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‘Highest AND Best Use’…What Should I Build?
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Deciding exactly what to build on your chosen site is a big deal. The wrong choice can dramatically impact your profits as a Property Developer and the right choice can provide a big leap forward in your quest for ‘financial freedom’.
The zoning might allow a whole range of uses, from detached townhouses to multi-storey apartments. Perhaps you’re allowed to include a commercial component where you can install a café or another small business owner. Or maybe your neighbourhood could support either a mid-range or premium product and you’re not sure which way to go.
Well, there’s a way to simplify the decision-making process. It centres around the highest and best use for your site. Let me explain...
The zoning might allow a whole range of uses, from detached townhouses to multi-storey apartments. Perhaps you’re allowed to include a commercial component where you can install a café or another small business owner. Or maybe your neighbourhood could support either a mid-range or premium product and you’re not sure which way to go.
Well, there’s a way to simplify the decision-making process. It centres around the highest and best use for your site. Let me explain...
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To arrive at the highest and best use for a development site you need to figure out three things: is what you want to build permissible under Council’s planning regulations? Is it physically possible? And is it financially feasible?
Is it permissible?
First up, whatever you’re thinking of building has to be permissible under the site’s zoning. While you may get approval for an application that sits outside the boundaries of existing legislation, it’s likely to take more time to process. And in the development game, time is money.
My approach is to follow in the footsteps of others rather than forge a new path, which means going for the type of projects that others have successfully completed in your neighbourhood on a site with your zoning.
Is it permissible?
First up, whatever you’re thinking of building has to be permissible under the site’s zoning. While you may get approval for an application that sits outside the boundaries of existing legislation, it’s likely to take more time to process. And in the development game, time is money.
My approach is to follow in the footsteps of others rather than forge a new path, which means going for the type of projects that others have successfully completed in your neighbourhood on a site with your zoning.
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Is it physically possible?
So your block size dictates you can build six townhouses, but is there a flood overlay that will scupper your plans? Is there a suitable location for garbage collection? Does the soil type preclude multi-storey development?
A site’s physical constraints can rule out certain development options, which will effectively simplify your build choices.
Is it financially feasible?
At the end of the day, we’re getting into Property Development to make money so if the proposed build doesn’t turn a reasonable profit, it’s back to the drawing board to find another site.
You may have heard me say this before: 90% of the sites out there that are developable are not profitable. Your job is to identify all the issues and challenges, cost out all the problems that you need to solve and figure out what the finished product will actually sell for.
For my money, I target a 15% annualised return. Under 15% and the deal doesn’t get across the line. 15% or higher and I’m ready to get serious.
Understand the time value of money
Of course some projects will take nine months to complete, while others might stretch out to 24 months. How do you decide which is more profitable? You’ll need to annualise your profit forecast so that you can compare projects of different sizes and durations.
If a project is going to take nine months and generate a 9% return, that equates to an annualised return of 12%. Compare that with a longer-term project that takes 24 months and generates a 34% return.
In this instance, your money's working harder, generating 17% per annum. So it's a much better deal from a how-hard-is-your-money-actually-working perspective.
Maximise profitability
Finally, we want to supercharge our returns by nailing the wishlist of our potential buyers.
Start looking at the sales data for your area. Are there many townhouse or apartment developments? What are they selling for and how long does it take for them to sell? This will give you a snapshot of demand and supply.
Is there a gap in the market – an undersupply of a particular property type? Maybe townhouses get snapped up as soon as they hit the market, with noticeable increases in value every time.
What is the typical price point in the area and is there room to push that price point?
What appetite is there for higher quality homes?
If you look at the median income for your chosen suburb it’ll give you an indication of the level of debt homeowners can sustain.
So your block size dictates you can build six townhouses, but is there a flood overlay that will scupper your plans? Is there a suitable location for garbage collection? Does the soil type preclude multi-storey development?
A site’s physical constraints can rule out certain development options, which will effectively simplify your build choices.
Is it financially feasible?
At the end of the day, we’re getting into Property Development to make money so if the proposed build doesn’t turn a reasonable profit, it’s back to the drawing board to find another site.
You may have heard me say this before: 90% of the sites out there that are developable are not profitable. Your job is to identify all the issues and challenges, cost out all the problems that you need to solve and figure out what the finished product will actually sell for.
