Subdividing: Pam Walkley The golden rules

Doing the groundwork first will help uncover the hidden costs of subdividing

Subdivision – breaking a property into two or more separate titles – sounds like a simple and easy way to make quick profits, but in most cases nothing could be further from the truth. Yes, you can make money from subdividing but it usually requires a great deal of effort and a big outlay of cash upfront. “Very often property investors underestimate the financial and time costs of subdivision,” says Margaret Lomas, property expert, author and founder of Destiny, a financial planning firm that helps property investors. “Subdividing doesn’t mean you get a ‘free block’. In addition to the local government charges to subdivide, you will face additional costs like sewer and drainage, engineering, potential retaining walls, driveways for access, fences, benching and levelling, and a whole host of hidden costs. These can run to tens of thousands and sometimes hundreds of thousands of dollars, depending on the original block.”

One hidden cost I incurred when I subdivided a block in the inner Sydney suburb of Balmain many years ago was paying to concrete around a sewer on the new property. This required extensive excavation and was a very expensive condition of development. The outlay was partly offset by adding a cellar to the new house, which increased its value when we sold it 10 years later.

Before you even think about subdividing, you need to be aware of planning rules in your state and area, as these can vary significantly. A rundown of the process in NSW, Victoria, Queensland and Western Australia is available on build.com.au.

So just what is required to successfully

subdivide a block and turn a profit? The most important thing is to have the right property in the right location. Maybe you have a home or investment on a big block of land within easy commute of a big capital or major regional city. If so it could be worth investigating your options to create wealth from your existing property. Your first port of call should be the local council to see just what their planning rules will allow on your site. You need to know minimum lot sizes, zoning, access issues, building restrictions and setback rules, as well as how easy it will be to connect services to your new block or blocks.

“Before you subdivide, it’s critical that you establish the likelihood of being able to make a considerable profit from the exercise, both in terms of the final value of the subdivided property and the improved rental yield if it’s an investment,” says Lomas.

So just how do you work out your likely profit? And what checks should you carry out to ensure accuracy?

Property investor and author Peter Koulizos, who is co-authoring Diary of a Small Developer with Margaret Lomas (expected to be published next year), says that you should consider three scenarios:

1. Best-case scenario, where you carefully estimate all costs and add them up.

2. Most likely-case scenario, where you add 10%-15% to the overall costs.

3. Worst-case scenario, where you add 25% to the costs.

If the project won’t work on the worst-case scenario, don’t go ahead because this is the one which is, more often than not, the correct one, says Koulizos.

One of the most common types of subdivision is to split your property in two. It’s preferable if you can keep the existing house on one of the blocks, even if you have to renovate it, says Lomas. “Being able to keep the original house can make the venture much more palatable.” Usually you can still get an income while you subdivide and having an existing dwelling keeps costs down. But make sure the costs to keep an existing dwelling – renovations and alterations to suit the newly created subdivision – won’t be so high that they make it not worthwhile, says Lomas.

If you need to demolish the existing dwelling on the site, do your numbers really carefully because demolition can run to tens of thousands of dollars, adds Lomas.

The same rules apply if you’re looking to buy a property to subdivide. Don’t simply believe the vendor’s real estate agent as to what is allowed on the property; always do your own due diligence.

Once you’ve established that it’s likely you’ll be able to subdivide, it’s worth hiring your own town planner who is familiar with the area your property is in. Town planners will be able to confirm that your proposed subdivision falls within the council’s application (DA) requirements and can help you efficiently navigate the development approval process. “A qualified town planner will not only be up to date on the latest planning schemes, conditions,

zoning and codes, but he or she will also have inroads with council,” says Craig Christie, owner of ASI Planning.

After finding out basic information about the property and doing some searches, Christie says he can tell clients whether or not their subdivision is likely to be approved and highlights any areas of concern. In some cases, he recommends meeting with council before submitting the development application to discuss any issues, reducing the risk that the application will be held up or denied.

If a site doesn’t meet all the requirements, a good town planner can also advise whether you could be eligible for an exemption of some sort, says Lomas. They should be able to arrange surveys, engineering drawings for driveways, drainage and easements, and even prepare the subdivision submission.

When your subdivision is approved and registered, you need to decide whether to sell with approval or take on the project yourself.

A lot of the work and the costs are incurred in getting that approval in the first place, says L omas. “It’s much easier to get a price quote for the build, which is fairly accurate. A good strategy is to get a project home builder to quote, as they provide fixed price quotes.”

But first you have to establish your reasons for subdividing, Lomas says. If you want to create investments, you need to assess how much they will cost to hold and if they’re affordable. If there’s a weekly cost to hold an investment property then the price growth in the area will need to outpace the costs to make it worthwhile.

If you want to sell for a profit then compare how much the block will sell for with a dwelling and without, deduct the costs and see which yields the bigger profit.

“When you’re doing all these sums, remember holding costs,” says Lomas. This covers the time when you receive no income from the property, which could be well over 18 months if you build. “If you’re holding a mortgage or using funds which would otherwise be earning an income elsewhere, you must add the costs of this to your bottom line. Selling blocks will obviously happen sooner than if you waited to build and so holding costs will be less.”

Be aware that you can’t guarantee demand for what you’re creating will exist once you are finished, even if it’s there when you start, says Lomas. Add additional holding costs in case it takes you longer to sell than you planned, and be prepared for the fact that the sale price might be at least 10% below the bank valuation.

Remember, too, that subdividing can have capital gains tax (CGT) implications when you sell. If you subdivide your main residence block, and sell off the vacant land with plans and permits for the construction of the new dwelling, you’ll encounter a tax liability. The cost base of each block will need to be determined because the amount of tax payable will be based on the difference between the cost base and the sale price. For example, if you sell off a block for $400,000 and the cost base is $205,000, your likely tax liability will be $97,500 ($400,000 less $205,000 x 50% general discount because you’ve owned the property for more than 12 months).

If you build a new house on the subdivided block, a good tax strategy is to sell your original home, as this benefits from your main residence CGT exemption, and move into the new building, which would become your new main residence. If instead you sell the new property you will incur a tax liability

If you rent out your new development, rather than sell it, you will pay tax on the rental income as you would with any investment property. Another alternative would be to move into the new property and rent out your current home, giving you the flexibility to decide which to nominate as your main residence when you sell the first property. This is because once you have lived in a home you can rent it out for up to six years and still claim it as your main residence for CGT purposes.

Be prepared for the fact that the sale price might be at least 10% below the bank valuation