The Property Speculator

Developing a Mixed-Use Property

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A very common way of getting started in property development and investment is converting or renovating a mixed use development.

‘Mixed-Use’ can mean a combination of Residential, Office or Retail within a single development (it’s highly unlikely Industrial type properties would be included in this, for example I can’t imagine a residential flat being situated above an industrial unit). So an example of this could be a shop with a flat/flats above it, or offices with residential above. Incidentally the residential portion is situated towards the top of the property because it’s not likely to require a street-level frontage, like a shop or an office might. The residential area of the property also tends to be quieter and the commercial occupants are less likely to have cause to go upstairs into this area of the property.

© Copyright John Lord and licensed for reuse under this Creative Commons Licence

It is certainly possible to convert only part of a property to a use that’s different to the original one. Be aware though that (currently) Planning Consent is required to change the use of a property (or part of a property) from Commercial to Residential and between sub-groups within Commercial. Building Regulations also need to be fully complied with.

The different ways of occupying a property are:

Freehold. This is the closest to owning the property outright (It’s only a Government body which can carry out compulsory purchase though). The Freeholder theoretically owns the plot, the land beneath the plot and the area above it (although this isn’t really enforceable in reality). Being a Freeholder offers the luxury of selling a leasehold interest in the property if he/she wishes.
Leasehold. This is usually for a period of time (term) of 99 years or more (sometimes 999 years). The freeholder effectively sells the right to use the property for the term stated in the contract. Along with this, the Leaseholder sometimes receives the right to allow Tenants to occupy the property and collect the rent. In order to reduce the chances of confusion, this is often called the Long-Leasehold interest. It is bought in a similar way to the Freehold Interest (i.e. a large amount of capital is paid for it, rather than a monthly or quarterly rent).
Tenancy. This is really just a different way of occupying the property under a leasehold interest, however for the purpose of avoiding confusion over these occupancies, I refer to it as a Tenancy (even though the occupational contract is still called a Lease…). This is paid for in the form of rent, usually paid monthly or quarterly (depending on it being Residential or Commercial). A tenancy is always shorter than the long-leasehold interest (even if it’s only 1 day shorter) but is usually much shorter, between 3 and 25 years is usual. A tenancy does not really have much value in itself other than to the landlord. This is because it’s not really possible to sell a tenancy by itself; you can however purchase the leasehold interest with a tenant already in place.

Commercial and Residential tenancies are usually quite different. The main issue is that all Commercial tenancies are awarded Security of Tenure unless specifically contracted out of it. This means that a Commercial landlord can only make the tenant leave the premise at the end of the term in certain circumstances (for example if the landlord wants to redevelop the property and has plans in place to prove this). To contract out of this, the lease agreement must specifically state that both parties wish to contract out of the Security of Tenure provisions of Part 2 of The Landlord and Tenant Act 1954, s 24-28 (or words to the same effect). Contracting out of the act should benefit both parties (such as when a lower rent is agreed upon to reflect a lower ‘risk’ to the landlord).

In contrast, Residential tenancies tend to be more heavily weighted in favour of the Landlord. A tenant does not really have any Security of Tenure at the end of the term. Many Residential tenancies are only for an initial period of 6 months. If the tenant stays in the property with the permission of the landlord at the end of the term, a Periodic Tenancy is formed. If the tenant pays rent on a monthly or weekly basis, this period becomes the notice period for either party to bring the tenancy to an end. A periodic tenancy continues until the landlord or the tenant brings it to an end.

It’s important to have an understanding of how the different types of occupation work. When developers of mixed use properties consider their projects, they intend it to work in a slightly different way to the usual private residential developer. Where a private developer buys a property at a reduced price, spends the bare minimum but produces a good finish then sells on to a new owner, a mixed use development often requires a different approach. Of course it is possible to buy and sell a mixed use development in the same way as a small residential (i.e. the freehold), but because of the combination of property types within the development it usually makes more sense to keep the freehold of the property and sell the long-leasehold interest as and when an occupier or investor is found.

