What makes a Successful Property Development?



It's amazing how many TV shows are dedicated to property improvement and development. I watched one last night where two professional property developers mentored a couple develop their own home in Berkshire. At the end of the show the mentors looked at how much the couple had spent versus the post development value (they took the average valuation of 3 estate agents).


The mentors congratulated them on making an £85,000 profit to which the home owners grinned like Cheshire Cats having won the lottery. Except they hadn't! On my numbers they had made a paltry £13,740; a figure some 84% below what was presented.


Here's how the mentors presented their gains:


Purchase Price: £365,000

Development Cost: £55,000

All-In Cost: £420,000

Current Value: £508,000


Profit "on TV": £88,000

Return on Capital: 17%


The presenters conveniently managed to omit stamp duty, finance costs and the estate agents fee if they were to realise the gain. These costs would make the figures look like this:


Purchase Price: £365,000

Stamp Duty: £8,250

Development Cost: £55,000

Finance Cost*: £11,863

Add Sales Agents Fee: £9,144

All-In Cost: £449,257

Current Value: £508,000


Developed Profit: £58,743

Return on Capital: 12%


Still pretty good I hear you say. Except it isn't. The couple bought the house 2 years ago. A quick check on the Land Registry for their area and the local market has appreciated 20% over that period. If the couple had done nothing therefore, their profit would look like this:


Purchase Price: £365,000

Stamp Duty: £8,250

Development Cost: £0

Finance Cost*: £11,863

Add Sales Agents Fee**: £7,884

All-In Cost: £392,997

Current Value (+20%): £438,000


Profit if Un-Developed: £45,003

Return on Capital: 10.3%


So to summarise:


Profit "on TV"": £88,000

"Developed Profit": £58,743

Profit if Un-Developed: £45,003

Difference (True Profit): £13,740


In other words, the proud householders made just £13,740 more than would have done had they done absolutely nothing, hardly a ringing endorsement for all their hard work.


The lesson here is that to calculate profit from development you need to look at including all costs (stamp duty, finance and estate agents fees) and back-out the uplift in the market over the same period (or assume zero market growth if you are doing a pre-development appraisal). Only then will you arrive at your true profit.


Notes:

* Finance Cost: assume 2 years at 2.5% rate on 65% LTV

** Estate Agents Fee: assume 1.8% including VAT


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