Subdivide and sell land vs build. Thoughts?

Discussion in 'Investment Strategy' started by PerthieNewbie, 15th Jan, 2019.

Join Australia's most dynamic and respected property investment community
  1. PerthieNewbie

    PerthieNewbie Member

    Joined:
    10th Jul, 2018
    Posts:
    24
    Location:
    Perth
    Hello

    I have a property in Koondoola (bought for $280k, can be subdivided into 3 lots) which is currently rented at $270 per week.

    Right now I'm deciding whether to subdivide and sell land or to build.

    This is my first project, and I'm just weighing up different options. Interested to hear of different opinions or advice anyone has to give.

    My research and strategy is below -

    Sell land option -
    Subdivide the back, use the profits to put towards the current mortgage and keep some to put towards a deposit for a another property and subdivision.

    Potential sale of land based on recent Koondoola land sale - $160k

    Subdivision costs - approx $25-30k (based on other subdivision on same street)
    Agent fees - approx $3k
    stamp duty and fees - approx $5k
    Other misc costs - $10k

    Total approx profit before tax- $112,000 (not taking into account land cost etc)

    pro - quicker, less overextending finances
    con - harder to sell

    Subdivide and build option (to keep as rental) -

    Build and subdivision costs - approx $190-200k (quote from builder)

    Once completed, rent for around $300 (depending on market at that time), approx rental yield of 5.3%. (250x52 ÷ half of purchase price as estimate plus build cost).

    Also rent out the older front house for reduced rent of $250 as the backyard will now be considerably smaller (also depending on market), but that gives rental yield of approx 9%. (250x52 ÷ half of purchase price as estimate).

    I roughly estimate based on current comp, that both the new house and old house would be around $555,000 (conservative estimations of $250k for old and $300k for new). And then, use the equity to buy another property and start another project.

    pro - additional investment property, easier to sell if I had to
    con - over extend finances, longer

    Thanks for reading!
    Newbie
     
  2. Archaon

    Archaon Well-Known Member

    Joined:
    20th Mar, 2017
    Posts:
    555
    Location:
    Newcastle
    You will need to account for GST on the sale of land as it's classified as trading stock (I think, not 100% sure).

    If you aren't operating within a company for the sale of land you will have to attribute any profits directly to your assessable income, which will possibly mean losing upto 45% of any profit to tax.
    E.g:
    90k income = 21k tax
    + land sale 90k profit
    180k income = 54k tax
    1/3rd profits gone instantly.

    If you build on the land, and then rent that property out, your cost base is reset at the point it becomes income producing.
    Are these turn-key completed prices? What are your estimates once the house is ready to rent out? What have similiar properties in the area sold for?

    Seek specific tax advice.
     
    Last edited: 15th Jan, 2019
    PerthieNewbie likes this.
  3. thatbum

    thatbum Well-Known Member

    Joined:
    18th Jun, 2015
    Posts:
    2,275
    Location:
    Perth, WA
    Are you sure the numbers are even worth it? I wouldn't be recommending something like this as a first project - small lots or even small villas in Koondoola do not sound like something that would be easier to offload as an end product.
     
  4. PerthieNewbie

    PerthieNewbie Member

    Joined:
    10th Jul, 2018
    Posts:
    24
    Location:
    Perth

    Thanks for your reply, Archaon. Won't I be able to use the 50% CGT discount?
     
  5. JohnPropChat

    JohnPropChat Well-Known Member

    Joined:
    10th Sep, 2015
    Posts:
    1,244
    Location:
    Perth
    That is a 5% yield. Don't know about the LVR but is it self paying? If so leave it as is and use the money for the next purchase (something better this time).
     
  6. Archaon

    Archaon Well-Known Member

    Joined:
    20th Mar, 2017
    Posts:
    555
    Location:
    Newcastle
    Subdividing to sell is trading stock I think, and therefore not eligible as a capital sale, so it becomes income and not Capital Gains Tax.

