Last week, I posted the second installment on my series about real-estate development under the ‘teaser’ headline: how much money can you make developing real-estate?

But, of course, I didn’t actually answer the question!

And, that’s simply because I don’t know …

… it depends on the project, and what you are trying to achieve.

But, I DO know two things:

1. Typically, real-estate developers work on:

– a 20% to 25% profit margin on residential real-estate projects,

– a 35% profit margin on commercial real-estate developments,

– upwards of 50% profit margin on land subdivisions.

2. I also know the EXPECTED profit margin on the two projects that I’m working on.

What that expected margin on my projects will translate into is anybody’s guess, because it depends on so many RISK FACTORS – which is why real-estate development is (in my opinion) a Making Money 201 income acceleration activity, not to be taken lightly.

But, I can share Tab 3 of my spreadsheet, which shows:

– That there’s about $2,000,000 (Australia … approx. $1.8 million US dollars) of land related costs: I estimated this as $1.5 mill for the actual purchase price of the property, plus $500k allowance for taxes, closing costs, and the necessary project permits. Obviously, I will put in better estimates for some of these costs, as they come to hand.

– I’ve assumed that the bank will lend me 60% of the total project development cost of $17.9 mill. (which includes, the land component, all the costs of consultants, permits, etc., and the building costs). I’ve since spoken to the bank and they will lend closer to 80% of the total build costs, PROVIDED that I sell enough condo’s ‘off the plan’ to cover their total debt.

– Based upon the 60% that I have used in the spreadsheet, I will either need to come up with $7,160 million of my own money (i.e. the $2 mill. that I will have already spent on the land and permits, etc. PLUS the $5.160 million ‘shortfall’ in bank funding) OR find a mezzanine lender who will lend me some of this (at inflated interest rates, naturally) OR find one or more equity partners, who will put up some of the $7+ mill. shortfall in return for a good chunk of the project profits.

– In this case, I’ve assumed that we sell the condo’s in year 3 (more likely – hopefully – to be a 2 year project) and pay back the bank and this spreadsheet assumes 10% interest rate (although, that can be easily changed), leaving $10.6 million to pay back my and/or the investors’ equity and (hopefully) leave some real profits.

– I’ve assumed that we’ve had to pay some interest at ‘preferred rates’ (read: higher interest rates) on my (and the investors’) equity, which leaves a ‘real profit’ of $892k … but, don’t forget that the preferred interest is also part of our (i.e. the investors’) profits … so, they need to be added together.

– Now, I have a management partner who is a builder (but, won’t be physically building this one), who is providing time and expertise in return for 30% of the profits of the venture. He has a sweet deal: not risk (he provides NO funding and only his payment is ‘at risk’) and 30% of the upside. In my next life, I want to come back as him 😉

– According to this spreadsheet, I make 32% on my money. Not a shabby return, and pretty much in line with the estimates that I provided above.

The good news is that the project has actually become much more profitable than the early version that I am providing here, but since it’s merely an estimate – as all budgets are – I’m not holding my breath 🙂

I should point out that one of my readers has kindly provided a more sophisticated analysis of the returns that you may wish to substitute in your version of the spreadsheet, if you are going to use it; Jonathan says:

On tab “Proforma”, shouldn’t the annual return equation in cell E34 be something like =(1+E31/E5)^(1/3)-1
It looks like you have =(+E31/E5)^1/3
This drops the return from 32% down to 25%, but I do believe 25% on 2mil over three years comes to 3.9mill (2mill + 1.9mill)

Thanks, Jonathan! This tab of the spreadsheet was actually created by a consultant friend of mine who specializes in this type of thing, so I didn’t really look that closely; still, I will be keen to hear what other readers think?

These exist all over the world …

… the idea for aspiring home owners is appealing; rent a home for a few years, and a portion of your rent is applied towards your eventual – if you want to – purchase of the house:

– If you decide that you don’t want the house, then simply vacate when your lease runs out, just like any other rental, or

– if you do decide to go ahead and buy, then a portion of the rents paid to date go towards your purchase of the house

… you may even have built up enough in ‘rental credits’ to count as a deposit, then all you need to do is go cap-in-hand to the bank for a mortgage for the balance.

Appealing? Certainly.

But, watch out for the sharks – and, there are plenty, as consumer advocate, Neil Jenman points out:

Here is a simple fact: ‘Rent to Buy’ schemes are dangerous scams. They are designed by predators who prey on the poor. They are a complete rip-off and should be outlawed.

