When To Develop Property
By Luke Andersen
Ask anyone who understands market cycles when to develop property and they will probably tell you to purchase development sites in a time of recession or trough and to sell the developed property in a time of growth or when the cycle is at its peak. Whilst at an intuitive level this may sound appealing, there are a number of problems with its implementation in reality.
Firstly, no one can consistently predict macro-economic cycles with any great accuracy. In fact, the prediction of macro-economic movement is becoming more and more complex in light of globalisation and the liberalisation of markets. If economists cannot predict macro-economic movements then how can ordinary property developers!
Secondly, it would be great if we all had an abundance of lazy cash sitting around so we could purchase development sites outright in the troughs and wait until the peaks to sell. In reality most property developers don't have an abundance of lazy cash sitting around and have to finance the purchase of a development site. To purchase a site in the trough and sell in the peak would therefore involve the payment of land holding costs (eg. rates, land tax) and finance costs (eg. interest, management fees) for the interim period which may last for many years.
Thirdly, it implies a direct relationship between the broader economic environment and the property market. Whilst on a broad level this may hold true, in reality the property market is made of many sub-markets which each behave differently and not all in line with broader economic movements. To simply talk about the property market is to overgeneralise as there are property markets within property markets (e.g. Australian property market - Queensland property market - South-East Queensland property market - Brisbane property market - Bayside property market - Manly property market). In other words, whilst the Australian property market at large may be in recession the Manly property market may be performing strongly.
Fourthly, the property development industry, like any other industry is driven by the forces of supply and demand. If there is increasing population growth, as is the case in most of the developed world, then there will be increasing demand for dwellings to accommodate the increasing population. This increase in population does not have any relationship with macro-economic movements. Therefore, imagine if developers only developed during the growth phase, where would the individuals demanding accommodation in the interim live?
So if the use of the economic cycle is no good indication of when to develop property, than what is? Well, any serious property developer will tell you that if the financial feasibility analysis and due diligence analysis on a project shows an adequate return for the risk involved than the project should be undertaken. This is not to say that broad macro-economic factors should be ignored but rather the financial feasibility analysis and due diligence analysis of a project should be the determining factors in deciding when to develop. And besides, a thorough financial feasibility analysis incorporates such macro-economic factors as interest rates and inflation and their effects on project returns.
Whilst there will still be those who advocate the use of the economic cycle for timing property development projects, in our experience we have tended to do just as well financially irrespective of which stage the economic cycle is at.
During the growth or 'good' times suitable development sites are harder to find, are often overpriced by sellers, and often have to be purchased without local authority permits and without suitable contractual conditions. Local authorities are overworked and are slow to issue permits causing frustration and sometimes increased land holding and finance costs for developers. Building contractors are busy and their profit margin and the cost of materials increase. Sales will occur quickly and marketer's fees may decrease due to the higher turnover. Fear of an overheated real estate market by the financial regulators may initiate an interest rate rise in an attempt to dampen demand.
During the recession or 'bad' times suitable development sites are easier to find, are often fairly priced by motivated sellers, and can often be purchased with local authority permits and on attractive contractual conditions. Local authorities are not as busy and are quicker to issue permits. Building contractors aren't as busy and their profit margin and the cost of materials will generally stabilise or possibly decrease. Sales will occur more slowly and marketer's fees may increase due to the lower turnover. Interest rates are generally stable and may even fall in an attempt to stimulate demand.
Confused? Don't be. Just remember that serious property developers develop property in any market. If the financial feasibility analysis and due diligence analysis on a project shows an adequate return for the risk involved then the project should be undertaken.
About the Author
Luke Andersen is a partner of Positive Property Strategies and co-author of 'Residential Real Estate Development: A Practical Guide For Beginners To Experts.'
Positive Property Strategies is an innovative property development business offering property development management, property development advice and property development education. To find out more please visit http://www.propertystrategies.net
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