If the freehold is retained, tenants can be found to occupy the office or retail portion. The residential areas of the building can be let the same way as the commercial but this involves a lot of management of tenants taking 6 or 12 month tenancies and of course, the developer will not receive capital in return in a lump sum. It’s far better to sell the long-leasehold interest in the residential units to either investors or leasehold-occupiers. This way, a profit can be made (the value of a long-leasehold interest is more-or-less the same as the freehold price) on individual units of the property. Investors or leasehold-occupiers can buy individual long-leaseholds interests one-by-one if necessary. If the residential units are above the ground floor, it is not possible to sell any of the freehold interests in these. A freehold must always be on the ground floor or associated with a property on a ground floor. If an investor purchases any of the long-leasehold interests, they will be obliged to honour any tenancies that might have been agreed prior to their completion.

It’s also important to understand how service charges apply to a property of mixed uses. A service charge is essentially a further charge to the tenant(s) to contribute to the upkeep of common areas such as grounds maintenance or cleaning and decorating of hallways and stairwells. Service charges should be ‘fair and reasonable’ and not produce a profit or a loss for the landlord. For Commercial tenants, The Royal Institute of Chartered Surveyors publish a Code of Practice guide on service charges. The method of dealing with dispute resolution will be stated in the lease. Residential tenancy service charges however, are very strictly regulated. A landlord who doesn’t follow the statutory procedures might find himself limited under law as to how much can be recovered from the tenant at the end of the occupancy.

Tenants should be supplied with a schedule of the previous year’s service costs and justification of the current level of charge. In a mixed use property however, tenants will occupy different sized areas and even use different facilities in the property. For example a Commercial tenant on the ground floor would not be expected to pay for the upkeep of a lift to service the residential units on the floors above. The principle way of deciding who should pay for what, is to consider which property a particular service will benefit. A Commercial tenant should have the opportunity of negotiating the service charge. It is sometimes possible to opt out of the charge for services that are available but will not be used.

Sep 4th, 2011

Finding a Property Development Opportunity (Part 2)

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In the earlier post, I mentioned the 3 most popular places to find opportunities for development. In this post, I look at some less obvious places to look for development opportunities.

1. Local Planning Authority Website.

The property or plot might have been the subject of an unsuccessful planning application in the past, or the application might have been granted but never acted upon. The local planning authority will have a record of all applications regardless of the outcome. If the consent was never acted upon, then it might have expired.

2. Large Scale Residential Property Developers.

Companies such as Barratt and Bryant Homes, always develop large areas of land due to their calculated economies of scale. When development plans are drawn up, small pockets of land are sometimes ignored because they do not ‘fit in’ with the flow of the scheme. These areas are often small enough to fit one or two individual houses onto and might be available to purchase from the developer at a price below market value.

3. Land websites (for example Plotsearch and BM Land).

These are sometimes free to use, and sometimes you need to register. You do tend to get what you pay for on these though. The free sites depend upon a finder’s fee from the vendor. The paid sites will offer you a subscription to a selection of counties in which to base your search. The amount of counties offered will depend upon the subscription fee.

Most of the paid websites will concentrate on plots that already have planning consent (outline or full) in place. These plots can sometimes be as much as 10 times more expensive that if planning permission wasn’t in place.

4. Large Utility Companies.

Not many people would relish the idea of living close to an electricity substation or a railway line. However, large companies that run utility services like the railways and electricity/water companies often have land that was originally owned simply to provide access. For example, an electricity company might own a long stretch of land that was once used for access to a substation or supply. If access is no longer required because of decommissioning, this access area might be surplus to their requirement.

Contact their estates department to enquire after any surplus land. Patience is required to follow this approach because having personally worked in an estates department; I know that it is very important to speak to the right person as others might not be familiar with recent company operational reshuffles.

5. Local Newspapers.

Not an obvious place to look in these days of freely-available information on the internet. The fact remains though, that sometimes the ideal plot of land or house can be found by looking in the local papers. The reason is that it is almost always a quick and cheap way of advertising. For an opportunity to be placed on the main property search sites, an agent often has to be appointed first. The owner might not want this, as a quick sale is sought.

Finding a development opportunity is almost never easy. A great deal of pro-activity is normally required, and let’s face it-if it were easy, everyone would be doing it.