Like all slick scams, ‘Rent to Buy’ schemes are so seductive. The pitch goes like this: We are here to help you. We have a unique system. If the banks reject you, we can help you.

And on and on and on it goes. One twisted truth after another. The straight truth, however, goes as follows. Victims of these scams (many of whom do not even realise they are victims until it’s too late) are ripped off in three ways.

First, they are charged an exorbitant amount of rent. Astonishingly, [one ‘rent to buy’ promoter] openly admitted yesterday that his rents are “double” the market rent.

Second, as well as the exorbitant rent, the “buyers” (victims) pay an exorbitant price for the home. The purchase price being asked for a home [that we recently looked at] was $380,000.   [Yet a] local agent estimated its real value at between $250,000 and $270,000.

So, on top of the double rent, the victims are also paying at least $100,000 too much for the home.

From the moment they sign up … they have instant negative equity (meaning they owe at least $100,000 more than their home is worth).

The third rip-off with the ‘Rent to Buy’ schemes is that the buyers are not the owners of the homes they are buying. No, the homes remain in the name of the rogues running the scams. Quite simply, this means that if the buyers pay the rogues and the rogues go broke or their companies collapse (as many do) then the buyers – who have done nothing wrong – are instantly evicted.

These schemes (sorry, scams) are just a variation of the notorious wrap schemes which were once promoted by get-rich-quick spruikers

So, the message is clear: be very aware of both the market prices for rentals and sales of similar homes before you even think about entering into such an arrangement.

On the other hand, let’s say that you do have a property that you want to rent out; offering ‘rent to buy’ for your prospective tenants can be an interesting option to ‘buy and hold for you’ …

… let’s say that you have purchased a new condo ‘off the plan’ and want to take advantage of the depreciation allowances (which are are strongest in the first 5 years), but don’t want the hassles of tenants not looking after the property and having to rent the property every 12 months or so to a new tenant.

In this case, offering rent to buy can be an interesting option; you could:

1. Find a young professional – or, young couple – with good credit and good job prospects,

2. Offer them market rent (towards the top of the range for your property type and area),

3. Give them a 5 year lease, with 12 month options (which means that they are no worse off than if they signed a simple 12 month lease at market rates)

4. After 5 years [AJC: or, at each lease renewal after Year X], credit a % of their rent towards the purchase of the house.

Now, think about this:

If your tenant stays for a number of years, and looks after the condo as though it will be their own, you won’t need a property manager, nor will you spend nearly as much in repairs and maintenance, nor will you suffer the usual 5% to 10% expected vacancy rate – and, you may be able to get away with something approaching ‘top rent’ (but, still within the market) for your area.

Now, isn’t that worth crediting 10% to 20% of the total rent payments towards their purchase if they stay the full 5 years?

Then, you get to sell the condo to them at market rates (as assessed by a licensed appraiser) LESS (say) another 5% to 10% (after all, you don’t need to spend any time and money of Realtor commissions, marketing, advertising, etc. (and, perhaps, have the property vacant while you do so).

The downside?

Well, what if they don’t stay the full 5 years? You still get top market rents … how can THAT be a bad thing?

How about property condition? Well, one of the clauses should stipulate that the tenant shares in the cost of any ‘wear and tear’ to bring the property back to selling condition (this can come out of the ‘deposit fund’ that you have been building up for them), because you still need it to appraise well. And, the tenant remains solely responsible for any UNFAIR wear and tear (e.g. damage that they have caused).

Sweet deal for both you and the renter/purchaser?

You betcha’ … IF you are ethical, and careful in your tenant / potential purchaser selection. Don’t forget, you get to take up all of those juicy depreciation allowances, then sell just in time to do it all over again … just make you cover off all of the bases with a good REAL-ESTATE SPECIALIST attorney and tax advisor 😉

Last week, I told you that I’ve been out shopping for commercial real-estate and ended up with not one, but two, high rise condo/office development lots …

[AJC: for those of you who have been keeping up with this blog, you will know that I feel that development is really a MM201 activity, whereas I was really out shopping for MM301 buy/hold commercial real-estate ‘with a twist’ – i.e. something I can rehab or otherwise add value to before letting it out – instead, I kind of just ‘backed into’ these deals by accident … and, my entrepreneurial instinct grabbed hold and took over 😉 ]

… and, this week I want to share ‘the numbers’ with you i.e. what do I think of the deal that just one of these properties offers?

