Unsure About Developing? How AI Legalese Decoder Can Help Inexperienced Individuals Navigate Legal Requirements
- May 6, 2024
- Posted by: legaleseblogger
- Category: Related News
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## Considering a Building Project with a Friend
I have a close friend who is also a builder, and we have been exploring the idea of embarking on a joint building project together. After a year of searching, we stumbled upon a property in Green Bay, Auckland, priced at approximately $1.2M, boasting a generous land size. The plan is to demolish the existing structures and construct multiple townhouses on the site.
### Breakdown of Costs
#### My Costs:
– House deposit: $240k
– Estimated RC & BC costs from the builder (his company): $120k (I am unsure if the quoted amount is reasonable; seeking advice)
#### His Costs:
– Building costs for 4 townhouses, each featuring 4 bedrooms and 3 bathrooms: $2M (inclusive of landscaping, driveways, etc.)
#### Total Overall Costs for Both of Us:
Estimated between $3.2M to $3.3M
### Expected Returns
Our goal is to sell the completed townhouses by the end of 2025 for a collective sum of $4M to $4.2M, generating a potential profit of around $1M. The profit will be divided equally between us.
### Other Considerations
1. Should I seek additional advice or precautions besides consulting a lawyer and verifying building costs?
2. Is the investment financially viable and worth the risk?
Despite feeling apprehensive about committing a significant amount of capital to this endeavor, the potential rewards are promising and could potentially pave the way for a more secure financial future for me.
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****** just grabbed a
You also need to consider tax on profits.
I am not a property developer, but inclusive of tax on profits and the general cost risks around this type of construction plus housing market pricing risk, this would give me the absolute heeby geebies
Who in their right mind is going to offer finance on an inexperienced developer with minimal experience and almost no equity lol. Development finance for multi town houses often requires around 50% equity of the total cost of the project.
Borrowing for developing is different to borrowing to live in, as you have greater risks that the bank will be left with a barren section with a pile of poorly built framing on it that cant have anything done with it.
If this was a viable development then you would not be involved in it and it would be snatched up by someone in the development game. The fact that its available and this is being discussed with you who is not a developer but being expected to front risk for it would be enough to make me think its gonna fail.
It’s unclear what your role would be.. are you investing in his building company? Or buying the land yourself for 1.2m and then partnering with him to build, with him somehow obtaining the 2m to build? Obtaining finance would be one hurdle to overcome.
Has your friend built townhouses before? That’s a big project. Presumably he has built regular houses? You should check any properties he has built recently. Even knock on the doors, tell the owners you’re thinking of hiring him, don’t say you’re a friend, but ask what was the build process like, any ongoing issues, etc.
The biggest risk isn’t what the market will do (although that is quite a big risk too). The biggest risk is what your friend will do. Just because you trust him as a friend doesn’t mean you should trust him as a townhouse builder and business partner.
Also, take 100k off the profit to pay the real estate agents. Then like 200k each in taxes. Perhaps some other costs you will need to find out about (council development contributions can be very expensive, not sure if those are included in your costs yet, these are different to BC and RC). You might be taking a lot of risk just to hopefully make 200k in the end. If prices shot up over the time period, you’d be rich though.
Something is not making sense.
Actually quite a lot, but you need to get advice from a trusted lawyer and/or accountant, mortgage broker. The numbers are not making sense.
I would be looking at your friends history with this kind of development very carefully, as he is contributing $2m + labour/management – nearly 10x your contribution and wants to split the profit 50/50? Or reading it again, you put in everything you have and take on a mortgage of ~$1m for the build? Not sure the bank will lend on this as a business development rather than buying a new house build unless you structure it as separate parties and/or pay higher interest rates. Messy
Worst case; you hand over the $240k (+ $120k?) and the builder can’t get $2m in lending to build, goes under and you lose the lot. A real risk.
Best case; you hand over the $240k (+ $120k?) + ongoings and the build + council consents etc goes perfectly and you end up with 4 houses that after selling fees (RE agents are not cheap) you earn ~$500k before tax, $350k after. You are still looking to ~double your money, so its not really about buying a house, but speculating on a get rich scheme. Which can work; but risk vs reward.
You need to do a lot more research. I understand build costs are approximately $4000 a square metre at the moment. So the $2m build cost only gets you 4 x 125 sq metres of build. How do you squeeze 4 bd / 3 bath into that? My guess is that you are *assuming* lower build costs and 150-200 sqm builds. I don’t like that assumption as things can go wrong, and to sell you really need a fully finished and dressed house. But drive around a look at new townhouses in the area. Would you clear that after all the RE fees and while paying the cost of finance?
