Joint venture with developer

After looking for few options which provides high returns >15% pa with low capital, I am exploring joint venture investment on new land release.
I have Capital of $50k and further monthly investment of potential of $3k

More specifically I am looking at New land development by developers which will be released after few years. One of them is in Melbourne, Tarneit/Rockbank. Initial investment of $30k and monthly payment of $3k. At the end of 4 years land of 300sqm will be transferred. As the ongoing rate is $300k, this is approx $120k discount (excluding the interest return and compounding for a sec).

I find this option good as it will help me invest monthly and will provide a land at the end of 4 years where I can easily build IP.

I know the developer bankruptcy risk etc, however unless the developer runs away, I am unable to see risk. Isnt this a good option for someone looking above 15%return and regular investment into real estate.

 

Almost sounds too good to be true doesnt it.

30 plus 3 a month isnt much. Did the developer run out of friends who want that sort of riskless return?

 

So how is this more than 15% pa returns exactly?

 

Similar land is currently valued at $300k and estimated min $350k at end of 4th year. So if you look at the end of 4th year you get a land valued $350k for $174k, the return is higher than 15%pa.

 

Apparently there are many offers like this in Victoria in land development. I have heard of such offers only in apartment construction in NSW which has higher risk thank land development.

 

What are the risks here?

 

That's my question too. The fund is not in an escrow account which means if the developer uses and goes bankrupt, investors cannot recover. Second is if the land purchase/development is not approved by Council, then the funds will be returned without any return, third if there is a huge cost of development, this will be passed onto the investors as an additional development cost. I am only concerned about the bankruptcy risk which is highly unlikely as this is only land and not multi story apartment construction. Does anyone here who have invested in similar project like to share some experience. Thanks

 

If the development is not approved they return your money. So why do they need it if theyre not using it? How are they paying the bills, interest, lawyers? As you said the money is not in a trust account.

Have you asked, if this is such low risk, why they cant find someone with money to take 100 lots? Melb has peaked in the current cycle. What happens to new land? It gets hit hardest. How sure are you that in four years new land will be worth the same as now?

Dont ignore the risks just because you want to do something. In a downturn, waiting and saving might be the best strategy.

 

They go into liquidation - Who owns it ? Seems like you are going to fall for scam 101. The unsecured creditor has 100% risk, no capital or income return and nothing at all to show for it apart from very costly legals.

HEAPS of land developers cant count let alone finance and complete a land dev fast. They rack up council debts (s94 has to be paid up front), land tax debts and bank debts. And ATO often gets in on the act as puts a hex on the title. Alongside the mortgage with bank. Liquidation ?

 

Thanks for your input. Yes there is a liquidation or bankruptcy risk. But that is there in every business venture or investment except keeping at 1%interest rate in Commonwealth Bank. The question should be how much is the bankruptcy probability.

If the Melbourne property market stabilizez and doesn't go spiraling down, I don't think there is bankruptcy risk. When the developer has got 150 lots and all is sold in advance through this scheme, I don't see liquidity risk. The developer is already getting approx 150%of costs and he is walking away with his 50%margin. The buyers are still getting a better deal than provided by stockland and lendlease.
If you leave scare mongering, in my opinion this investment opportunity is balanced with risk and return.

 

I seen a developer do a JV with a client who lost $1mil when the project failed.

 

I wouldn't classify this as a JV. This is more of an investment into a speculative deal.

Risks/cons
- developer covers their butt with sunset clauses in the contract (like most do with OTP) and potentially you lose your block of land if it exceeds the sunset clause
- developer has the land on options contracts which fall over
- developer encounters difficulting getting rezoning/subdivision permission from govt/local government. Project falls over
- developer miscalculates costs of subdivision/civil works and goes bust
- developer doesn't get enough finance to do the subdivision and is unable to continue with the project
- your money is tied up to the project and you might have made more money using it somewhere else = opportunity cost
- changes to various government/tax policies may make your investment unable to be offset against your income (ie negative gear) until it's built or potentially never depending on future policy. See changes surrounding Steele's Law (intent to be an IP) and federal potential changes to negative gearing.
- how do you control which block of land you get? Will it be that awkward shaped block, next to the ugly drainage area with a power substation on the other side?

Pros
- get in at ground level for a subdivision and potentially get a block of land at wholesale rate

Personally I can tell you that I am involved in a subdivision which is already 2 years behind schedule. It has taken a lot longer to get through local council and state govt than initially thought.

 

Hi Tiger,

Your comments are very insightful than most other commentors here who peddle their one off examples and scare mongering without sharing any experience.

Yes, I have considered most of what you mention but I think the last part -project delays is the most critical.

Regarding the JV, they do provide a deed of JV and identify land title and have already done subdivision maps and I will be selecting a lot. So in the deed there is a "nominated lot number". And the deed provides me "an option to purchase the lot". It also has an associated contract of sale. See below extract -
"Simultaneous with the execution of this Deed, the Contributor will enter into a
Contract of Sale (as Purchaser under the Contract of Sale) for the purchase of the Nominated Lot which will be deemed a valid enforceable Contract of Sale upon the Contributor exercising the herein option to purchase the Nominated Lot."

Almost 90%of the lots are booked that means I am not foreseeing liquidity risks.
I have small concern regarding fully gearing the IP to claim maximum interest deduction. My concern is if I pay $150k for a lot and build with $250k, I will not be able to claim interest expenses on $150k out of total $400k cost and get deduction only for $250k. If I had done outright buy at 80%LVR of $400k for another IP, I would have got interest deduction on $320k. This matters a lot in the long term and even if negative gearing is removed by Labor, it will be a factor, it's a opportunity loss of $3500 every year.(And before anyone else butts in and says speak to your tax advisor, I am accountant and I do my own returns).

 

Just so a no jv experience amateur understands.

You pay x for an option to buy a lot from a developer. The developer takes the money to subdivide, put in sewerage and whatever. Most likely the developer takes on some debt to do this as well.

What are the risks? Costs overrun. Takes longer to do than expected, costs more. The option fee isnt enough to cover costs. Market falls and land usually gets hit hardest.

Amateur doesnt understand what the liquidity risk is, but see plenty of other risks. A lot depends on the expertise of the developer, and the market cycle.

 

Why do you think would this be the case?

 

Hi Terry, Because ATO doesnot allow interest deduction on your own money and allows on borrowed money. $150k is my own money here. $30k initial deposit and remaining monthly instalment that I would pay out of my income to fund the JV. Apologies if I was not clear.

Do you have any source for that assertion? Or just peddling some thoughts?
And to run down some one for still being amateur is not a good forum etiquette.

 

But are you purchasing from the same entity?
If you are why not borrow the money to make contributions?

 

Would a bank even consider lending against such a deal? I wouldn't have thought so?

 

No they wouldn't. But that doesn't mean you cannot borrow to acquire it!

 

Ah true, they could use something else as security. Gotcha.