let.

Let’s compare two examples side-by-side.

Imagine you were buying a £400,000 buy-to-let property. You’d typically put down a 25% deposit, which is £100,000. On top of that, you’d have assorted purchase fees, plus you may need to do some work on the property before you rent it out – let’s call it another £40,000 in total, making your total cash investment around £140,000.

Now, let’s look at a small development project. Let’s say you’ve bought an empty shop for £400,000 and want to put four flats above it. We’ll also assume that the cost of doing this conversion (including all construction costs, finance costs and professional fees) is another £400,000. So, on paper, that’s an £800,000 investment, which is much greater than our buy-to-let scenario. But this is often as far as people get, and they fail to appreciate where the money actually comes from.

Development is supported by an industry of commercial finance providers who specialise in funding developers. Those lenders will typically lend up to 70% of the purchase price of the shop: in our example, leaving you as the developer to fund the deposit of £120,000. But here’s where you have your first big win; these commercial lenders are happy for you to borrow the bulk of this deposit from private investors – it doesn’t need to be all your own money. That said, they will almost certainly want you to have some skin in the game – for example, you may need to put in 10% of the deposit yourself (in our example that would be £12,000), but you can borrow the balance from other investors.

Of course, there’s the issue of the £400,000 you need to do the development work. Which is where you encounter your second big and somewhat surprising win: the same commercial lender who advanced you 70% of the purchase price will also be happy to lend you 100% of the development cost.

Let’s say your buy-to-let property doubles in value over the next 10-15 years and nets you a £360,000 profit from your £140,000 investment. But our shop conversion will target a £200,000 profit over 12-24 months for an investment of just £12,000. From a financial leverage perspective, it’s in a completely different league. And, of course, these lenders want to lend you money because it’s immensely profitable for them – that’s the beauty of development. Plus they will insist you target a minimum 20% margin for yourself because they’ll want to make sure you don’t lose money.

  1. How do I find people to work with me on my very first development?

This is an understandable question. As a new developer, you’ll be entering a world where everyone else knows a great deal and you know very little. You’ll feel like you’ve got the ‘L’ plates on and will be fair game for unscrupulous contractors. Or will you?

Part of the answer here involves a mindset shift. In development, it is the developer who creates all the wealth. No one gets paid unless the developer decides to develop. So, you’re the boss, the entrepreneur looking to take advantage of a business opportunity. The other beauty of development is that it’s highly leveraged. As the developer, you don’t lay bricks, design flats or even choose curtains. You employ an army of professionals to do those things for you. You’ll have an architect, contractor, structural engineer, planning consultant, and many other specialists, each of whom has decades of experience in development. When people look at your team’s CV, they’ll see a group with centuries of experience who have completed thousands of projects.

But how can you manage this experienced team if you’re a first-time developer? This is another massive benefit of small-scale development. Because you have a six-figure development budget (albeit none of it is your own money), you can afford to hire a professional project manager (PM) to oversee the build on your behalf. They’ll be the ones who go to the site each week and will ensure your contractor delivers. And they’ve seen it all before – there’ll be no fast ones being pulled. You simply have a weekly phone call with your PM to keep yourself up to speed and to make any necessary decisions. You become the CEO of the outfit rather than the site project manager. And that means less work for you – and also far less risk.

  1. How can I find a profitable project?

One of the big attractions of development – and commercial conversions in particular – is that your source buildings do not have a fixed value. Let’s take a run-down commercial building. It might be worth £100k to someone who wants it for their business, but because you’ll be converting it to residential, you’ll be getting a huge uplift, meaning you can pay significantly more than its commercial use value. This is great, but you’ll be up against other developers looking to do the same thing. This is where a little expert knowledge goes a long way. Imagine that other developers could get five flats into the building, but I showed you a way you could get six. With a 20% profit margin, all their profit is in their fifth flat. But your profit is in flats five AND six, allowing you to outbid the competition.

One of the significant advantages here is that, in development, people tend to stick to what they know. Most established SME developers focus on new builds rather than conversions. Knowing how to unlock the hidden value in a building isn’t a case of having decades of experience – it’s simply knowing tips and tricks that other people don’t know – plus having a solid understanding of what’s possible using PDRs. So, get yourself properly trained and genned up and you can get a massive edge on your competition. You won’t just avoid the pitfalls; you’ll see many more opportunities, too.

  1. Why would anyone want to work with you?

Ok, this is an easy one. Architects only get paid by developers; the same goes for other professionals. They’ll get paid regardless of whether you make a profit, plus a first-time developer has every chance of becoming a long-term client when they do their second and subsequent projects. In other words, your money is as good as anyone else’s. Also, assembling a team is easy because you don’t have to pay them until you get a project. You simply appoint them as your preferred partner. And they’ll want to work with you because that’s what they do. The same goes for lenders and commercial estate agents. They make money on the back of what you do. And providing you look professional, they’ll want to work with you because that’s how they get paid.

  1. How can I guarantee I won’t lose any money?

This is also an easy question to answer. In short, you can’t. Property investing is a risk-and-reward business, so there are no guarantees. But there are a lot of things that you can do to reduce your risk significantly. The first thing to remember is that you should always be targeting a 20% profit margin. That way, even if the market moves against you, you shouldn’t end up making a loss. Your commercial lender will only lend you the money if they believe the deal makes a 20% profit, which gives you added comfort. You’ll also have a contingency fund of 10-15% of your build cost to allow for unexpected costs. Also, get yourself properly trained; most mistakes that new developers make are wholly avoidable – a simple case of ‘they didn’t know what they didn’t know’ – so don’t be a ‘have a go’ developer.

One final risk mitigant is that you automatically have two exits. If the market dips at the point you come to sell, you can refinance the units onto a buy-to-let mortgage and then rent them out until the market recovers. The good news is that rental prices tend to rise when house prices fall. It should mean you’ll command a rental premium while you wait for sales prices to bounce back. And, of course, many developers build flats to keep and rent out in any event – it’s a very sound strategy where you establish your equity through development profits rather than having to invest your hard-earned savings.

Hopefully, that’s put a few things straight – and maybe even busted a few myths. The critical thing to do is to do your due diligence before you commit to a project. First, discover precisely what’s involved in developing a building and where the best opportunities lie. You can use the QR code below to access a free webinar where I put more meat on the bones.

The second thing I would recommend is to get yourself properly trained. There are big profits to be made in development, but you don’t want to fall into any holes – and there are plenty of them if you don’t know what to look out for. The investment in training should pay you back manyfold on just your first project, plus it means you leapfrog much of the competition who are simply ‘giving development a go’.

And with the government looking to bring in even more PDRs in 2024, now could be the best time to look more closely at getting into small-scale development before everyone else does.

ABOUT THE AUTHOR

Ritchie Clapson CEng MIStructE is a veteran property developer of 40+ years, an author, industry commentator, and co-founder of the leading property development training company propertyCEO. Ritchie is passionate about tackling the lack of housing in the UK and helping ordinary people to be part of the solution. To discover how you can get into property development, visit www.propertyceo.co.uk

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