Many property-focused entrepreneurs are shifting their focus. Once upon a time the buy-to-let model ruled, but a new strategy is gaining favour; a rising number of individuals and investors are redirecting their interests towards small-scale property development. Ritchie Clapson CEng MIStructE, co-founder of propertyCEO, explains
Typically, small-scale property development involves converting commercial buildings, such as offices, shops, or light industrial units, into residential flats. It could be as simple as converting a small office building or the upstairs storage areas in a shop. Building between four and 20 units, target profits will be between £100,000 and £500,000 per project, with each project lasting 12-24 months or so.
It is an attractive property investment strategy, but before pursuing it, any first-time small-scale property developer needs to address five questions:
1. Where does the money come from?
Let’s say you want to buy an empty shop for £400,000 with the intention of putting four flats above it. We’ll also assume that the cost of doing this conversion (including all construction costs, finance costs and professional fees) is another £400,000. That looks like an investment of £800,000.
However, property development doesn’t necessarily require a substantial personal investment. Commercial finance providers specialise in funding developers, lending up to 70% of the purchase price of the commercial property, and 100% of the development cost.
In our example, you as the developer need to fund £120,000. The commercial lenders are happy for you to borrow the bulk of this deposit from private investors, looking for your “skin in the game” to be about 10%. In our example that would be £12,000.
So, small-scale developments can provide substantial returns with a relatively modest personal investment.
2. How much work is involved?
As a first-time developer, it is important to recognise that you are the driving force behind creating wealth – you are not providing any bricklaying, plumbing, or decorating skills. For these tasks, you will be employing experienced professionals, including a project manager – they will have the necessary experience to keep the project on track. Your “CEO” role will likely be weekly phone calls with your project manager to keep yourself up to speed and to make any necessary decisions. Your focus is on the strategic aspects of development and minimising associated risks.
3. How are profitable projects identified?
The flexibility in valuing source buildings, especially in commercial conversions, offers a unique advantage. Proper training and understanding of permitted development rights empower first-time developers to uncover hidden value in buildings, gaining a competitive edge over other developers.
A run-down commercial building might be worth £100,000 to someone who wants it for their business, but because you’ll be converting it to residential, you’ll be getting a huge uplift, meaning you can pay significantly more than its commercial use value. However, other developers will be looking to do the same thing, and a little expert knowledge can give you an advantage. Imagine that the other developers could get five flats into the building, but I showed you a way you could get six. With a 20% profit margin, all their profit is in their fifth flat. But your profit is in flats five AND six, allowing you to outbid the competition.
Training doesn’t just help you to avoid pitfalls, it can also allow you to see many more opportunities.
4. Is being a fresh face a drawback?
Remember that your money is as good as anyone else’s. And building professionals will be paid regardless of you achieving your profit goals or not, so you being a first-time developer doesn’t make you a risk. But it does make you an opportunity; if they do a good job for you, you are likely to employ them for your next project(s). All building professionals need to move on to fresh projects to keep making money.
The same goes for lenders and commercial estate agents. They make money on the back of what you do, and they will want to work with you because that’s how they get paid.
5. How risky is this kind of venture?
While there are no absolute guarantees in property investing, targeting a 20% profit margin, maintaining a contingency fund, and obtaining proper training significantly reduces risks. With the ability to refinance or rent out units during market downturns, small-scale developers have built-in flexibility for risk mitigation. Also, take comfort from the fact that your commercial lender will only lend you the money you need if they believe the deal makes a 20% profit; you only have a project if they have faith in you.
The critical thing to do is to do your due diligence before you commit to a project. You need to know precisely what’s involved in developing a building and where the best opportunities lie. You can use the QR code below to access a free webinar where I put more meat on the bones.