Small-scale property development is something you may want to consider if you are unhappy with your current strategy. And if this current strategy is largely or entirely focused on buy-to-let, you’ll have good reason to rethink.
Once upon a time
There was a time, not too long ago, when investing in real estate was a no-brainer, assuming you had some spare cash. With property values largely doubling every ten years or so, and strong demand from tenants, many of whom have been unable to move up the housing ladder, this has been a financially attractive proposition. You can hand over your 25% deposit, use the rental income to cover your mortgage payments and other expenses, and sit back and wait for the market to do its thing.
Happy until the end of time? Not really
Today the world is a somewhat different place for rental investors. Multiple tax hikes and regulatory changes have taken away the luster of the business model to such an extent that many owners have called it a day and exited the market. Those who remain face an increasingly uncertain future.
The problem that every landlord faces is that they are the sweet spot from a tax standpoint. Tax them hard, and not only are they unlikely to slip below the poverty line, but they’re also unlikely to vote differently. They also don’t evoke much public sympathy and, with just 2.5 million people, they are a minority group with little political clout. In short, no one cares that homeowners are taxed because they can probably afford it.
So, is it time to change strategy and get into small-scale real estate development?
Too good to be true? Nope
To be fair, historically real estate development has had a public relations problem compared to rental investment. It looks like it could be quite complicated and possibly quite risky as well. It also feels more like a job than an investment strategy. Yet, as more and more landlords are discovering, the opportunity to convert small commercial properties into residential apartments can be very lucrative and allow them to build their portfolios faster. And it’s not as complicated or risky as many initially feared.
One of the biggest appeals of taking on small development projects is that although they are small in terms of development, they still produce large sums of money. The relatively simple conversion of commercial highs into apartments or offices into apartments will usually produce a healthy six-figure profit over a relatively short period, say 18-24 months. Compared to the more icy growth in buy-to-let equity, this steady influx of cash allows landlords to build up their portfolio much faster than simply waiting for their existing properties to appreciate in value.
But surely development is more complex than setting up a buy-to-let? In many ways it is, but not usually for the developer. You see, when most landlords renovate a rental property before renting it out, they usually hire a builder and personally oversee the work, becoming their own project manager.
But with a small commercial conversion project, not only will they be able to afford a prime contractor, but they can also afford to hire a professional project manager to oversee the project for them. Ironically, the developer makes more money doing less work, and this “hands-off” approach makes small-scale development a big draw for people looking for a more passive model of wealth creation.
Some numbers to consider
So just how big are these small-scale projects? There is no definitive scale, however, as an approximation you would typically consider programs which would have a gross development value of between £500,000 and £2.5m and which would produce target profits of £100,000 £ to £500,000.
Now, that begs an obvious question: Surely you’ll need a lot of money to tackle one of these projects? But here lies another common misconception. You see, a development project will often require you to invest LESS of your own money than a rental property, and with some margin.
There are two main reasons for this: first, commercial lenders financing developments are happy to lend up to 70% of the purchase price and 100% of development costs. This leaves you with a deposit of around 30%, which is not a million miles from a typical buy-to-let deposit. However, many lenders will allow you to borrow most of your deposit from private investors, rather than funding it entirely yourself.
I know some sophisticated owners are also looking to borrow their deposits from private investors. They then buy below market value and refinance, allowing them to repay the borrowed down payment soon after the sale.
But in today’s market, buying rental properties below market value is increasingly difficult and as a result the majority of buy-to-let deposits are likely to be investors’ own cash. And why would a private investor lend you part of his money for your development project? Because the prevailing interest rate for private investment in development is a rather impressive 8-10% per year, there aren’t too many places where investors can get that kind of return.
The opportunities are there
This is all very interesting, but how many small-scale development opportunities are there? The answer, it turns out, is a lot. While the government was busy squeezing out pips from landlords, it did all it could to encourage people to become developers. Whitehall has recognized the need to reallocate the glut of unused brownfields across the country as it would create up to 1.3 million new homes. And unlike building on greenbelt land, converting existing buildings is usually a vote winner rather than a vote loser.
So they recently introduced a revolutionary range of Permitted Development Rights that allow developers to change the use of a wide range of commercial buildings to residential WITHOUT the need for full planning permission. And if you’ve ever noticed the number of vacant or dilapidated commercial or commercial properties in your city, you’re only too aware of the magnitude of the opportunity.
But surely the bigger established developers would handle it? Unfortunately for the government, they won’t. Not only are the big players not interested in a few hundred thousand profits, but their model is usually to build new homes on large empty lots using existing designs. Creating point solutions to fit into an existing small building is not their bag at all. Still, it’s perfect for small-scale developers who know where the opportunity lies.
It’s worth remembering
Real estate remains a very attractive asset class to invest in. One of its biggest attractions is that demand for the product is virtually guaranteed. They don’t do land anymore, but there’s a constant stream of people wanting a place to live, and there aren’t enough houses for everyone. We’ve seen property prices soar recently, and they continue to rise despite a European war, runaway inflation and a cost of living crisis. To maximize your property investment profits in today’s market, take a look at small-scale property development – it might be a better fit than your current strategy.