Welcome to our channel. It says that 2021 is the best time in a generation to be a property developer. Not only builders, but more public joined this game.  Many clients came to us enquiring for construction loans, and some currently do not even have their own property.

Although people are now enthusiastic about property development, few of them can actually start or even finish their construction. To avoid surprises and be underprepared, want to share with you the four challenges people face in property development based on my observations of my clients, as well as my personal experiences of building my own home.

If you plan to develop houses in NZ or are interested in housing development, don't miss out on this episode. It can be  helpful to you.

The four challenges in property development

Timeline:
1. Construction costs keep rising rapidly - 01：45
2. Finance costs increase significantly caused by construction delay - 02：35
3. Hard to get a Fixed-Price Contract - 03：40
4. The project margin is not viable to start the project - 05：30

1.      Construction costs keep rising rapidly.

You may have heard that the costs of construction materials in New Zealand have significantly increased because of the materials and labour shortage. Actually, the construction costs are not only going up but surging.

From my observation, building a standard residential property now costs $2800 to $3000 per square, which is even more expensive than building a mansion in the past. What's even worse is that the continuous increase in construction costs has no sign of slowing-down at all

2.      Finance costs increase significantly caused by construction delay.

There are two main reasons causing the construction delay: the Alert Level 4 lockdown and the shortage of materials.

At Alert Level 4, the construction sector has to stop. Suppose your project has already started and paused by the lockdown. In that case, your finance costs will keep increasing because your loan interests still accumulate despite the lockdown.

Then, the material shortage can lead to a construction delay as well. Every time the builder orders material, it could take months to arrive. As a result, it prolongs the construction. The loan interest cost takes a big part of the total project’s budget. The longer time you spend on the project, the higher the financial cost you need to pay. If the interest cost increases, the project cost will significantly go up.

3.      Hard to get a Fixed-Price Contract

Banks always favour fixed-price contract. This is because the builder will take the risk of cost overrun, not the client. In the past, if your loan takes a relatively small part of total cost and completed value, and you have some experience in house construction, you can purchase the material yourself and employ an experienced project manager to help you managing the project, instead of using fixed-price contract. The benefit of this approach is that you can significantly reduce the construction cost. However, the construction costs are rising too fast now. The banks cannot be sure whether your budget is sufficient. In case the budget is underestimated, while you don’t have a cash reserve to meet the shortfall and the bank cannot provide more loans, then this project will become an unfinished one. which is a big risk for both you and the banks. Therefore, now the banks are not willing to provide loans to a client who does not have a fixed price contract.

We are working with a client who has nearly 40-year building experience. He preferred to manage the project by himself rather than get a Fixed-Price Contract to save cost. We have spent two months working with the bank for his case as his bank is not comfortable with the project budget and they want to make sure the budget is definitely sufficient to complete the project. Although we believe the bank may finally approve his application, the application process is not easy, and the scrutiny on his application was extremely strict. Most of us do not have 40 years of construction experience. So, if you do not get a fixed price contract, it will be tough to get approval from the bank under the current credit appetite.

On the other hand, it is not easy to get a fixed price Contract because the builders are not willing to take the risks of cost rising as well. After all, nobody knows how high the construction costs will go during your project. It is hard for builders to estimate the building budget and offer a fixed-price contract. If the fixed price is set too low and the construction costs rise fast during the project period, the builder will make a loss. But if the builders wanted to reduce their risks and set the fixed price too high, you may not accept the contract. As a result, the clients and builders cannot easily agree on making the fixed-price contract.

You can see you are in a dilemma. On the one hand, it is hard to get a fixed-price Contract. On the other hand, the banks will not provide loans for people without a fixed-price contract. Without a fixed-price contract, people have to go to some non-bank lenders for financing their development project, but the finance cost will increase significantly and reduce the project margin.

4.      The project margin is not viable to start the project

When you consider a property development project, one of the most critical factors is if the project is feasible. That means how much profit you will make from the project. In a simple term, profit feasibility is the total market value after completion, less all costs including contingency. If the margin is small, then the project is very risky and not worthy of development.

Furthermore, if your project profit margin is less than 20%, banks will not consider your construction loan.

If you don’t currently own the development site, it will be very expensive to acquire the land in the current housing market. As a result, your profit margin is more likely to be under 20%.  you may want to think twice before you decide to develop it straightway. Maybe land banking is a better option? These are four challenges in property development based on my observations and personal experience. If you plan to develop your property or purchase a site for development, I hope you find this article useful.

Next week, we will bring a piece of good news for our subscribers who are planning to do a small property development project and can get a fixed-price contract. Make sure you do not miss it!

Read more:

Three tips to help you improve tax efficiency under the new interest deduction rules

Five Tips that new home buyers have to know

How loan goes during a lockdown?

Disclaimer: The content in this article are provided for general situation purpose only. To the extent that any such information, opinions, views and recommendations constitute advice, they do not take into account any person’s particular financial situation or goals and, accordingly, do not constitute personalised financial advice. We therefore recommend that you seek advice from your adviser before taking any action.