Written by Motion Property’s Managing Director, Ariel Brukarz.
Any private enterprise needs to obtain a return on its investments of at least 30%, not only to recoup expenses but to also affect a premium for the entrepreneurial risk undertaken by such an enterprise. Developers are no different. They undertake large risk for a handsome profit in the correct economic environment, but also suffer deplorable losses when housing markets plummet or commodity prices soar to erode their profits. One poorly performing project can detract from a number of years profit.
The investment a developer makes begins with the purchase of land and formulation of plans to obtain development approval (DA). This alone can be a substantial sum to invest depending on the size and nature of the project. Often developers in cities will take on projects of considerable size that involve the provision of a vast number of apartments that each absorb an exorbitant sum of capital during construction. Presently Melbourne apartments cost more to construct than free standing houses on the suburban periphery, and carry with them construction costs alone of approximately $1800-$2000 per square metre. While apartments vary in location, characteristics and size, for the average Melbourne inner city apartment this results in an average price tag of approximately $450,000.
Making purchases in bulk can often obtain economies of scale for the large scale developer, but still a number of contingent costs are payable by the developer prior to even commencing construction.
Surveyor’s fees and architectural plans need to be obtained along with council fees of development approval. This process can be rather protracted as it takes time to coordinate a number of professional services in order to produce a DA application. Further, if the DA is issued additional stamping fees, construction certificates and water and sewerage fees will be applied.
Despite this arduous process being negotiated, the council may not in fact issue development approval, due to non compliance, or it may simply ask for amendments to be made to the application. In this instance it is experience and expertise of the developer that will avoid an application being disallowed. For this reason, developers often purchase an option over property in order to guard against the DA not being issued or some inadvertent reason.
Project finance is provided to developers on a case by case basis, but invariably requires considerable investment by the developer and will rarely be provided until a substantial portion of properties on offer are sold off the plan. When pricing their investment, developers incorporate the estimated sale price of each apartment over a timeline, as large scale developments will take considerable time to complete. Often developers will discount the properties sold off the plan in order to obtain the requisite finance, and recoup the shortfall with the balance that remain unsold.
It is in these periods that investors can benefit as purchasing of the plan will merely require a deposit and an executed contract for sale, but settlement will be deferred until completion which can often be an extended period of time.
While a legally binding obligation, in this manner, a purchaser has the opportunity to differ a cash flow obligation while purchasing an asset with inherent property rights at pre-market rates. In a strong economic climate this type of transaction may well result in a capital gain being made prior to completion.