Tag Archives: due diligence

Buying Off-the-Plan Property?

Thinking of buying off the plan investment property?

 

Buying off the plan property is one topic which generates more grumblings, rumors, and misinformation than any other investing strategy. When it comes to property investing, timing matters, right?

In context to “buying off-the-plan” does it mean safe, predictable returns and annual rental increases?

The purpose of buying off-the-plan is no management fees, vacancy periods with security of a long term lease, so you can live comfortably knowing your future is financially secure; buying a block of land without actually seeing the property before sale, right?

What’s the reason why many property investors like to buy off-the-plan? Obviously they want to make sure its as safe or as less risky investment with reliable and high rental yields…yet are they’re speculating that the property will be worth more when it is completed?

Is off-the-plan properties a good solution for investors needing to organise finances or first home-buyers which don’t have enough equity to purchase?

buying off-the-plan property
Buying Off-the-Plan Property

Would an established property which you can buy today, whereby value is easy to confirm and rental return is more assured? Confirming an accurate future rent return is also nearly impossible, as this is affected by demand and supply.

Where the development is large, depending on release dates or time frames, there could also be a sudden oversupply as all the completed developments become available and you could get far less rent than expected causing further financial distress to you.

While buying off the plan is an option may offer benefits, it’s important for both investors and home buyers alike to perform their due diligence and understand where many trip up.

Buying off-the-plan property, in reality…unless you’ve done this type of property investment strategy before, does it really mean the value of a good investment property is underpinned by attributes such as:

  • Location
  • Land size
  • Land value
  • Property style

When looking for an investment it is vital to focus on the tangibles which over time change because need to establish the value of your finance commitments in context to your investment finance criteria:

  • Target Market
  • Population growth
  • Unemployment rates
  • Consumer sentiment
  • Supply and demand
  • Dwelling approvals
  • Median value growth
  • Rental yields/rates
  • New DA applications
  • Project commencements

You cannot just move a house and land and drop in in a more desirable or handy location a few years after you buy it, right?

Even at great expense, you’re most likely not able to change orientation of land, position of block of townhouses/apartments or what surrounds the property. In reality, you have no control over the supply of new property coming onto the market around you…

Good investment property is often very hard to buy because you are put in a competitive environment, while risky investments are often easy to buy. Buyers need to understand the market and why they’re opting for off-the-plan instead of an established property.

Buying off-the-plan property carries far greater risk than an established property and has little advantage.

It’s very difficult to establish whether buying off-the-plan property is at a fair market value, even a registered valuer cannot forecast future values accurately to assure what you’re buying is going to be what it is worth when completed.

When you tie up your borrowing capacity on a yet-to-be completed project, you may not be allowed by the bank to borrow for additional investments, as your true position cannot be determined until the property is complete and owned by you.

If you’re getting a loan to buy property off the plan, what if the property has a value less than you agreed to pay?

Firstly, you may not be able to borrow enough cash to complete the sale because your bank will use the valuation, not your purchase price to determine how much they will lend you.

off the plan
Off the Plan, which is the better property strategy?

 

Off-the-plan, while this may sound straightforward, there are a number of considerations to take on board. If you cannot complete the purchase due to lack of funds, you’ll be forced to move forward at risk of losing your deposit.

Buying off-the-plan property and tracking changes: For example, off-the-plan apartments run work on the concept of putting down a deposit today and waiting for capital growth to kick in by the time the property is completed.

To avoid a potential purchase disaster, property investors need to put in the hard yards and do their on-the-ground research. The most crucial factor is knowing your target market, demographics, infrastructure, and whether the market is going to be over or under-supplied and to understand specific economic impacts of the area.

Due diligence: As a property investors you would talk to local councils or visit Department of Infrastructure website to find out about projects that are underway or in the planning stage.

Buying off-the-plan property by analysing supply and demand: it is critical to understand the strength and amount of supply in the existing market, because as a property investor you also need to be aware of other properties becoming available.

Equally important are population growth and job opportunities in the area; this data can be used to compare the last Australian Bureau of Statistics census against the most recent census to get a snapshot of how an area is changing.

For investors, historical trends such as vacancy rates and rental yield growth rate are indicators to consider, including how vacancy rates performed over last five to ten years and which figures have established a sub-two percent as a good benchmark.

Buying off-the-plan contracts: Buying off-the-plan property involves entering a contract to buy a property that is not yet built.  Investors therefore need to find a professional lawyer who is able to comb through the details of the contract with them.

As a property investor you need to make sure you are happy with the length of sunset clause you understand the full extent of the contract in every complete and detailed ways as possible…

Buying Off-the-Plan Property

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Safe as Houses?

