[sub-heading]I recently notified the hotspotcentral.com.au subscribers about an off-market opportunity we had recently reviewed.[/sub-heading]
I got a call from an investor (Cathy) who said, “Michael, what’s the catch? It seems to good to be true”? I realised Cathy was rightly sceptical as so many investors are nowadays.
You see, this opportunity offered a discount of $80,000 against a bank valuation of $400,000 for a brand new townhouse in a location tipped by many to be the next Gladstone without the reliance on mining.
With this in mind, Cathy continued, “If the bank says it’s worth $400,000 and it’s in a desirable location, why on earth would they give away $80,000?”
Before going into some detail I first asked, “if you buy a new property (e.g. off-the-plan) and you are promised an upfront cash profit of $80,000 in return for putting down a small deposit of say 5%, 10% … and the property is in a solid location … then is this too good to be true”.
We agreed nobody could offer a 200% plus cash-on-cash return. That’s too good to be. So I explained it as the builder-developer offering $80,000 in instant equity put it to me when I first started my investigations:
“If each investor puts in $150,000 to settle the land, I can then build 4 townhouses on it and still make the usual 15% builders margin.
Each investor can keep the (1) developers profit, save on (2) stamp duty and save on paying the (2) selling agents commission. I create these benefits for the buyer for one simple reason: I can take on 10 times as many projects without having to go to the bank for money to settle the land”.
99% of investors pay more for marketing hype
I explained to Cathy that 99% of investors by on emotion and the expensive brochures and slick salespeople are adept at creating that emotion, particularly when the market gets overheated. Who pays for this marketing hype? The retail investor does (and the cost is buried in the purchase price).
In this scenario, the builder-developer quickly realised taking on ten times more projects without the headache of dealing with the banks and looking for retail buyers was just too good to pass up.
And that’s when Cathy realised putting up $150,000 to save 20% on the typical retail price by stripping out costs like stamp duty, selling agents commission and the developers profit is a fair and equitable exchange rather than something that is too good to be true.
I then mentioned 2 major banks approved the model and happily fund the construction and take out finance (mortgage on the completed townhouse) because for them it’s low risk. They fund a project that is 100% pre-sold to investors. The land has DA approval and is ready for construction just before they tip their funds in. On completion they get four mortgages as most investors choose to hold.
Best of all these new customers have an immediate 20% buffer in place (retail price less cost price) and have put skin in the game (i.e. $150,000 of their own money). If the investor chooses to leave their initial investment in, the LVR drops to around 42%. If they re-mortgage out their $150,000 upfront investment, they’re still left with an 80% LVR. No lenders mortgage insurance required and a ‘manufactured’ deposit.
SMSF investors also win knowing they have an immediate capital gain of 20% in a smaller, more desirable boutique complex appealing to tenants and owner-occupiers alike. These smaller complexes attract better rental yields and higher resale prices.
So I said to Cathy, “you can see why it’s not ‘too good to be true’… you need $150,000 to play this game and you need to know the right people to make it happen”.
Not everyone wins…
The selling agents admittedly lose out and so does the traditional developer. Are they worried? I don’t think so simply because most investors follow the pack: those 99% of investors who pay inflated retail prices after responding to the marketing hype which selling agents are paid to drum up.
There is a reason why only 1% of property investors own multiple, positively geared properties with good capital growth upside.
As a side note: this strategy is not for everyone. At hotspotcentral.com.au we see these off-market opportunities all the time and recommend a select few. Before jumping into these ‘passive’ development opportunities, get educated so that you can determine the wheat from the chaff.
If you want to know how this works here is some free know-how
By the way, it’s article in the Australian Financial Review (July 2013) that reminded why I strongly believe in giving investors the chance to by property at the cost end rather than the retail end.
This article was title SMSF Disaster waiting to happen but it applies equally to any investor.