For my money, I target a 15% annualised return. Under 15% and the deal doesn’t get across the line. 15% or higher and I’m ready to get serious.
Understand the time value of money
Of course some projects will take nine months to complete, while others might stretch out to 24 months. How do you decide which is more profitable? You’ll need to annualise your profit forecast so that you can compare projects of different sizes and durations.
If a project is going to take nine months and generate a 9% return, that equates to an annualised return of 12%. Compare that with a longer-term project that takes 24 months and generates a 34% return.
In this instance, your money's working harder, generating 17% per annum. So it's a much better deal from a how-hard-is-your-money-actually-working perspective.
Maximise profitability
Finally, we want to supercharge our returns by nailing the wishlist of our potential buyers.
Start looking at the sales data for your area. Are there many townhouse or apartment developments? What are they selling for and how long does it take for them to sell? This will give you a snapshot of demand and supply.
Is there a gap in the market – an undersupply of a particular property type? Maybe townhouses get snapped up as soon as they hit the market, with noticeable increases in value every time.
What is the typical price point in the area and is there room to push that price point?
What appetite is there for higher quality homes?
If you look at the median income for your chosen suburb it’ll give you an indication of the level of debt homeowners can sustain.
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‘Highest and Best Use’ does not always equal highest density
It’s important to realise that the highest and best use does not always equal maximum density for the site.
You might be allowed to build a small block of six apartments, or alternatively three high-end townhouses. While it might seem logical that six dwellings will net more profit than three dwellings, if there’s demand in your neighbourhood for luxury townhouses, this might be the option that delivers the best return on your investment.
Remember that the cost of construction will have a major impact on your bottom line, so it often pays to choose a simpler, lower-risk option over a more highly-engineered build.
Do your high-level feasibility: within all balance of probability, given typical construction costs, calculate which type of build will be more profitable.
Ultimately what we’re looking for is the most amount of money for the least amount of hassle and time. If the difference for a more ambitious project is in the tens of thousands of dollars then you’ll probably want to put the effort in, but you don’t want to go too hard too early.
Whenever possible, make your money work harder in the shortest possible space of time.
It’s important to realise that the highest and best use does not always equal maximum density for the site.
You might be allowed to build a small block of six apartments, or alternatively three high-end townhouses. While it might seem logical that six dwellings will net more profit than three dwellings, if there’s demand in your neighbourhood for luxury townhouses, this might be the option that delivers the best return on your investment.
Remember that the cost of construction will have a major impact on your bottom line, so it often pays to choose a simpler, lower-risk option over a more highly-engineered build.
Do your high-level feasibility: within all balance of probability, given typical construction costs, calculate which type of build will be more profitable.
Ultimately what we’re looking for is the most amount of money for the least amount of hassle and time. If the difference for a more ambitious project is in the tens of thousands of dollars then you’ll probably want to put the effort in, but you don’t want to go too hard too early.
Whenever possible, make your money work harder in the shortest possible space of time.
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Get Agent input
Once you’ve made your decision, you can ask your local Agent contacts to confirm your assessment.
It’s important that we do the homework up front and that the Agent is just endorsing our result rather than giving their Agent opinion. After all, they’re not a Developer and they’re often selling property based on possibility (subject to council approval) rather than reality.
What you decide to build will be a combination of looking at all the market drivers.
Use the ABS stats, see who’s moving here, figure out if people are still looking for this kind of stock.
Once you’re an ‘Area Expert’ you should go to inspections, targeting property that falls into the category you plan to build. Turn up and see who’s there and what’s happening. Then build the thing your target market wants, can’t get enough of, and is prepared to pay a premium for.
Simple!
Once you’ve made your decision, you can ask your local Agent contacts to confirm your assessment.
It’s important that we do the homework up front and that the Agent is just endorsing our result rather than giving their Agent opinion. After all, they’re not a Developer and they’re often selling property based on possibility (subject to council approval) rather than reality.
What you decide to build will be a combination of looking at all the market drivers.
Use the ABS stats, see who’s moving here, figure out if people are still looking for this kind of stock.
Once you’re an ‘Area Expert’ you should go to inspections, targeting property that falls into the category you plan to build. Turn up and see who’s there and what’s happening. Then build the thing your target market wants, can’t get enough of, and is prepared to pay a premium for.
Simple!
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