Generating positive returns from property development investments is not dependent on capital growth, meaning the asset class can produce solid earnings regardless of the market cycle position, a wealth manager has said.
“One of the key things with running a development is that the risk is usually not market risk – it’s assumption and cost risk,” CFMG Capital group general manager Andrew Thomson told delegates at the recent smstrusteenews SMSF Trustee Empowerment Day 2019.
To illustrate his point, Thomson referred to the activities of some amateur property developers he knew.
“They’re buying large blocks of land and knocking down the old house or maybe knocking down two. They’ll then complete those projects in six to 12 months and make a tidy profit when there has been absolutely no capital growth in that space,” he said.
“Provided they’ve got their cost assumptions right and their town planning assumptions right and their servicing assumptions right, they’ll make a profit by improving that single asset as opposed to taking on any market risk or growth assumption.”
According to Thomson, knowing this is how a property developer generates return means logically they can experience earnings in all market conditions.
“Your large developers, your Stocklands, your Mirvacs and your Lend Leases, they perform positively all the way through cycles and are not reliant on market growth,” he said.
“So the key risk is getting your assumptions right.”
He pointed out it is for this reason investing with a professional developer is key for SMSF trustees.
“You see it all the time where someone buys a huge block of land, thinks they can knock down the old house, build two new houses and make a profit. But the house might be pre-war and they can’t knock it down, or they can’t get sewage access, they can’t get storm-water access, there’s a tree blocking where the driveway would’ve been, and they find they thought they were going to do a simple development, but run into all sorts of trouble and end up selling a distressed asset,” he noted.
“That’s why you should rely on experts to run these projects.”