Quick look shows other houses in the area (18A Lantana Road, Green Bay) going for ~$1m so bit lower than you hope to get for a 3bd/2 bath.
One thing I noticed when looking on TM for Green Bay (besides the place with the 2400 sqm section, which might be what you are looking at) was one leaker that you could potentially buy and go in with your mate to rebuild. Might be lower cost/lower risk/lower reward starter option to get a house?
What’s the m2 rates of the following:
Land per home
Build per home (incl contingency fund)
Sale per home
Also are all services on site or do you need an easement over someone else’s land? Is the site flat and rectangular/square or is it oddly shaped in a way that will impede maximum return?
That’s a good starting point. Then is there demand? Does similar stock on the market currently show that there is price justification? What skin is the builder putting into the game? And by skin I mean money. You’ve outlined his building it as his cost – has this been broken down? Hourly rate, materials, project manager, all other services including electrical, plumbing etc. You don’t have much profit margin and any issues that arise during building will very quickly eat into it.
So you are going into business using leverage. There are several layers of risk and value exchange going on here that explain why your friend can give away value:
Timing and consent risk: You appear to be taking the bulk of timing risk, this is not market risk, sales value risk etc. Those come down to you being optimistic or pessimistic about property. This is the timing risk of getting consents, coupled with the risk of not getting consents. This is also what’s in it for him, he gets to start another project using your money and you assume the risk. You need to know how long you can sustain the holding costs and what breaking the arrangement looks like if you can’t or don’t want to sustain it in the future?
Margin transfer: Your friend’s costs of $2m likely include some gross margin for them, even if only in the form of remuneration for their labour or project management. Be clear what this is? Is it a fixed price contract? Who takes the risk if construction costs increase beyond budget? Who makes the margin if they come in lower than expected? Where margin transfer exists the risk of not being aligned on outcome also goes up – there are scenarios where your friend can still make money while you lose money.
Cost of sales: Who is selling the finished property and what is this cost? This appears it could be a material portion of your margin after land and development costs, does it still stack up? Or are one of you doing the selling?
Liability: I suspect this deal is done in two distinct stages which I’ll call pre consent and construction. The debt is obviously yours at pre consent. How does it work during construction? A lender will want security so it means the construction cost finance plus your mortgage likely get blended into some sort of development finance arrangement. The rate will be higher and the term “joint and several” will be introduced, meaning you are both 100% liable for debts. If things go wrong, the debt spirals with penalty interest and fees on top of high rates and incomplete project are not known for selling at premium prices. Understand how the development is financed before you get into the first phase. Understand the risks and even if this is a partnership you are 100% liable for debts.
Property development can be very profitable so I’m not trying to scare you, just be aware. Your first development like a first business is a dice role; most people don’t have the reserves to survive a really bad idea or execution. The risk of bad execution is also higher due to experience levels.
I’ve seen deals like this done fairly well – a recent three way partnership that a friend asked me to review worked well because capital commitment was equal from the get go and margin transfers minimal, clear and documented (2 of 3 partners were tradies and provided labour and materials but at terms that benefited the partnership). The partnership agreement also included various “here is what happens when things go wrong” clauses. This works like a pre-nup, it’s easier to make difficult decisions before the stress is on and the risk of falling out elevated. This added value, all their cash flow ended up being tied up in a last unsold property during the recent soft market. Their agreement allowed them to make fair and clear decisions when the pressure was on rather than have it turn into a falling out.
Think through it carefully, get legal and financial advice, if it stacks up and your risk appetite can handle it go for it, if not, walk away. The deal of a lifetime comes past your desk more frequently than you might think. Good luck!
Contract!!!!! You need an excellent contract. All prices are changeable, so estimates may be way out.
Nope. Neither of you sound like you know what your doing. He sounds like he just wants your money the BC and RC fees sound like they’re for the whole site and may include subdivision costs.
Who’s the designer? You should talk to them at least. I just watched a developer near to me buy a similar section, down the back while excavating foundations they found a massive peat deposit. Took them at least an extra 6 months to dig it out. In the end they just sent hundreds of trucks of metal in to fill it. Must have blown out their costs by at least $250k. Even the guys who do it all the time make mistakes.