Mar 13th, 2011

Using Gross Development Value to carry out a Property Residual Development Appraisal

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The Residual method of property appraisal (or Hypothetical Development Method) is used to help in assessing whether a property development project is financially viable or not. If a property has development value (it can also be known as ‘latent value’), it means that its expected future value after works exceeds the expenditure.

The first value that must be established is the Gross Development Value (GDV). This is the capital value that the completed property is expected to be worth on the open market when sold to a willing purchaser. The GDV is different to the forecast price, where the developer attempts to predict the value of the property in line with a falling or rising market. This is unsurprisingly quite inaccurate, but it’s a common misjudgement among novice developers. The GDV should always be based upon values available at the time the appraisal is carried out. The GDV should be based upon the most efficient use of the property/plot. If a site is available that can accommodate 4 houses (for example) and only 2 are built, the completed value of the development is not the true GDV.

To establish the GDV, the most accurate method is the comparative method of valuation.

The residual appraisal is a very easy concept to understand, the equation is based upon a very logical approach. It is as follows:

The amount available for land purchase is the absolute maximum that the developer should consider paying. This is because there will be other considerations, such as repayments on the development mortgage, legal fees and Stamp Duty Land Tax (SDLT). Therefore, if the developer can purchase the property for less than his budgeted amount, he will certainly benefit.

Through transposition of the individual components within it, the residual method can be used for 3 main purposes:

1. Calculating the potential profit margin where the GDV, build costs and land/property cost is already known.

2. Finding a maximum value for build costs, where profit, GDV and land value is known.

3. Establishing a maximum price to be paid for the land/property when other values are known.

Build costs are probably one of the trickiest aspects to consider when carrying out a residual appraisal. The easiest way to do this is to apply a rate per sq ft or sq M and multiply it by the expected area of the completed property. So if a property of around 2,000 sq ft is to be developed or built, a rate of £100 per sq ft could be applied. This would produce a build cost of around £200,000. However, a more realistic rate is more likely to be closer to £80 per sq ft (by current standards). This will include fees and a contingency amount. If development work is substantial, then a ‘build cost rate’ can be applied as it will be so similar to a ‘renovation cost rate’.

Finance costs can vary quite considerably, depending on amount borrowed, construction time and rate of interest. As discussed in many other posts, to provide all project funds in the form of equity (money that has not been borrowed) is not a particularly shrewd idea. Likewise, to borrow too much in the form of a loan is not a good idea either.

If the project takes 12 months from initial completion to sale of the property, then that’s 12 months worth of loan repayments that must be included into the associated costs. For a mortgage of £200,000 that can be around £12,000 in total, depending upon the variable mentioned above.

Profit is also a vital aspect of development. Many novice developers calculate their projects the wrong way, they consider the property cost; add the expected build/renovation costs and the remainder once it has sold is profit. This is not the best way to approach your venture, a business needs profit to survive and you need it to invest in your next property project.

An example of a residual appraisal is as follows:

This calculation shows that around £130,000 (to round the figure up) would be around the price you should be buying the undeveloped house at. This does NOT mean that you should start negotiation at this figure, it would be prudent be place in an initial offer comfortably below this price.

To download the very finest guide available on the internet to Assessing Land Value, the Residual Valuation method and Gross Development Value for only £5, follow this link to my ‘Assessing Land Value‘ page.

Mar 8th, 2011

The Comparative Method of Property Valuation

It is essential when planning a property venture that you have an appreciation of what the property will be worth when you have finished it and it is ready to be placed on the market or let to a Tenant. This anticipated future value forms the very foundation of your property project financial planning. The final capital value (the price it would be expected to fetch on the open market to a willing purchaser) is known as the GDV (Gross Development value).

It is an excellent idea to carry out an appraisal of the project prior to committing to purchase. The GDV is the figure that underpins your profit, the amount available for fees and building work and ultimately, the price you should be paying for the undeveloped property.

So how do you produce an accurate GDV figure for your development property? This is where you have to attempt to do a valuers job; you have to place a reasonably accurate figure on your completed property.

All forms of property valuation are based in some way upon the comparative method of valuation. It requires an appreciation of the 2 major factors that property value is dependent upon, Supply and Demand. Unfortunately these are never constant but the valuation has to be based on an identical situation to recent, surrounding property sales. Subsequently the valuation figure has to be manipulated to reflect anticipated market conditions. So if a property is sold for £250,000 one week, then an identical house should sell for the same amount the following week. However, it won’t. This is because market conditions can change quite suddenly, purchasers have differing requirements and considerations, and no two properties are ever absolutely identical.

