Lessons from Top Financial Traders for Property Developers – Part 1

Lessons from Top Financial Traders for Property Developers – Part 1

Property Development is not for the faint hearted

We all know property development is not for everyone. Your resources are always under pressure to deal with competing demands. Few career or business choices challenge you like being a developer.
One similar profession is that of a professional financial trader. Like property developers, financial traders operate with imperfect information and base their decisions on the skills, expertise and intuitions built up over a career.
Professional Trader & retired US Army Colonel Ken Long was one of the first officers on the ground in Operation Desert Storm in 1991. He has taught decision making and military strategy at West Point (America’s #1 Army Officer Academy) so he knows a few things about operating in situations of uncertainty.
15yrs ago I heard a radio interview with Ken Long….. This one quote from Ken has never left my mind:

“I have been shot at for my country, and trading is every bit as stressful as combat and must be processed psychologically the same way.”

Property Developers can develop Post Traumatic Stress Disorder

During the October 1929 market crash on Wall St that started the Great Deprecation, history verified that at least 8 market participants chose to jump off skyscrapers rather than face bankruptcy. They were past their psychological breaking point.
In 2009, I saw dozens of Property Developers worth +$10m lose everything.
Some developers I knew chose to end their lives whilst still being worth a few million.
Post the trauma of losing most of their nett worth, they were past their “short term” psychological breaking point.
Research is now confirming that continuous or isolated events of trauma (ie domestic violence or vehicle accidents) can permanently disable an individual.
PTSD can be as real for property developers as it can be for war veterans.

Lesson#1 “Its my fault – I didn’t know it was a mistake”

“Its my fault – I didn’t know it was a mistake” is the #1 mistake traders make worldwide according to financial trading psychologist Dr Van Tharp.
In essence, the best financial traders;

  1. Plan for every conceivable scenario.
  2. Play for survival first and profits second.
  3. Exit their positions if something unconceivable occurs.

For Developers this means;

  1. Thinking of every possible outcome in advance of any action;
    • Variance to; DA, valuation, QS, selling costs/period, construction costs/period, On-Completion Value, purchase price
  2. Planning how you will respond in advance
  3. Acting as planned

Below are 2 examples of how this applies to real projects.

  1. Starting Construction without Construction Finance
  2. Your land valuation remains unchanged but you suspect the sales rate is declining.

1. Starting Construction without Construction Finance

Almost monthly I will meet an owner builder/developer who has started construction on his site. They are great at what they do and are being promised by their usual lender that the loan will be approved shortly.
This is a mistake because banks and the majority of non-bank construction lenders will not take over a partially finished project.
In every case the client at best ends up paying twice the rate they would have paid with presales and at worst they get funding that costs the majority of profits.
This section re-issued.

2. Valuation unchanged but you suspect the sales rate is declining.

Below is a development manager’s feasibility for a 20 Lot industrial subdivisions.
In the first scenario it is expected to take 12 months post completion of construction to sell the lots and in the second it is expected to take 6 months less to sell the lots.

Your Development Manager’s Feasibility

Selling Period12 months6 Months
Industrial Allotments20$12,307,500$12,307,500
Gross realisation$12,307,500$12,307,500
GST$0$0
Selling costs$378,870$378,870
Net Realisation$11,928,630$11,928,630
    
Contsruction Cost  
Land$2,800,000$4,000,000
Land Transaction costs 4.67%$130,760$228,675
Construction costs$3,188,400$3,188,400
Professional fees$200,000$200,000
Statutorey fees Contributions & Preliminary Expenses$634,000$634,000
Project Contingency5.00%$318,840$318,840
Land Holding Costs$156,000$156,000
Miscellaneous(ie Marketing, DM, Legals, Presales) 0.00%$257,600$257,600
Total Hard Costs$7,685,600$8,983,515
Finances charges3.81%$445,474$342,672
Intrests$303,876$233,751
Finance and Interest$749,350$576,423
TOTAL COSTS$8,434,950$9,559,438
PROJECT PROFIT$3,493,680$2,368,692
Development Margin41.4%24.8%
Project IRR% Before Debt80%80%

Imagine this is your project and you have;