Obviously you can’t do proper Geotechnical testing on site till after you buy and after you removed the existing structure. Pretty big risk.
Think through the worst cases and make sure contact covers them. What happens if he get injured and can’t work? A lot of small building companies only have one fully qualified builder so work grinds to halt …. unless you are also a builder. It sounds very risky for you. I am not a financial adviser
Sounds like you’re going to get swindled from the builder
Have you worked out the gst impact?
Do you have finance sorted? Unless you have at least 50% pre-sale banks won’t touch and you have to go to 2nd tier lenders.
It doesn’t look like you have factored in subdivision costs
What about site clearance, services etc
How solvent is his business, does he have enough to pay for subbies and materials through the whole build process
Think you need to do some thorough costing to understand your real risk/reward and see what the opportunity cost is too
Big no, massive risk youre taking
Generally to get funding you’ll need to put the section in freehold. Start by chatting to some second tier lenders to get an idea of what their requirements are. Good luck, it’s fun but hard work!
I would BRRR the first couple of projects to create a track record and iron out any issues you may have personally. Money & mates is a hard mix. Good luck.
I am doing a similar thing. You need to be aware of subdivision costs and also interest. Interest is about 13% for a second tier lender up to 16%. You won’t get main bank lending unless all units are pre sold. Unlikely in this market. You also need about 20% equity in the total project cost. So if it costs 4m in total you’ll need to front at least 800k yourself.
You need to do a detailed feasability that includes cost of land, subdivision costs, build costs, 10% contingency on all build costs and then add in finance at around 15% (do a 10% loan at 70% loan utilisation) and then 3% establishment fee and 2% line fee on facility limit.
Once you’ve done that feasibility you’ll need at least 15 or 20% margin otherwise you won’t get lending. Oh and don’t forget gst
I recently developed 6 townhouses in similar scenario, 50/50 with a builder friend. It has been bit of a disaster, costs blew out 50%, many delays dragged the project on for 2.5 years (mostly due to covid).
It’s not the worst case, as it still is profitable, but would have been better to just buy a house 4 years ago instead of the section, which I was trying to do but house fell through during DD. In my case it was only 30% of my net worth also.
There is no “easy money”.
1.5 years from buying land to selling houses isn’t going to happen, nor is even close to a million dollar profit.
Also it’s highly unlikely you’re going to be able to borrow 1.2m for land from a 240k deposit, let alone the build costs.
Never ever go into business with a friend unless it is 50/50 the whole way including time/capital contributed and profit sharing – unless you don’t care about losing a friend.
I would also say it is a fairly chunky first collaboration with your friend. Start smaller first so you can build up confidence with this friend.
I don’t understand why this developer requires your $240k for the land of he has four projects already going and enough finance to be able to finance $3m+ for the build. If you are responsible for buying the land for $1.2m and the RC and BC costs which can be upwards of $300k, are you really able to get finance for that?
I’m just wondering what your relationship is with this person? I’m asking because you’ve said he’s done 4 housing lots already but is seemingly lacking in money despite making millions multiple time.
Has he done a deal with someone else like this that could speak to his character here and/or advise you why he isn’t borrowing money from them instead.
I’d also query who exactly has $4m in NZ that is willing to forgo a lawn and a car park to live in a cookie cutter townhouse. People with money usually like their houses custom designed, and not share a wall with a neighbour.
Holding costs
Real estate agent fees + marketing
GST
Vector costs + potential growth charges
Watercare costs + growth charges
Infrastructure development fees from council
There’s so many more associated costs you have not allowed for.
He is in financial trouble. Builder’s can’t do their sums. That is why he is not an accountant.
Tell him business and friendship don’t mix. Tell him it’s nothing personal, it’s just business.
It’s the gst that gets you. Can’t claim it on the property you buy, but you have to pay it on the property you sell. And the agents fees so take c. 18% off the sell price altogether
Ok, I would plan for 30% higher costs and have a $200k buffer. There are so many variables that could derail your plans and being caught short will be a disaster.
Also whenever I have embarked on a significant development I always factor in the property price cycle – ie when you are ready to sell the market could be down. Roughly every 4/5 years you’ll hit a dead spot.
I’m assuming you’re renting at the moment. Can you afford the mortgage and rent payments all at once?
Don’t forget the taxes on that profit.
Why are you paying a house deposit if the houses are to be sold.
What are the tax implications of the profit – he would be classified as a developer.
And this is why our housing market is screwed.