How To Get Into Property Development
Whether you are looking to become a property developer purely as a hobby to build up a nest egg for retirement, to establish a part-time or full-time job for yourself, or to create a formal business maybe at some stage with employees, there are really no barriers other than your ambition.
Of course you will need some start-up finance or access to funding, you will need considerable time in order to do it properly and you will need some basic common sense and a solid understanding of the property investment basics. But the main knowledge and experience comes as you progress, and in order to get into property development, well, essentially, anyone can do it. Everybody has access to the property market, so there is nothing stopping you starting as a property developer.
Naturally there are a number of key factors that you need to consider when planning your fledgling property development project, and we will outline these here, along with some common errors and misjudgements that amateur property developers tend to make. These can really make the difference between this being an expensive mistake, a frustrating pastime or you becoming a successful entrepreneur in your own right.
Write a Business Plan
However serious you are about this venture, and whatever funds or other resources you have behind you, there must be a solid and credible business plan in place to ensure your project can get off the ground. You should take advice on how to structure a business plan, and there are plenty of online resources available, but essentially, the more professional your business plan is and the more viable the business appears to be, the more chance you will have of securing adequate funding and of course, the more chance your business will have of succeeding.
You need to consider what structure your business will take and the legal implications of this, particularly if you are entering into a formal partnership or joint venture with someone. You need to address your sources of funding and you need to look at what resources you will need. You may be planning on relying on the free help of your partner or a family member, or you may have to employ someone. You may have friends in the building trade who can help you out with the development work. You also need to look at things like a website and the associated marketing costs, if you are really taking this seriously as a business.
Which Property Business Model?
The two main vehicles for property development are buy-to-let and buy-to-sell. Perhaps the first thing to consider is your exit strategy, which is perhaps not how you want to look at it, but effectively, if everything goes wrong how can you minimise your losses? This might dictate which route you go down.
Buy-to-let tends to be more of a long term property investment strategy that is a good way to start out and test the water, as it provides a regular rental income that can hopefully support you financially and allows you to move onto your second property a little sooner, if that is financially viable. You would need to seek some professional advice on how your rental income is taxed.
With buying a property to develop and sell, there is more risk associated with this method, as you are at the mercy of an often volatile property market and specific locations, but you can generally make money faster. In terms of professional advice you should seek information on capital gains tax.
What Money Can Be Made From Property Development?
As mentioned above, the two main ways in which anyone starting property development will look to make money is through becoming a buy-to-let landlord, or taking the buy-to-sell route, which is often called flipping a property.
Buy-to-let is a very popular way for property developers to make money, and it typically represents a more patient route, which is perhaps less lucrative but is steady, regular and reliable. Your income is derived from rental yield, and this can be affected by initial costs incurred before you see good returns on a regular basis. And even if you take the buy-to-let route, you can choose to sell the property at some point when the market conditions are good, and you may make a profit this way also. In addition, it is common for buy-to-let landlords to build a portfolio of properties which eventually all work in tandem and produce several simultaneous income streams for the property developer.
Calculating Rental Yield
There are many factors that dictate which property model you decide to pursue (ie. buy-to-let or buy-to-sell) but working out the income yield is perhaps the biggest. Rental yield is the return you make – or expect to make – on a property you are leasing out, or are about to lease out. When you are getting into property development, rental yield is a measure of the value of your investment against the capital outlay, so it is important that you pay attention to this.
Rental yield is expressed as a percentage figure, and for a buy-to-let property it can be calculated by working out your annual rental income versus the value of the property, using a simple formula:
Rental Yield = (monthly rental income x 12) ÷ the property value (x 100)
So as an example:
Your monthly rental income is £1500
So your annual income is £18000
You purchased the property for (or its current value if you haven’t yet purchased it) £260000
Your rental yield is (18000 ÷ 260000) x 100 = 6.92%
As a more accurate measure, and where these figures are known, you can add other costs to the purchase price, such as stamp duty, mortgage fees and refurbishment costs. And you can also add other annual costs such as council tax, insurance or ground rent, which of course will reduce the rental yield percentage.
Of course, an acceptable rental yield figure will differ for every individual and is dictated by circumstances, but as a general rule anything between 5% and 10% is considered to be a good return.