The comparable method of valuation is only accurate when the following conditions can be met:

The properties are physically similar
The properties are in the same area
The legal interest is the same (freehold or leasehold)
There are many accurate records of similar transactions
The transactions are recent
The market is stable

If these become less ‘perfect’, then the valuation becomes less accurate. An example of comparative valuation is shown below:

Property 1 is a 1920s –built, detached house. It has brick cavity walls with solid ground floor.

The interior dimensions are:-

Lounge 27′ x 10′; Dining 12′ x 13′; Study 12 x 13′; Kitchen 10′ x 9′; Bathroom 6′ x 7′.

Bedroom 1 is 12′ x 11′; Bedroom 2 10′ x 9′; Bedroom 3 10′ x 9′.

The interior and exterior have been very well maintained, it has a brick garage and around 1/8 acre of land.

Property 2 is a detached, Victorian house built around 1880. It has rendered walls, a shingle roof and hollow floors. Internal dimensions are:

Lounge is 12′x10′; Dining 8′ x 10′; Study 12′ x 7′; Kitchen 10′ x 14′.

Bedroom 1 18′ x 14′; Bedroom 2 14′ x 14′; Bedroom 3 12′ x 10′; Bathroom 9’ x 7′

The first floor requires updating, but it has a new kitchen fitted. The exterior requires some maintenance and it has a wooden garage and around 1/3 acre of land.

Sold 1 year ago for £250,000

Property 3 is a newly-built estate type house. It has a brick outer skin and concrete suspended floor. Internal dimensions are:

Lounge 12′ x 14′; Dining 12′ x 10′; Family Rm 14′ x 10′; Cloakroom 10′ x 11′

Bedroom 1 12’ x 10′; Bedroom 2 12’ x 10′; Bedroom 3 12′ x 10′; Bathroom 8’ x 8′

The interior and exterior are finished and maintained to a high standard. It has a brick built garage and around 1/3 acre of land.

Sold 18 months ago for £230,000

To establish a market value for Property A, a consideration of the sale prices of Properties B & C is necessary.

Property A must first be ‘adjusted’ to allow a proper comparison between properties. This is done by adding particular values to the sale price of property C ( estate-type houses are typically less sought-after than modern, estate type properties) and subtracting from property B; this is because Property B would be expected to fetch a higher price on the open market due to the desirability of its period Victorian features.

The exact values to be added or subtracted would be judged by the valuer himself, but a general guide might be:

Subtract £20,000 from the sale price of Property B because Victorian era houses are in higher demand than 1920s ones.
Subtract a further £15,000 from the value of Property B because Property A has a fairly small garden.
Adding £10,000 because Property A has been maintained to an excellent standard and can be considered to not require updating by the new purchaser.

Using the guideline of Property B, this brings the value of Property A out at £225,000 if it had been sold around 18 months ago. If it can be established that house prices have increased in the approximate area by 6% per year, then the value of £225,000 can be increased by 9% to bring it into line with current values. This produces a figure of £245,250 or £245,000.

So property A might be expected to be placed on the market at around £245,000. However, bear in mind that this might a ‘strategic’ price. It is comfortably below the (current) SDLT threshold of £250,000, and also priced under the vast majority of properties in this price bracket that always seem to be placed on the market at £249,950. The vendor would be sensible to understand that this is merely a starting price and might end up bearing little relation to the eventual selling price. The established final value of the post-work project is the GDV.

Dec 3rd, 2010

Finding a Good Builder

Finding the right builder is one of the most important aspects of any development project. People you might speak to seem to have no end of horror stories to put you off the whole idea of property development.

Make no mistake however, there is potential to completely ruin a project if the builder turns out to be totally incompetent. Anecdotal evidence of this is really not difficult to find. However, it really isn’t that difficult to find a builder who will accommodate your plans.