Safe as houses an expression to satisfy a doubting person…

 

Oh…it’s as safe as houses, i.e., perfectly safe, apparently a  figure of speech used in property as an investment.

Safe as houses phrase originated when the railway bubble began to burst, and people began to turn their attention to more reliable or stable forms of speculation, which was slow and steady…

Safe as houses, let’s firstly establish your investing strategy, criteria and action plan:

  • How much money can you borrow to invest
  • How much time required for research/due diligence
  • How much money can you afford to lose
  • How much debt can you manage
  • What type of property deals
  • How far from CBD
  • What’s the maximum interest rates for borrowing

Residential real estate is almost the sacred cow of Australian investment. What if your sights are set on building a real estate empire, does it mean embracing risk with open arms?

safe as houses

Whatever real estate strategy you decide to do, just bear in mind networking is even more important in real estate than in other industries…so start pounding the pavement as soon as possible selecting the all-important team to manage your projects.

Risk, reward and reality. It’s easiest to think of property investments from least risky to most risky and analyze the pros and cons in each category:

(a) Least risky investing means acquiring and operating existing properties/buildings (buy and hold strategy)

Property investing is all about stability and getting high single-digit returns by operating existing assets (least risk when a building is already operational and generating rental income)

(b) More risky or value-add using opportunistic strategies for improving existing properties.

This is where investors aim to make substantial improvements and renovations to existing properties instead of acquiring and operating, (returns from 15–20% range, may go higher depending on how risky the strategy)

(c) Most risky which is real estate development and building completely new properties. Most risk equals highest returns?

You might think real estate development offers the highest returns because it’s also the riskiest, right?

Real estate development involves buy, sell, develop, managing properties, third party joint ventures (stakeholders) and of course all professionals including:

  • Surveyors
  • Town planners
  • Real estate agents
  • Civil engineers
  • Architects
  • Building contractors
  • Construction managers
  • Solicitors
  • Accountants
  • etc…

The real money in real estate development primarily goes to investors, which put their money at risk in the developments. To complete the construction of a new property, developers only put down a very small portion of total equity, perhaps 5% or less.

Many times the developer contributes land as the only form of equity in the project using debt and mezzanine financing to fund the entire construction cost.

You weigh up the risk versus reward before deciding. It is generally accepted the higher the reward the greater the risk. Property development slightly increases risk because of the many variables such as:

(a) Site costs

(b) Development costs

(c) council approvals and contribution costs

(d) Construction costs

(e) Resale values

Safe as houses…a thorough working knowledge of all these areas is required in order to succeed. Most of the returns go to the third party investors which come up with the rest of the funds.

safe as houses
Safe as houses

How does no cash flow from properties sound like because buildings are under development, so there’s no cash flow generated until tenants move in and rental income starts flowing.

The fees property developers charge are not great compared to the amount of overheads, sometimes there isn’t much money left to pay salaries to employees.

That’s the reason why you wouldn’t get into real estate development if money is your main goal, only do it because you’re interested in building and construction side of real estate and you’ve cash resources with small surplus to cover contingencies and enough money to invest in development projects yourself.

What if you just love every aspect of real estate? People which find the greatest success in real estate focus on the end goal of owning income properties. There are actually real estate investors from all walks of life…

Investing in real estate yourself…you don’t need to raise hundreds of millions of dollars just to buy a house. The key is to find your core strengths where you can be initially be successful, so you’re able to generate enough cash flow to own properties yourself.

So let’s take a wild stab at your future goal here…you want to make a lot of money and ideally own three or more properties debt free and outright (perhaps multiple skyscrapers with your name on them one day, might even end up with your own island one day:)

You’d also like to avoid working in a job if at all possible, and perhaps you want to make the transition from investor to developer?

As an added bonus, you don’t want to earn badges from a top notch school of hard knocks to get started, right? You’re thinking its all worth learning how to crunch the numbers, and sounds like real estate investing is a good fit for you…

How to analyze real estate deals, making sure the numbers work?

Each property is unique and brings a different value to potential investors, so it’s trickier than it sounds to find the right property.

Investors generally look at three factors when analyzing a property:

(1) Investors look at what the property/building is currently doing, how much income it has been generating and what the property-level expenses are, which gives you the net operating income (NOI).

(2) Investors look at the property to make sure it can maintain its current income.

It’s one thing to have generated strong income in the past, sometimes factors like:

(a) Mismanagement

(b) Demographic shifts

(c) Changes to the local area can drive a property right into the ground…

(3) Investors project what the building could do in the future to increase income and/or cut expenses.

Depending on what kind of deal it is, investors will focus on either the current income or the projected income.