  1. the above advice from your development manager;
  2. No presales
  3. Knowledgeable agents telling you a 12-18 month selling period is likely;
  4. Valuation of $4m with a selling period of 6-12 months.
  5. An offer from another developer to buy the site for $4m cash unconditional in 30 days;
  6. $2m debt on your land;
  7. An identical project commencing next door in 3 months time; and
  8. No-presale construction finance offer

You have a choice between;

  1. Completing the project immediately; or
  2. Selling it.

Selling it is easy. You get about $2m before agent fees in 30 days and take no risk.
However, if you complete the project you are gambling and will receive 1 of 3 possible outcomes;

  1. Best Case: Your Equity of $2m & Forecast profit ($2.37m
  2. Expected Case: Your Equity of $2m & 30% Forecast Profit ($0.76m)
  3. Worst Case: Construction is halted part way through the deal.

The reasoning for this is as follows;
Imagine you neighbour receives similar advice to you from local real estate agents. They tell him nearly the same thing they told you but add that your supply coming onto the market could push his selling period out considerable. Your neighbour and his banker panic and decide to presell the project now at lowest price that still makes the project financially viable.
As the landowner does not have any debt and is not concerned about the “As-Is” value of the site, he decides to reduce the price by $83k per lot in order to completely presell his project. This makes his banker happy as the feasibility study is now as follows;

Your Neightbours’s Feasibility

Selling Period6 months
Industrial Allotments 20 $10,650,000
Gross realisation  $10,650,000
GST $0
Selling costs $327,846.07
Net Realisation  $10,322,154
Construction Costs
Land $2,800,000
Land Transaction costs 4.67% $130,760
Construction costs $3,188,400
Professional fees $200,000
Statutorey fees Contributions & Preliminary Expenses $634,000
Project Contingency 5.00% $318,840
Land Holding Costs $156,000
Miscellaneous(ie Marketing, DM, Legals, Presales) 0.00% $257,600
Total Hard Costs  $7,685,600
Finances charges $274,138
Intrests – 6 months $187,001
Finance and Interest  $461,138
TOTAL COSTS  $8,146,738
PROJECT PROFIT  $2,175,416
Development Margin 26.7%

This makes your banker unhappy as this limits the sale price of your lots and implies your project is no longer feasible for funding.

Your Neighbours’s Feasibility

Selling Period6 months
Industrial Allotments 20 $10,650,000
Gross realisation $10,650,000
GST $0
Selling costs $327,846.07
Net Realisation  $10,322,154
Construction Costs
Land $4,000,000
Land Transaction costs 4.67% $228,675
Construction costs $3,188,400
Professional fees $200,000
Statutorey fees Contributions & Preliminary Expenses $634,000
Project Contingency 5.00% $318,840
Land Holding Costs $156,000
Miscellaneous(ie Marketing, DM, Legals, Presales) 0.00% $257,600
Total Hard Costs  $8,983,515
Finances charges $342,672
Intrests – 6 months $233,751
Finance and Interest  $576,423
TOTAL COSTS  $9,559,938
PROJECT PROFIT  $762,216
Development Margin8.0%

The worst case outcome is that your lender discovers the new on-completion value of the project and requests presales and/or additional capital (aka a margin call) before advancing further progress claims or not defaulting your mortgage.

Your Banker’s New Feasibility for your Project

Selling Period6 months
Industrial Allotments 20 $10,650,000
Gross realisation  $10,650,000
GST $0
Selling costs $327,846
Net Realisation  $10,322,154
Construction Costs
Land $2,800,000
Land Transaction costs 4.67% $130,760
Construction costs $3,188,400
Professional fees $200,000
Statutorey fees Contributions & Preliminary Expenses $634,000
Project Contingency 10.00% $318,840
Land Holding Costs $156,000
Miscellaneous(ie Marketing, DM, Legals, Presales) $257,600
Total Hard Costs  $7,685,600
Finances charges $342,672
Intrests – 6 months $233,751
Finance and Interest  $576,423
TOTAL COSTS  $8,262,023
PROJECT PROFIT  $2,060,131
Development Margin24.9%

Development Finance Partners are experts at managing battle weary developers through difficulties within their projects/pipelines. Making the right decisions at the right time is key to moving from survival to success.
If you want to reduce the stress and uncertainty associated with a project, contact Development Finance Partners for expert advice.

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