I get asked this question so often that I’ve decided to write something about these common mistakes to instill this knowledge into newbie or smaller developers in their earlier development journey.
Well very often, the newbie developers get so excited and eager to start their first or second development projects that they forget about the most common mistakes that could set them back financially or wipe them altogether before the game really starts and they drop their blinders down in the fear that they will miss out on their first deal.
From www.nestland.com.au November 15, 9:12 AM
Our insight:
I remember that feeling too well, where you have been following your target market closely for quite a long time and now something special has just come up on the market, fitting most or all of your development criteria on the site. There’s that feeling of confidence or overconfidence that you tend to drop your blinkers down and your emotions get into play.
The first common mistake to avoid is the fact that construction costs keep climbing to a new level that if you’re not keeping tabs on regularly, could potentially make or break the deal so easily. A quarterly or even monthly update of construction costs needs to be revised in your feasibility modelling to reflect the current situation of price fluctuation due to shortage of timber, steel and global supply chain impact. A constant update from a reputable builder will keep you up to date on the price level that you should be using in your current feaso.
The number two mistake that I find many developers do is, to overly use inflated end value of the individual dwelling in their calculation. Just because one dwelling just got sold slightly over the average price in your target market does not necessary reflect this trend and must not be used in your feaso for similar dwellings, unless the higher sale price becomes more of the trend over the last three to six months. In a very dynamic market where the volume of dwellings are moving fast, a 12 month snapshot of the market could be used as a conservative outlook on the price movement, but a monthly or quarterly snapshot will indicate where the market is currently trending.
So if you have overinflated your sale end value, obviously your feasibility will look very profitable and you could be misguided by false expectations about all the other mistakes below. I understand that by the time your project is fully constructed or being sold off plan, the current market would have shifted, but nobody has a crystal ball of what the market situation will be when you will be selling your project in that market. Therefore it is very precautionary to adopt a conservative approach by using your current prices in your calculation and avoid building false expectations which could be devastating for your project.
The next common mistake I see too often is to over confidently expect more dwellings from the site than your worst case scenario analysis is projecting. If a raw site, without any permits in place, is being sold on the market, too often the vendor will want to maximise the perception of the maximum higher density on the site by engaging a designer to draft a concept plan to indicate what the maximum height, density ratio or number of levels can be achieved on the site based on the current town planning rules.
However this is only the vendor’s architect view being misrepresented by this cunning approach, but this is not the council view of the concept proposal that will fit within the current surrounding neighbourhood character for a permit to be granted.
So until you can expect a formal permit being approved by the relevant authorities, this proposed concept is like gambling and could wipe you financially if your decision is solely based on the vendor’s conceptual plan at time of acquisition. Instead as part of your independent due diligence process, you should consult an independent architect who has done many projects in your current target area to provide their views on the maximum number of dwelling allowed on the site and the reasons why for their assessment.
This way you are not being biased by the vendor’s proposed concept plan and ultimately drive your feaso to unexpected profitability levels giving you a false calculation of the price of dwellings per lot. This analysis can significantly skew your profitability level if one or two dwellings must now be removed from the concept drawings if council was to approve such proposal.
The second last mistake is one that a number of my clients all too often make in their feasibility modelling when they use an interest rate similar to their residential home loans. Fair enough this is the interest rate that they are being charged by their respective banks on their residential home, but in order to prepare a feaso for a commercial project where development funding will be applied, a commercial lending interest rate must be used in your calculation.
I would suggest that if you’re starting out, the chance that your big four banks or even the second tier banks will fund your project is very slim even though you have met their indicative pre-sales level in this current market. Therefore a non-bank or private lender alternative will be the most likely financier on your first or second project with a higher blended interest rate including application, evaluation, establishment, line fees and so on and these will usually start with a double digit number. This is where a number of newbie developers get outrageously burnt especially when the project holding costs get compounded with all types of delays due to the lack of experience and knowledge in this game, resulting in a bad to worst project outcome.
The final mistake that many developers encounter when putting their letter of offer together or bidding at an auction is paying too much for the site. Especially at an auction when the competitive atmosphere is being created by the auctioneer for a number of potential bidders and your emotions get wrapped into this environment.
Not only you may have devised a strategic plan not to go beyond a certain price point which would make your project going from an ideal scenario into a not so good scenario, but your game plan is sometime thrown out of the window with all the other competing parties trying to outbid you. And you keep pushing back at it in the fear of missing this site given you spent all of your hard work, time, effort and resources in the last few weeks and you tend to turn into more of a desperate case in that very moment, causing you to go to an even higher price level.
Very often when I visit some auction site and I know for a fact what the maximum price the site should be acquired at to make the deal still profitable, I often wonder what’s in the bidders’ mind, scratching my head when they going way past the maximum price I would be offering, even fifteen or twenty per cent more. Either they are a very astute developer and have considered all the above common mistakes in detail with all the consequential thinking behind them, or they really gambling in this game and have to funky** ideas what they really doing showing even their lack of expertise by the price they offering and inflating artificially the prices of other surrounding development sites.
So after tracking a few of their formal council application in the months ahead, I realised how inexperienced and how outrageously stupid they are playing this game when council have declined their proposal. And this is based on the lack of proper advice and knowledge they are surrounding themselves with resulting in two negative outcomes. The first one is that, they are wiping themselves financially big time or fast and they are also pushing up the development site prices that they artificially inflated in the first place. So this is a totally funky** game plan that they have decided to embark on and I trust you’re not in this category if you really want to make this journey a long, profitable and ever lasting legacy for you and your loved ones.