If you were buying a second hand car, you would have it checked out by an expert before sealing the deal. Why wouldn’t you then do the same with property development deals you’re investing in? Surely you want to guarantee your investment is protected as much as possible before parting with your hard-earned cash?
At QB Investing, we add value through the due diligence we carry out on our projects. Each project goes through a rigorous analysis process against our minimum investment criteria, before an investor even lays an eye on it. We turn away many more deals than we accept, because investing is not a game. It’s about weighing up the risks, mitigating them and making informed investment decisions based upon our knowledge of them.
No investment is watertight, but you will certainly reduce the risk of losing your cash by following the ten tips below.
Build in a realistic profit margin
Is there sufficient profit margin in the deal to weather any unforeseen increased costs or market fluctuations? The profit margin is normally calculated as a percentage of gross development value (GDV) (the resell value) or of project costs. Stress test your project by what you think the market could fall by, or what your project costs could increase to and make sure there is enough profit in the deal to ensure you at least get your initial capital back plus inflation. At QB Investing, we normally stress test at 20%.
Vet the developer and contractor
It’s crucial to know exactly who is behind the deal that you’re investing in. Make sure you fully vet the developer and main contractor. Check their track record to see if they have successfully finished projects similar to the one at hand. Ask for client testimonials. Carry out background checks, such as asking for passports and proof of address. Perform bankruptcy and insolvency searches. Think about searching publicly available databases, like Companies House. Don’t overlook how fruitful Google searches and social media can be either. If the deal is of high value, consider using an external vetting company like Risk Advisory to do a more thorough background check.
Ask for security to cover investment value
If you are providing your investment by way of debt, ask for security to be put in place over the property or land to secure your investment. Check the existing value of the property to ensure that any security that you do have is effective. For example, if the property is worth £100 but your investment is £120, £20 of your investment will be underwater and therefore may not be recoverable.
Consider multiple exit strategies
In this current climate, especially with Brexit looming around the corner, it is vital that you have a robust exit strategy in place with at least one (but preferably more) backup options.
If you cannot exit the investment at the predicted GDV you will either have to reduce your price or wait to exit (which can be expensive if you have financing costs). Both scenarios will decrease your return on investment. You can mitigate the risk of this happening by formulating a viable Plan B and/or Plan C.
Understand gearing ratios
If the developer is using external financing as well as your cash, then you will need to understand the implications of this. It is likely that any development finance being injected into a deal will rank ahead of you. If the deal is taking on too much debt in relation to equity then the chance of a default is increased, which could lead to the finance provider accelerating the loan. Once this happens the finance provider gains control of the project. Their principle aim will be to get their cash out quickly, leaving your capital at risk. The key here is to ensure the gearing ratio on the project is within safe limits. At QB Investing, we do not go over 60% debt to GDV.
Ensure estimated construction costs are accurate
The costs of construction can make or break a project. It’s vital to make sure all costs are included and that these are realistic estimates. If you don’t have construction experience, you can ask for an independent quantity surveyor to verify these costs for you.
In addition, you must always make sure that adequate contingencies are built into the cost analysis. Market standard for construction contingencies is usually around 10% of the construction cost budget.
Develop a strong marketing strategy
This is an often overlooked but crucial area for success. A marketing strategy should be set at the outset. In precise terms this means creating a detailed plan of how the property will be marketed. Will there be CGIs? Will the property be sold off-plan (before a structure is constructed on it)? Interior design input should be given at the planning stage to ensure the best room layouts. Be ahead of the curve and plan the exit. Waiting to deal with these issues at completion will only lead to delays and increased finance costs.
Predict and mitigate planning risks
If the deal you’re investing in requires planning, you should be aware of the risks if planning isn’t granted or if the scheme needs to be reduced to receive planning. Analyse the project from a worst case scenario. Does the project work without planning in place? Has the developer submitted a pre-app to mitigate planning risk?
If there is planning in place, is it sufficient for the build? You want to avoid having to go back to the planning stage because of an oversight or because amendments need to be made. Such a scenario will only lead to increased costs and delays.
Ensure the project has secured adequate finance
If the project is dependent on additional funding such as development finance, you should ensure this has been secured prior to entering into the investment. At the very least you should make your investment subject to obtaining development finance on the rates and conditions set out in the cost analysis.
Without these assurances, you could be tied into a project lacking sufficient capital to develop the property.
Encourage developer equity
One way a developer can show commitment to a deal is by contributing their own funds. It shows that they have skin in the game and therefore will be motivated to ensure the deal completes on time and within budget.
This list is by no means exhaustive, but it will set you on the right track to analysing deals better. By performing this due diligence you will feel more comfortable in the investments that you make and greatly increase your chances of making some significant returns.
If you have any questions, or want to find out what QB Investing is all about, please email me at: [email protected]
Or check out our website qbinvesting.com.