Property remains a highly attractive asset class in which to invest. The demand for the product is virtually guaranteed: we’re busy making new people and they’re all going to want somewhere to live, and no one is making any more land (well, maybe the Dutch and the Chinese, but you know what I mean). We’ve seen house prices soar recently, and they’re still rising despite a European war, rampant inflation, and a cost-of-living crisis.
But the shine that was once on buy-to-let has faded.
Multiple tax hikes and regulation changes have seen many landlords throw in the towel. Those that remain face an increasingly uncertain future. The problem that every landlord faces is that they are the perfect target from a taxation point of view. Tax them hard, and not only will they be unlikely to slip below the breadline, but they’re also unlikely to vote any differently. Nor do they evoke much in the way of public sympathy, and at only 2.5 million strong, they are a minority group with little political clout. In short, no one minds if landlords get taxed because they can probably afford it.
So, if you don’t want to get out of property, but you’ve decided that buy-to-let is no longer where you want to be, what should your strategy be? Where should you be looking?
Small-scale property development
Now, historically, property development has had something of a PR problem when compared to buy-to-let investing. Isn’t property development more like a job than an investment strategy? Isn’t it quite complicated and possibly rather risky?
More and more landlords are discovering that the ability to convert small commercial buildings into residential flats can be highly lucrative and allow them to build their portfolios quickly.
Despite being small in development terms, smaller development projects still produce significant lumps of cash. The relatively simple conversion of retail uppers into flats or offices into apartments will typically produce a healthy six-figure profit over a relatively short timeframe, say 18-24 months.
Compared to the more glacial growth of buy-to-let equity, this regular influx of cash allows landlords to build their portfolios far more quickly than simply waiting for their existing properties to increase in value. But surely development is more complex than doing up a buy-to-let? In many respects, it is, but not usually for the developer.
You see, when most landlords refurbish a buy-to-let property before renting it out, they will typically hire a jobbing builder and will oversee the works personally, effectively becoming their own project manager. But with a small commercial conversion project, not only will they be able to afford a main contractor, but they can also afford to hire a professional project manager to oversee the project for them. Ironically, the developer makes more money by doing less work, and this ‘hands-off’ approach makes small-scale development a big attraction for people looking for a more passive wealth creation model.
Look at the numbers
So, exactly how big are these small-scale projects? There’s no definitive scale, however, as a ballpark, you’d typically be looking at schemes that would have a gross development value of between £500k and £2.5m and which would produce target profits of £100k to £500k.
Now, this raises an obvious question: surely you will need lots of money to tackle one of these projects? But here lies another common misconception. You see, a development project will often require you to invest LESS of your own cash than a buy-to-let property will, and by some margin.
There are two main reasons for this: firstly, the commercial lenders who finance developments are happy to lend up to 70% of the purchase price and 100% of the development costs. This leaves you to find a circa 30% deposit, which is not a million miles away from a typical buy-to-let deposit. However, many lenders will allow you to borrow the bulk of your deposit from private investors, rather than funding it entirely yourself.
I know some savvy buy-to-let landlords also look to borrow their deposits from private investors. They then buy below market value and refinance, which allows them to repay the borrowed deposit shortly after the sale. But in the current market buying rental properties below market value is increasingly challenging, and as a result, the majority of buy-to-let deposits are likely to be investors’ own cash. And why would a private investor lend you any of their money for your development project? Because the going interest rate for private investment in development is a rather impressive 8-10% per annum, and there aren’t too many places where investors can get that sort of return.
The opportunities are there
While the government has been busy squeezing landlords’ pips, they’ve gone out of their way to encourage people to become developers. Whitehall has recognised the need to repurpose the glut of unused brownfield sites across the country as this would create up to 1.3 million new homes. And unlike building on green belt land, converting existing buildings is usually a vote-winner rather than a vote-loser.
So, they’ve recently introduced a game-changing swathe of permitted development rights that allow developers to change the use of a broad range of commercial buildings to residential WITHOUT the need for full planning permission. And if you’ve ever noticed the number of vacant or run-down retail or commercial properties in your local town, you’ll be all too aware of the scale of the opportunity.
But surely the larger established developers would take these on? Unfortunately for the government, they won’t. Not only are the big players not interested in a few hundred thousand in profit, their model typically involves building brand new homes on big empty fields using existing designs. Creating one-off solutions to fit within a small existing building is not their bag at all. Yet it’s perfect for small-scale developers who know where the opportunity is.
*Ritchie Clapson CEng MIStructE is the co-founder of propertyCEO and co-author of the new book “Guide to Small-Scale Property Development”