For example, a stabilized deal which isn’t expected to see much upside or current rents which is the key valuation driver.

There are four main real estate deal types:

(1) Stabilized deals (buy and hold) are “blue-chip stocks” of real estate investing. These properties are generally recently built and currently have a stabilized high yield, e.g. 7% or 8% per year.

When investors look at these properties/buildings, they’re generally maintaining income which is currently produced. There isn’t a lot of risk with a buy and hold (stabilized deal) and also not much reward.

(2) Renovation is the next type. A property which is a good candidate for a renovation would fit the description of an older building in a stable growth sub-market (one which can support higher rent prices) could get significantly higher income or value from renovating houses, units or entire building.

There is more risk involved with renovation type deals than a buy and hold stabilized deal, because property investors are banking on future upside of renovating the property (perhaps reselling to homeowner or another investor).

Value-add deals do limit risks? Typically the property/building is in decent condition and is a tangible asset ( i.e, asset = liability + stockholders equity) which is easier to show, discuss and understand.

An asset is a resource which is expected to provide future economic benefits (i.e. generate future cash inflows or reduce future cash outflows)…an asset is recognized when:

(a) Asset is acquired in a past transaction or exchange

(b) Value of asset’s future benefits can be measured with a reasonable degree of precision

In markets where there is increasing momentum and upside, value-add deals are easier to do because it requires vision and creativity, which is fun. Downside of increased momentum is competition from other bidders dramatically increases pricing for certain assets.

However, added value is created by gaps in information and understanding. This is where real deals can be made by being innovative,
creative and diligent with the details.

Success comes from properties which others may have overlooked or passed due to their lack of motivation and understanding.

Nothing in real estate is easy, yet if you have the desire to roll up your sleeves and get a little dirty, there are diamonds in the dirt.

Real estate is challenging and rewarding and you just got to know how to dig for the value-added, diamond in the rough deals.

(3) Real estate distressed properties, these usually need a lot of work (units or building itself is in bad shape) or under performing.

Often, these building have huge vacancy rates, so the projected income is a big factor in valuation. Real estate distressed properties carry even more risk than a renovation deal because the building needs work and it is already under performing.

4) New development deals. These are just what they sound like. Development happens when an investor wants to take raw land, then evaluates what can be built on it and what kind of future returns can be generated.

Development deals have the highest risk, and also carry the highest return. In reality, you don’t necessarily make the most money with development deals, because of inherent risks and uncertainty, don’t assume highest risk equals highest profits in your bank account.

Property valuation and due diligence: You are primarily wanting cash flow and reliable cash-on-cash returns because in real estate, property itself produces the income for your return on investment.

While the numbers are generally used to support valuation, comparable sale analysis is king when valuing properties because property is only worth what someone is willing to pay for it.

In residential “yield” is often used instead of “cap rate”. Capitalization rates are used as the primary metric in property valuation.

safe as houses
Safe as houses

Cap rates are a very simple way of calculating the return on a building. Essentially, capitalization rates tell you what percentage of the funds you paid for the building comes back to you annually.

It’s just an easy metric to use; for example, if you have a 6% cap rate property and it’s at a 6% debt interest rate, you can easily see it is neutral leverage and isn’t returning any money.

Cap rates do have flaws and the biggest is everyone assumes cap rates in a specific sub-market to apply to every property within that sub-market. Simply this assumption isn’t true.

Every single property has its own nuances which makes it more or less appealing to potential investors.

If you get too clinical on only measuring cap rates, you could either be overvaluing or undervaluing your building. You really need to analyze each property/building and the market thoroughly to get a sense of how much value it is truly worth.

Another weakness, while cap rates are great to use in a city like Melbourne where buildings are constantly being bought and sold,
there’s considerably less data in other regions without as many sales taking place, so the numbers may not be reliable.

Basically due diligence means you are making sure the deal stacks up and doesn’t have more holes than a slice of swiss cheese.

Sellers want to sell their property at the highest price and investors have an interest in closing the deal.

Safe as houses, buyers need to protect themselves; due diligence is generally broken down into two components:

(1) You analyze the property at a micro level and then in the macro.

In the micro, you look at the building itself. You check the market to make sure projected rent prices at the property/building actually make sense, and people are paying those prices at similar properties in the area.

Next, you look at macro trends. You then dig deeper to make sure the tenants are in good financial shape. This is especially true if you are buying a single tenant building or more tenants in general.

You look at what other investors are paying for comparable buildings to make sure you aren’t over-paying. It’s also important to look at macroeconomic trends in the region you are investing to make sure the submarket can sustain positive economic growth over time.

Safe as Houses

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