Buy-to-sell (flipping a property)
Starting property development in the buy-to-sell market, or flipping a property, requires a range of skills. This involves having vision of the market and of your ambitions, having a good handle on financial numbers, having the nerve to hold on at the right times and make key decisions, being able to negotiate and being able to project manage.
In the buy-to-sell market your prime motivation is to make money quickly. You make money on the property’s value increasing quickly whilst you own it, this could be through market conditions changing in your favour, but most commonly it is through you making improvements to the property to make it more desirable. So naturally, you have to spend money to make money. This gets much easier with experience, and for the novice, flipping a property can be fraught with danger, but it can be extremely lucrative also.
There are lots of costs that can be incurred, however, and which make a project much less desirable, but due to timing, sometimes these only become apparent when you are in the middle of the project. This is where finance packages like bridging loans come into the equation. But essentially, a £30,000 profit on a property can very quickly be reduced to £15,000 by costs or delays you didn’t anticipate. And yet, a £15,000 profit for four or five months’ work is pretty good, and a bit like with buy-to-let, sometimes you have to take an initial hit just to get you started, and the bigger profits come later.
When looking at how to get into property development, buy-to-sell undoubtedly appeals to the more ambitious investors, and certainly it can be exciting and rewarding, but you also need to go into it with your eyes wide open and be ready to make some key decisions at key times.
What you will need to do to get into property development
As with any property purchase, location is a primary consideration, but as a budding property developer there are different reasons for this. If you spot an area that is rapidly developing then you need to get in early and make a purchase in order to maximise your potential returns. Look at the various property websites online and assess prices in certain areas, and then also consider what work will need doing on a particular house. When you look at a fair price for the house now and in the future, plus the additional costs to develop it, is it a worthwhile venture?
From a buy-to-let viewpoint you need to assess whether a location is suitable for the market you want to let a property to, ie. for a student market, is it near the university campus or where there is good nightlife? Families don’t want to be in the centre of town, they want to be near schools and parks and they want a garden, whereas young professionals want a more exciting life with less hassle and hence, don’t usually need any of that.
A property has to suit the market, and as well as location that means hi-spec or mid-spec interior fittings and how many and what type of rooms the property needs. Keep to your budget, but make sure the budget is appropriate.
Get to know an area and don’t be rushed by pushy estate agents into buying a property that you’re not 100% sure about. Timing is absolutely vital. If you are looking for your second property this is particularly critical. This is a bad time to overstretch yourself financially, or rush structural or interior developments on your first house in order to close a quick sale and move onto your next property. Also, you should remember that most people look to buy properties in the Autumn and Spring, rather than Summer and around Christmas time, so plan things accordingly and don’t put the property on the market at the wrong time, just because you are desperate for cash.
Mistakes at this stage can set you back a couple of years, or could put an end to your property development career completely. That said, when you are 100% sure about a property, you need to move quickly.
You should seek professional advice on the financial options open to you, which will depend on which property model you are pursuing and whether you are seeking finance alone, in a joint venture or as a limited company. Your money is likely to be tied up in your first property for some considerable time, and this is a very limiting factor that you have to understand and be patient with.
Finance for property development comes in many forms.
You may be in the fortunate position of having a lump sum to invest and you have chosen property. This may be an inheritance, a policy maturing or some savings you have accumulated over the years. Either way, having your own lump sum to invest is a big advantage when getting into property development, as you don’t incur charges for using it, there are no delays in accessing it and there is no one dictating how you use it. After that, however, all the careful considerations you need to make in spending it still apply.
A number of mortgage products exist for property developers, such as residential mortgages, buy-to-let mortgages or limited company buy-to-let mortgages. Funding for a buy-to-sell property is generally more expensive, as it is seen by a lender as a more short term investment, and hence they can offer higher interest rates than normal.
Also, with a buy-to-let mortgage, lenders typically want a property to be in a lettable condition immediately, as there is a risk involved for them. Some lenders will offer you a deal if light refurbishments are all that is required, but this is a difficult balance to strike. As a property developer you need to be letting the property ASAP, because two or three months of paying a mortgage on the property while making no income from it can be hugely damaging financially. So if work needs doing to make a property lettable, this needs to be considered when seeking the right finance package.
