Redeveloping Investment Property vs Purchasing Another

About 8 years ago I brought a 3br house as an investment property in Port Macquarie. It's all paid off now, worth about $700k, and I've got another $200k in savings. I'm considering options for my next steps:

Option 1: I knock down the house and spend $1 million to put three townhouses on the land (2x3br, 1x2br). I spoke to my mortgage broker and the bank would likely lend the full amount, as the development would be worth $1.4 million at the end. The goal would be to hold all into retirement as a solid cash flow (I'm 33 y/o).

Option 2: I leverage the equity and use my cash to buy other properties in Port.

I lean towards 1 as like the idea of a good cash flow in retirement. But my concern is that it may tie up a lot of my borrowing power for the short term.

What do you think is the best use of my capital?

Thanks.

 

Option 1: You want to spend $1m to increase the value of the property by $700k?

Even if the numbers made sense, I would be concerned about the current issues in the construction industry. If you don't need to take this risk at the moment (and have no experience developing), it might be better to wait and see what happens. There are much easier ways to get multiple sources of recurring income.

Option 2: If you are going to buy other investment properties, would you consider spreading your exposure by looking in other areas or are you committed to PM?

 

Thanks Chris, when you phrase Option 1 that way it doesn't look great. I prefer Port as I'm nearby. I've been hands on with the maintenance of my current one. Having grown up there I know the area and have family who I can call in a pinch.

 

I was going to reply exactly this but thought the final val of 1.4m was a typo as it just don't make any sense, in any circumstances.
a 2.4m final val would be about right to take on the risk involved and the extra cash injection required.

 

Also regarding development to hold, we've developed 2 townhouse complexes in Brisbane and a duplex in Sydney, all still held for 10+ years.
In all cases, it would have been better to just hold the properties undeveloped and continue to buy more land rich properties.
It would be a different story if developing to sell.

 

Thanks Chris. Out of interest, what kind of strategy could you use to get a higher valuation? Port is a regional town. So a 3 bed townhouse would go for ~$500k, and a 2 bed for $400k - that was the $1.4m. To get up towards $2.4m valuation would require the build to be done in a large city?

 

Buy developable land at a price where building on it will make a profit. It's not the case for most land at typical prices.

Not just any profit either, as you should be aiming for a certain amount to take into account the risk, costs, taxes etc.

 

Most small scale developers I've dealt with want to buy property where the majority of the value is in the land and where the existing home doesn't make good use of that land. The best use of the land will be determined by the zoning restrictions of what the council will allow to be built on the property, land size, shape, access, prices & the demand in the area. Properties on main roads or near train stations are often zoned for higher density development.

It is usually preferable if the existing house is liveable, so you can rent it out (or live in it) while plans & permits are being organised. Some developers target properties where the existing house is located far enough from the fence, so that they can keep the existing house and build townhouses at the rear.

 

You have $700k equity in the current property.

You want to reduce that to $400k?? By taking additional risk of building?

It sounds downright silly proposition.

Your build cost is $1m (not inc bank funding costs) and you end up with $1.4m of value...

You would need each TH to sell for minimum $700k+ to justify spending $1m in build cost where you will end up with more equity (approx $1m) versus $700k which you hold already.

Development is done to create extra equity/ value - not to obliterate what is already there.

I would 100% just buy another property and leave both of them for another property cycle and then develop.

 

100% agree with this.

A lot of people keep tinkering with development and lose a lot of money. The numbers need to be hard before you develop.

The other option is if you want something new and believe the property has been maximized its return...sell and invest in better assets which can grow even more.

Issue here is most people will never do this and requires a significant mindset change. Easier said than done.