Property Developers are a pretty resilient bunch on the whole. Developing can be a rollercoaster ride, and if you've attended a Property Developer Network Meetup and listened to some of the Real Deal stories shared, you'll know that for a fact.
One of the biggest nightmares many people have when they're thinking about becoming a Property Developer is the fear of running out of money before the development is completed, and ending up in a position where they lose money. Scary, right?
And I'm not going to lie - it happens. Not often, sure, but apart from completely unforeseen risks affecting the project, one of the common reasons is the Developer not understanding the difference between hard costs and soft costs in the project.
So let's take a look at what these are and how to give yourself the best chance of avoiding waking up in the middle of a nightmare.
Let's start at the beginning when it comes to financing a deal. There's three main categories of money needed to get a development deal over the finish line:
I love No Money Down Deals, and I've done a number of blog posts and Sunday Session videos around that topic. While some of those strategies are great for not having to find money yourself for the deal, I don't want to go down that rabbit hole today.
Instead I want to focus mostly on the third category - liquid cash to run the deal.
When you look at this graphic, the arrows above the line are amounts coming in, and below the line they're amounts you're paying out. As you can see, there's a big lump of money going out at the beginning, which is the purchase, then there's various sums that go out through the duration of the project, and at the end ka-ching! Pay day!
Hard Costs
It's all the arrows apart from those at the beginning and end that are usually referred to as hard costs. The timing of the arrows will give you clues:
And note that I said purchase loan - construction costs are classed as hard costs, but obviously construction finance will mean you don't have to find all of those funds yourself.
Still, there's plenty of other costs along the way that you will have to find cash for, particularly in the planning and building approval stages. That may be your own funds, or an investor's funds, but the bills still need to be paid.
Soft Costs
Soft costs are costs to the project, but you don't have to physically pay the money out of your pocket for them because they get paid at the end of the project.
A very common one is sales agent fees. You don't pay the agent before properties settle, they get paid out of the settlement funds. Legal costs for settlement are generally the same. With finance, some loans allow you to capitalise payments and interest on the loan, so you don't have to pay until the loan is settled.
There are assorted other costs that get paid when the final accounting for the project is done, and so come out of money received at settlement.
In the end, both hard and soft costs are expenses to the project, with the difference being when and how they're paid. It's easy to remember which is which by thinking about what happens when you run into an object. If it's hard, it hurts! But if it's soft, it might not be the greatest feeling, but it doesn't hurt as much.
So why is it important to understand the difference between these costs? That's all to do with what needs to be paid when. If an expense will need to be paid during the development process, then you need to have funds available.
As a result, you need to be very clear about everything you will need to pay so that you can ensure you have adequate funds available. Going back to the cashflow graphic up above, understand that as the project progresses, all those little arrows add up, until you reach what's known as peak debt.
It's that peak debt that is the total liquid cash you need to have available. This is the point in the project when you have the most money in the deal, and so the most risk. But if you've correctly worked out what all your hard costs were going to be and either put aside or borrowed sufficient liquid cash to get through that point to settlement, then you can breathe a sigh of relief. No more nightmare!
One of the biggest nightmares many people have when they're thinking about becoming a Property Developer is the fear of running out of money before the development is completed, and ending up in a position where they lose money. Scary, right?
And I'm not going to lie - it happens. Not often, sure, but apart from completely unforeseen risks affecting the project, one of the common reasons is the Developer not understanding the difference between hard costs and soft costs in the project.
So let's take a look at what these are and how to give yourself the best chance of avoiding waking up in the middle of a nightmare.
Let's start at the beginning when it comes to financing a deal. There's three main categories of money needed to get a development deal over the finish line:
- Deposit/Equity
- Serviceability
- Liquid Cash (available working equity) to run the deal
I love No Money Down Deals, and I've done a number of blog posts and Sunday Session videos around that topic. While some of those strategies are great for not having to find money yourself for the deal, I don't want to go down that rabbit hole today.Instead I want to focus mostly on the third category - liquid cash to run the deal.
When you look at this graphic, the arrows above the line are amounts coming in, and below the line they're amounts you're paying out. As you can see, there's a big lump of money going out at the beginning, which is the purchase, then there's various sums that go out through the duration of the project, and at the end ka-ching! Pay day!
Hard Costs
It's all the arrows apart from those at the beginning and end that are usually referred to as hard costs. The timing of the arrows will give you clues:
- Settlement Costs
- Development Approval
- Building Approval
- Construction Costs
And note that I said purchase loan - construction costs are classed as hard costs, but obviously construction finance will mean you don't have to find all of those funds yourself.
Still, there's plenty of other costs along the way that you will have to find cash for, particularly in the planning and building approval stages. That may be your own funds, or an investor's funds, but the bills still need to be paid.
Soft Costs
Soft costs are costs to the project, but you don't have to physically pay the money out of your pocket for them because they get paid at the end of the project.
A very common one is sales agent fees. You don't pay the agent before properties settle, they get paid out of the settlement funds. Legal costs for settlement are generally the same. With finance, some loans allow you to capitalise payments and interest on the loan, so you don't have to pay until the loan is settled.There are assorted other costs that get paid when the final accounting for the project is done, and so come out of money received at settlement.
In the end, both hard and soft costs are expenses to the project, with the difference being when and how they're paid. It's easy to remember which is which by thinking about what happens when you run into an object. If it's hard, it hurts! But if it's soft, it might not be the greatest feeling, but it doesn't hurt as much.
So why is it important to understand the difference between these costs? That's all to do with what needs to be paid when. If an expense will need to be paid during the development process, then you need to have funds available.
As a result, you need to be very clear about everything you will need to pay so that you can ensure you have adequate funds available. Going back to the cashflow graphic up above, understand that as the project progresses, all those little arrows add up, until you reach what's known as peak debt.
It's that peak debt that is the total liquid cash you need to have available. This is the point in the project when you have the most money in the deal, and so the most risk. But if you've correctly worked out what all your hard costs were going to be and either put aside or borrowed sufficient liquid cash to get through that point to settlement, then you can breathe a sigh of relief. No more nightmare!