It’s best if you start by downloading my ‘project feasibility spreadsheet’ – the actual one that I used to discuss with my project manager (who will be an equity partner) and accountant (who will earn some hefty fees) – from the new Real Estate Group/forum at ShareYourNumber.com by clicking on this link:

http://shareyournumber.ning.com/group/realestateinvestorsgroup/forum/attachment/download?id=2494516%3AUploadedFi38%3A5283

If you are having trouble, then try clinking on this image to go straight to the Real Estate Forum, and click on the actual link (that I’ve highlighted in blue for you in this image):

I’ve tested the link and it works for me … but, if you are STILL having trouble, e-mail me [ajc @ 7million7years.com] 🙂

Got the spreadsheet open, now?

Great, let’s get started with the first tab, labeled “Assumptions”:

– I bought the piece of land for $1.5 million (plus closing costs)

– There will be some ancillary costs (that we will go into later) to get permits to demolish and rebuild etc.

– But, this tab of the spreadsheet is more focused on getting down some of the key estimates that we will need in order to do a ‘back of the envelope’ analysis that should be enough to make the ‘go / no go’ decision on the land purchase, since this is exactly what I did with this exact same spreadsheet:

1. Any good multi-level builder worth his salt will be able to give you a ‘rule of thumb’ that says something like “a basement (for parking etc.) will cost you $1,000,000 for the first level, and $500,000 for each level thereafter” OR they may quote a ‘per square foot’ rate, like $100 psf to build it. If you can’t find a builder who will give you this for your kind of project, you may need to pay a GOOD quantity surveyor to do it for you. This is worth while for any reasonable size development project (e.g. quadraplex and upwards).

[AJC: you will need to know that this is an Australian project so you will need to multiply all the Australian dollar figures by 87 cents (i.e. multiply by 0.87) if you really want to convert this example spreadsheet to USA dollars – but, I don’t think that’s really necessary … what I DO think you should do is convert the ‘psm’ figures i.e. the areas given in ‘per square meter’ to ‘per square foot’ by multiplying or dividing by 10.75, as necessary … don’t worry, I’ll give you an example or two, as we go along]

2. To help me work out how large the basement needs to be, I need to find out from the municipal council how may car parking spaces that I need to allow for e.g. office space might be “one space for every 3 workers” whilst apartments and condos may be “one for every 2 bedroom apartment” or “one for every 20 square meters [215 square feet]”.

3. It’s critical that the builder or quantity surveyor is able to provide building costs, such as “it will cost roughly $1,500 dollars psm [$139.50 psf] to build out your office space and $2,500 psm to build the residential areas, depending on the quality of fittings that you want … this will be down to the last tap and door knob in the apartments/condos and the suspended ceilings and commercial-grade carpet in the office areas”.

3. You also need to know how large you want to make your apartments e.g. “do you want large, luxury 2 bedroom condos of about 70 square meters (including 4 to 8 square meters of balcony space) OR do you want smaller, urban-style condos of 35 square meters plus 4 square meter of balcony for your 1 bedroom apartments and 55 square meter, plus balcony, for your 2 bedroom apartments?”

[Hint: usually smaller apartments sell just as well as larger ones “off the plan”, but larger ones command a better price once completed; and smaller 2 bedroom apartments provide the greatest ‘return per square meter’ because you are still only fitting out one kitchen and bathroom; a 50/50 mix of 1 and 2 bedroom apartments usually works well … but, this can vary by location, so get EXCELLENT advice before you buy your land!]

4. Now, if you can’t be the expert on buying and building, these rules of thumb will be extremely critical – if you can find them and feel confident about them – but, you can and MUST become an expert in selling your condos … i.e research, research, research the areas you are interested in, how the condos are built/fitted out/marketed and how much YOU think they will sell for … get a good Realtor’s advice, too, and double-check it with one or two other Realtors.

5. As a ‘double-check’, you can try and run a spreadsheet (and/or ask your Realtor/s) how much condos are selling for ‘per square meter’ [or, per square foot], but this is a less critical figure.

6. If you have run the analysis that I showed you in this post, you should already know for yourself how much your office space (if you are building this as well as condos, as we are on the first two levels of this project) is renting for per square meter, and you can again double-check with a good Realtor or two who specializes in office rentals and sales (while you’re at it, ask him for the current capitalization rates for office rentals v sales …. we’ll get back to this in the next post in this series).

[AJC: you should have also already done this really simple analysis for the parcel of undeveloped land before you even think about buying it!]

Once you have these few figures (and, really, it’s not as hard as it might seem to get this stuff), you’ll be ready to move on to the exciting part:

How much money will this project make me?!

… which, I will answer in the next post in this series 😉