This is also known as mezzanine finance and is essentially a way to get cash quickly when you need it. This may be because you can’t release the cash you need to solve a short term problem, which is a common issue in property development. The accessibility of bridging finance also means that it needs to be repaid quickly, but this is usually OK because you know money is incoming. In property development, bridging loans are usually paid back when you sell a property or take out a mortgage on it.
Bridging finance is a common vehicle to allow you to buy a property while still seeking to sell a previous one. By not overstretching your finances you can use bridging finance to build your portfolio of properties. Bridging finance is also a popular product on crowdfunding platforms which can make the loans more affordable and more flexible.
Also known as peer-to-peer lending, this is another product that is popular on crowdfunding platforms as investors group together to put money into a property developer’s project. The money is made available and used in a way similar to bridging finance, and often the property developer will receive flexible terms and better interest rates than for a regular loan. This is because the crowdfunding platform is free of the typical overheads associated with loans coming from a bank, for example.
Loans from financial institutions
If you are starting out as a property developer then whether it is buy-to-let or buy-to-sell, there are light to heavy refurbishment loans available also. These generally can’t be searched for online, and you would have to approach an individual lender who would tailor a deal specifically suited to your circumstances, but typically the loan is a straightforward product which is available for the period of the refurbishments and is repayable upon sale of the property.
Where finances, skills and knowledge or, let’s face it, courage is somewhat lacking, one of the most popular ways to get into property development is to join forces with a friend, colleague or family member. From a practical point of view this shares the burden and the workload, but it is also possible to share the financial risk of the venture based on how you structure the partnership.
You will need to formally set up the company and therefore will need professional tax advice, as well as establishing the proper legal structure of the company in terms of ownership, liability and how profits should be shared.
In terms of securing finance as a joint venture, to most lenders you will still be classed as first time developers and hence, you carry the same risk. So it could still be quite hard to secure finance and it is recommended to find a reliable broker, they will search the right finance deal to suit the status of your business and what you aim to do.
Common Mistakes Made By Fledgling Property Developers
Getting the market wrong
This can mean buying a house in the wrong area for students or young professionals and not being able to let it out. You may also believe a property will gain in value in a certain area, but the market doesn’t go that way or it is a property type that struggles to sell generally, and your profits are reduced or non-existent.
Another way you can mis-judge your market is by refurbishing the property with fixtures and fittings that are inappropriate, ie. they don’t last and therefore add costs, they don’t appeal to your market so you have to replace them, or you forget about the exterior of the property and this becomes a barrier to selling or letting it. On the flipside, you can go over the top with lavish fittings or plush carpets that are unnecessary for a student property, for example. Also, don’t get fixated with personal tastes and take advice to tailor your décor and furniture to your target market.
It is also important that you develop the layout of the house in keeping with the type of buyer or tenant you are looking for. Don’t cram the house with bedrooms if your market is for a young family who prefer extra space or an extra bathroom. Think about layout and the flow of rooms. Likewise, for buy-to-let students, you won’t need enormous dining or living spaces or en-suite bathrooms, and you should probably go for four bedrooms and not three.
Naivety with builders
Unfortunately unscrupulous builders or other tradesmen do exist, so if you are dependent on them, get various quotes and make sure they provide references. If possible get them to sign a fixed price contract properly drawn up by a solicitor, and try to negotiate penalty clauses for the work being late, as this could have serious financial implications for you.
It is so tempting to push the boat out that little bit more, but you should only borrow what you can afford in the first instance. If you get the first project right then others will follow and they should gradually get easier to manage, so it will benefit you in the long run to be more cautious at the beginning. Seek professional advice and shop around for the best finance deals that are right for you, and be realistic over the cost and time of projects.
Of course you want to make money, but you need to be practical and realistic about the returns on your costs via selling or renting the property. You may have spent more on the refurbishment than you planned, or the property might not have gained in value as you had calculated, but don’t make the matter worse by ramping the purchase price or the rent up and making other people pay for your misjudgements. You might make less profit but you still need to sell or rent the property in order to create funds to move onto the next project, when hopefully you have learnt from all these valuable lessons.