The majority of novice property developers carry out at least some of the work themselves. The main reasons for this are:

1. To save money. All work done by you is free; or is it? There is what is known in economics as an ‘opportunity cost’. This means that if you spend most of your evenings and weekends renovating the property, what are you missing out on? It’s likely to be opportunities to spend time with family and relax. This is the cost.

I can also assure you from experience that working a full time job and spending all your free time working on a renovation is a very effective way of becoming stressed, fatigued and highly inclined to look for a convenient way out of the project before you complete your goal. Think very carefully, and be realistic about what you can achieve in the timescale you have planned.

2. To maintain an element of control over the project. Again, do not underestimate the amount of stress generated by a renovation. This can be down to deliveries not turning up, the wrong item being delivered, builders not understanding your requests, unforeseen problems etc. If you are involved with the project on a daily basis, this stress can be reduced as the problems are less likely to all come at once. However, this brings us back to the above aspect of spending all your non-work time at a building site.

Project management is a good way of maintaining control over your development. This does not all need to be carried out on site so it is more suitable for novice developers who also have ‘normal’ jobs. Builders often have the facility of bringing in their own Project Manager. You will need to carefully consider the level of free reign that you are willing to grant them though; you don’t want them ringing you dozens of times a day for approval, and likewise you don’t want to lose touch with how it’s all going.

It is said often, that the best way of finding a good builder is through word-of-mouth. This is very true, however what happens if an abundance of this information is not available? To start with, a simple look through the Yellow Pages or Yell.com will produce some results of local builder’s availability. If there’s an advert or website, simply look for the symbol of the ‘Federation of Master Builders’, in fact the FMB run a website – www.findabuilder.co.uk. This site lists individual trades as well as general builders and particular specialisms too, such as agricultural buildings, loft conversions or groundworks. The site also has a page for free contracts that are recommended to be used with their members.

Other sites that run a similar service are:

1. www.mybuilder.com.

2. www.goodbuilderguide.co.uk

3. www.findpolishbuilder.com

4. www.findatrade.com

These sites are an excellent idea, as they list feedback for individual builders and even photos of work carried out by them. However, I strongly recommend doing your homework on any builders found on these websites. It will not come as a surprise to mention that these websites do not offer any form of gaurantee whatsoever for the builders listed.

I would also like to add that it’s never a good idea to employ any builders that call house-to-house. It’s often difficult to find any background information on these people and let’s face it, if they’re any good, why are they calling at houses rather than working? I am also ‘reassured’ by the builder turning up in a van that’s in good condition and with professional signs (for the right company) on the side. It just gives the impression of a good, healthy company who are less likely to disappear with your money before completing the work.

The builder should see the property as soon as possible to get an idea of the work to be carried out (if you use one of the above websites, the builder should have supplied an initial estimate based upon the scope of the work initially described) he will no doubt want to confirm this work by looking at the development project itself.

The builder you use should be covered by Public Liability insurance (this is quite likely to be in place if a reputable builder is found, but definitely check). Many builders can offer a NRWB (National Register of Warranted Builders) Warranty; this is another excellent indication that they are not cowboys. Any time schedule that you are keen to follow, should be discussed and included within the contract.

The scope of the work is one of the most common sources of disagreements between builders and their clients. The problem is not usually the initially specified work, it’s the little extra bits that you might believe shouldn’t amount to much, but the builder thinks otherwise. It is very important to regularly discuss with your builder the progress of the project. Unless you are attending the site every day, regular phone calls are important. Better still, make a point of visiting the site every couple of days or so; this might contradict the advice regarding not spending all your free-time on site, but the visit need only be brief. The point is that it is very important to strike up a good working relationship with your builder.

To ensure that the Scope of Work that you provide for the builder is the same for each one you speak to, write it out and quote it word-for-word each time you ask for a quote. You should also remember that a quote is not an agreed cost for the work, it is just a fairly rough estimation. The quote should also include VAT. If you’re offered a discount for cash, then alarms bells should be ringing in your head. That’s not to say that anyone who offers this is a cowboy, but if their financial turnover is above the HMRC threshold they’re breaking the law.

