Choose Your Developer Carefully And De-risk Your Investment.

As an investor buying property in a new development, understanding the relationship between your developer and their financier is crucial in minimising your investment risk.

Australian law protects the Investor

Any new property development involves a complex set of factors, all of which need to come together to deliver a successful outcome for all concerned.

In Australia, most financiers require a developer to secure ‘pre-sales’ of the future allotments before they will provide any funds. This means the developer must already have sufficient capital resources to engage in marketing as well as other pre-project costs.

Unlike in some Asian countries where progress payments are common, Australia requires a developer to place deposits received into a trust account which are not released to the developer until the project is completed. These Australian regulations make it much safer for the buyer/investor, because if a developer goes broke, their deposit is held in a trust account and must be returned to them by law.

Secondly, all financiers carry out extensive background checks and financial due diligence as part of their loan approval process. So, to secure development funds, a developer must have a history of successfully completing similar profitable projects. This is reassuring to the investor and property buyer because a developer lacking this track record of success considerably increases the risk in any new development.

Each of these financing factors puts significant pressure on the developer and subsequently makes some types of developments less risky and more profitable than others.

How do development projects compare?

Broadly, residential property developments fall into two categories:

• Multi-lot apartments in non-landed projects (apartments and townhouses); and
• Single title, landed bungalows in residential estates.

For the developer, apartments tend to be shorter-cycle, fast turnaround projects, providing profits in 2 to 3 years. Whereas estate development for large numbers of single title allotments can take years (or even decades for larger ones) to return a profit. Hence, the appeal of apartments.

However, non-landed properties (apartments) carry greater development risks. Delays or non-completion of a project can lead to financial disaster for the developer and banks know this. An unfinished apartment development is extremely difficult to pass over to a new builder/developer. Also, in a market where prices are static or falling (such as now for inner city apartments), unsold allotments (units) make finance nearly impossible, putting further pressure on the developer.

Estate developers of landed properties, on the other hand, are much more committed as they have to find greater up-front capital funds. It may take far longer to return a profit, but land development is very straightforward and thus far less risky. A property with a high land component (house & land) always goes up in value, as land is scarce and in constant demand.

The developer can rely on this capital appreciation in its application to a financier and the financier has comfort in knowing that even with a longer completion time, the ultimate risk of losing money is significantly less.

De-risking your investment

It’s the same for the investor. Buying a property in the early stages of a residential housing estate is the surest way of minimising the long term risk because even if the developer gets into financial difficulties, the land is always appreciating. And if forced to sell, a free-standing house on a titled block of land is dramatically easier to re-sell than a unit in an apartment block, where the land component is minimal. Remember, multi-unit allotments on one block of land must be managed by an owners’ corporation, with its inherent costs and restrictions.

For the investor seeking a property investment where the risks are lowest, the starting point should be to ask questions of the developer. Treat such discussions as if you were a banker, and you’ll very quickly discover how likely your proposed investment is to:

• Be successfully completed,
• Be able to be financed at a competitive rate, and
• Make you money from capital gain over the life of your investment.

Conclusion

Buying an investment property in the early stages of an Australian land development is the safest way to de-risk your investment and avoid the opportunity cost that could result from a failed non-landed development.