    Specific tax advice from an accountant will give you a lot more info than I am able to.

    Regards,
    Arc
     
  7. PerthieNewbie

    PerthieNewbie Member

    Joined:
    10th Jul, 2018
    Posts:
    24
    Location:
    Perth
    Yeah, self paying. But why is it a bad idea to even subdivide and use that money to lower the mortgage even more? or to reinvest or even just use the equity it will produce?
     
  8. PerthieNewbie

    PerthieNewbie Member

    Joined:
    10th Jul, 2018
    Posts:
    24
    Location:
    Perth
    There were a few that sold last year through house and land, so my plan was to do the first stage and put it on market, and only do the rest of the subdivision when it's sold (that's how the other comparable in the area were sold). So there's no immediate outlay.
     
  9. JohnPropChat

    JohnPropChat Well-Known Member

    Joined:
    10th Sep, 2015
    Posts:
    1,244
    Location:
    Perth
    Nothing wrong. Maybe start with a chat to the council about the possibility of a retain-and-subdivide. Followed by a chat with a subdivision company to confirm. Your profit number of $112k is incorrect as you are also loosing land. See if the local council has any other contribution costs. Once you have accurate numbers, re-assess. A lot depends on the $160k sale price you quoted. Also get tax advice.

    In this market, accumulation is a better bet than building but every strategy is different.
     
    PerthieNewbie and jim1964 like this.
  10. PerthieNewbie

    PerthieNewbie Member

    Joined:
    10th Jul, 2018
    Posts:
    24
    Location:
    Perth
    Already done both, and all good. :) No developer contributions either.

    True... but the way I see it, I'll still have the original property on a decent size land that I can rent out which will still pay it self and more if i can reduce the mortgage. Then in the future i can demolish and build two more in future where I'll have a higher LVR, and if the market is looking better will be able to sell for more, especially since the suburb is undergoing rezoning and gentrification now....what do you think?

    But I see your point about accumulation in this market, that has got me thinking and I'll reach out to my finance broker to see if I can get an investment loan while doing this project (as this one is a time consuming one). Thanks for the advice.
     
    JohnPropChat likes this.
  11. Shogun

    Shogun Well-Known Member

    Joined:
    26th May, 2018
    Posts:
    330
    Location:
    Perth
    I have spent a little time finding end product on realestate.com then searching for building permits/DA for some of the costs. I have found quite a lot of developers selling at what I calculate to be at a lose.
    You might make a little money selling some land however any future buyers of large blocks will not look at land you have retained. From what I see very easy to lose money if you build at the moment.
     
    PerthieNewbie and JohnPropChat like this.
  12. JohnPropChat

    JohnPropChat Well-Known Member

    Joined:
    10th Sep, 2015
    Posts:
    1,244
    Location:
    Perth
    Once you have more concrete numbers (and tax advice). Take out 20% of the final number for risk margin and if the numbers still stack up then by all means go for it.

    Be careful not to cross-collateralize when you split the land or else Bank may not want to release all the funds.
     
  13. PerthieNewbie

    PerthieNewbie Member

    Joined:
    10th Jul, 2018
    Posts:
    24
    Location:
    Perth
    I just sent a few enquiries to property tax agents. :)

    "Be careful not to cross-collateralize when you split the land or else Bank may not want to release all the funds" - Sorry, what do you by this part?
     
  14. PerthieNewbie

    PerthieNewbie Member

    Joined:
    10th Jul, 2018
    Posts:
    24
    Location:
    Perth
    Hi Shogun

    if I build, I'd want to hold it and just rent it out. So both original and new house will effectively pay for itself, but then I'll have the additional extra equity available to start another project...that's what i was thinking...
     
  15. Shogun

    Shogun Well-Known Member

    Joined:
    26th May, 2018
    Posts:
    330
    Location:
    Perth
    Search for "development" for some thoughts on doing it and costs.
    Here is a thread where I mused the idea WA - Would this development have made a profit?