A fixed-cost arrangement is a very sensible one to ask for. This obviously enables you to draw up a budget with a reasonably accurate figure. However contrary to some popular belief, a fixed-price contract is not always 100% guaranteed to be particularly ‘fixed’. The conditions will be specified within the contract, but any work beyond the scope of the original specification will almost certainly cost extra. The method of pricing this extra work should also be stated in the contract. The contract should really be downloaded from the Joint Contracts Tribunal (JCT). The JCT are an organisation who offer standardised contracts for the construction industry. Their ‘Homeowner‘ section provides contracts for building work that are really easy to complete. I highly recommend the use of one of these!

Nov 2nd, 2010

Why unfashionable post-war properties should not be overlooked.

Much of being a successful property speculator is establishing a target market and tailoring the investment or development property to appeal to it. Unlike other walks of life, fashion in property tends to come and go quite slowly. Period properties remain very popular and no doubt will remain so for the foreseeable future. Meanwhile, many properties built in the post-war years were not particularly attractively styled (although generally they were actually built to a fairly high standard). This lack of popularity often means that in comparison to period properties, these houses are undervalued.

These unfashionable houses tend to be overlooked by many potential developers and investors, as they believe they are uninspiring and will not be occupied or sold easily. This need not be the case. The appearance of many post-war properties has been changed substantially to incredible effect.

Consider the following photos:

“The owners of this house wanted to add more space and improve its exterior. After an Erincastle Design Consultation, the front garden was improved, the front door and windows were restored to their original design and an extra floor was added to accommodate a new luxury Master en suite. The overall effect is obviously a breathtaking improvement, increasing the desirability and market value of the house.”

Pictures and text used under permission of Erincastle Exterior Design; www.erincastle.co.uk

This amazing transformation was created by exterior design consultants Erincastle. It’s not difficult to see that this programme of transformation would certainly add value to any investment or development project and therefore an opportunity to increase profit. Many residential developers believe that the only way to change the appearance of a property is to repaint the exterior and tidy up the garden. It is possible to achieve so much more.

The idea that a house considered by many to be ugly, can be transformed into one with character means that for now, there are more opportunities available than many thought. The more work carried out on a development property, the greater the opportunity to make a profit. Taking the time to make substantial, tasteful changes to the exterior is certainly an area that is likely to pay dividends upon valuation for resale or letting. However, the alterations carried out should not be too expensive. The cost of the works should still be substantially less than the expected increase in the property value.

Obviously if the property is within a row of semi-detached or terraced houses, a dramatic change to the exterior is likely to look rather odd and create too much of a contrast. Therefore when choosing a development property, your intended work should be taken into consideration. The building’s original layout, profile and shape will influence the finished item. A great deal of the property’s appearance can be changed; such as adding extensions, demolishing parts and altering roof lines.

Popular ways of changing the appearance of a modern property is by adding additional external finishes to the walls, such as replica wooden cladding to create the ‘New England’ look. If windows are to be changed, this also provides an opportunity to change the property theme, such as sash windows to give a Victorian or Georgian look. One of the most substantial changes that can be made is a roof alteration. This is probably the most expensive of all cosmetic works but can achieve the most substantial change of look. If much of these things need changing as part of the intended development work, then the additional cost involved in changing the property ‘look’ might not amount to a great deal more.

It should be pointed out that under the Town & Country Planning Act 1990, changing the external appearance of a property does correspond to the legal definition of ‘development’. Depending upon the amount of work you intend to carry out, planning consent will almost certainly be required.

For new-build projects, you might feel that options are limited in finding designs that don’t look too contrived. Erincastle also have experience in creating designs that genuinely look like listed buildings:

“TOWER HOUSE ” A NEW BUILD BESPOKE HOUSE DESIGNED BY STEVEN JAMES TYLER, COPYRIGHT ERINCASTLE 2006.

“HILL HOUSE ” – A NEW BUILD BESPOKE HOUSE DESIGNED FOR AN UNUSUAL HILLSIDE PLOT BY STEVEN JAMES TYLER, COPYRIGHT ERINCASTLE 2007

Note: If the property you intend to carry out these works to is listed, or in a conservation area; it is highly unlikely that you will be granted permission to change the look of the property. Houses that fall into these categories might not necessarily be full of charm, but unfortunately they cannot be changed without the express permission of the local planning authority.

For further information on Erincastle designs, visit their website: www.erincastle.co.uk

Sep 6th, 2010