    My thinking is a 750m2 block might be attractive to a future buyer.
    If you subdivide trying to sell a 500m2 block in the future might/will have a reduced number of buyers.
    From what I see there are people with lots of money developing and losing money.
     
  16. Erica

    Erica Well-Known Member

    Joined:
    19th Jun, 2015
    Posts:
    141
    Location:
    Adelaide
    Incorrect. I have sold 2 vacant blocks of land (which I subdivided them off of the back and retained the original front property). Goods and services tax is not applied as vacant land is not a classed as a new product or service.

    NO for the vacant land - capital gains tax is applied at your full marginal income tax rate. 50% discount does NOT apply (even if you've held the original parcel of land for over 12 mths) -as at is not classed as an investment property (ie. there is no house on the land with which to produce income from).

    Yes for the original house (all be it now on a smaller parcel of land), the 50% CGT discount does apply, however only to the correct base cost split (my first project the base cost was split 33.33% vacant land, 66.66% original house on now smaller allotment) but this 33/66 split may not hold true for all examples, ie, if you renovate the existing house it gets harder to work out base cost split)... gets complicated and you will need a good acountant.



    Disclaimer- I'm not an accountant. Myown examples only, not advice!
     
  17. Erica

    Erica Well-Known Member

    Joined:
    19th Jun, 2015
    Posts:
    141
    Location:
    Adelaide
    I'm having a boring afternoon so will have a crack at your calculations to see if you've missed anything (disclaimer- not advice! my opinion only, and 3 subdivisions does not make me an expert).

    $280,000 purchase price
    $15,000 purchasing costs (stamp duty / conveyancer/ etc etc)
    $0 holding costs - at that rent it shoud be about cash flow neutral yeah?? (I'm making big assumptions that you've secured a good interest rate for your loan, haven't had any extended periods of vacancy and no major maintenance dramas...).
    $30,000 subdivision costs 1 into 2 (retaining the front house).
    $5,000 to fence off the new allotment (another massive assumption here- are there any structures that need to be modified to get your subdivision approved by council? for example my last subdivision I needed to knock down an old carport and shed and clear lots of trees to get the new driveway past the existing house (hammerhead style), then had to construct a new carport on the other side for the existing house- which was a council requirement, this stuff starts adding up $$$$ quickly.

    So about $330,000 total outlay to achieve vacant land worth $160,000 + retain the old house on a smaller block now worth $250,000 (based on your valuations- I know nothing about Koondoola).
    $410,000 combined end values- $330,000 total outlay = $80,000 on paper gain (24% return on your total investment).

    To me these numbers look ok, but many things can reduce your return very quickly:
    1. not accurately calculating your end values (with the last allotment of land, I had to drop the price by $15k off my assumed value to get it sold).
    2. not accurately calcultating your capital works costs (those are the things you need to do to the land to get the subdivision approved by council- capital works on my last subdivision added $13,000 to the total outlay).

    Small developments like this can have large risk but also potential for large reward.

    Hope this (general only) info helps.
     
  18. Archaon

    Archaon Well-Known Member

    Joined:
    20th Mar, 2017
    Posts:
    555
    Location:
    Newcastle
    I think this will be determined by the ATO if they deem that a business activity occurred, if the intention was to subdivide and sell the land for a profit then GST can apply, Tax advice is highly suggested.
     
  19. Terry_w

    Terry_w Mortgage broker licenced 4 tax/legal advice Business Member

    Joined:
    18th Jun, 2015
    Posts:
    19,748
    Location:
    Remote
    As a tax lawyer I must disagree your comments Erica.
     
  20. Perthguy

    Perthguy Well-Known Member

    Joined:
    23rd Jun, 2015
    Posts:
    11,084
    Location:
    Perth
    ATO says However, when land transactions are undertaken as part of a business activity, sale proceeds may be considered ordinary income and subject to GST.

    Land - vacant land and subdividing

    Competent legal and tax advice is essential for anyone planning to create and sell vacant land