How to Make 20% a Year out of Property – A Step-by-Step Guide
History shows that over the long term, on average, property values grow at around 6% – 10% per annum*. This is the appeal – a relatively passive investment that grows.
But over decades of experience, we know that it is possible to make 20% p.a. (or more) by doing the right research, making the right decisions and taking the appropriate risks.
In this guide, we will discuss how it’s possible to make 20% p.a. from:
- Land development
- Commercial property
- Residential property
Land development is potentially one of the most profitable property ventures…mainly because it usually involves the most risk. To our mind there are 4 main stages to the land development life cycle with decreasing profit percentages as you move through each stage.
The re-zone stage can often be one of the most profitable stages because it usually has the highest amount of uncertainty and can take the longest. It can take a long time because whether you drive the re-zone process yourself with council, or wait for the council to re-zone, it is often years from acquisition through to getting a new zoning in place. Plus…a rezone can often involve properties with minimal or zero income – e.g. a farm waiting for a rezone to residential.
The key to a rezone play is great foresight, which comes not from guess work but good research.
Let’s look at a couple of examples
- Residential rezone
Back in in 2007 when we started Erskine Owen, we were buying residential property on behalf of property investors – i.e., acting as a buyer’s agent under the REAA – which we still do. This is a full service offering where not only do we do the search and negotiation, but we also do the deep research as to where cities are likely to expand to, and thus where there will be maximum capital growth. Our early research showed that the Auckland Council had plans to develop the rail line out to West Auckland. Specifically, the plan was to double track the railway to New Lynn, take the New Lynn rail stop under a bridge so it could more easily connect with buses, and sync the bus and rail timetables. Not in itself a re-zone…but…that lead us to ask, ‘why the effort on all the public transport?’ It was not long before we unearthed discussion papers for a Super City that would include a ‘Unitary Plan’ with new zonings for more intensive development. Like all these papers, the wider public takes little notice of them in the early stages… mainly because they aren’t that widely socialised at first. But, put this together with the fact that government research papers are saying Auckland will run out of space to build more standalone housing and you realise that the new zonings have to happen. That lead to us advising clients to buy around train stations in West Auckland. At the time pretty much everything in West Auckland was $350k. A lot of clients had never been to most of the suburbs we recommended and when they drove around them, they came back with quizzical looks. Just over 10 years on, having taken our advice and purchased, we now get grinning faces with their $350k investment worth well over $1m because of zoning changes.
- Rural to residential re-zone
In 2018 we were relatively new to syndicating property opportunities – i.e., bringing investors who don’t know each other together to buy a larger property they wouldn’t be able to afford by themselves. We had been buying property in Queenstown for some years and had a good feel for what was happening. One real challenge for the town was the lack of housing. The town was booming, and why wouldn’t it be…one of the most beautiful places in the world – skiing, mountain biking, wineries. It was attracting tourists and families in their droves. What’s more, our research suggested the trend would not abate. A five-hectare rural lifestyle site came up for sale that we believed had to become residential land one day. Look at the map below. Sitting on Frankton Ladies Mile, south of the property on the other side of the road was Lake Hayes Estate – fully developed, and adjacent to Lake Hayes, Shotover Country, was also fully developed. We believed the land north of Frankton Ladies Mile was logical to be re-zoned. So, in December 2018 we settled on 497 Frankton Ladies mile for $5m in a syndication.
A couple of years later the council floated the idea of re-zoning our land to residential. We certainly didn’t object! As at 2023 the re-zone is in its final stages. The latest valuation was $20m and Queenstown prices are starting to lift again. We are anticipating a significant value jump once the rezone is finalised, estimated to be May 2024. The property was bought with about $3m of equity – not a bad return…on average a 91% gain per annum:
It is very important to have a good team around you for a re-zone. While the council is leading this, we will spend about $300k on consultants who are protecting our interests by participating in the council led consultation process. We have a lead project manager, a planner, a barrister, and a research/ statistical expert all just to defend our position on key matters such as minimum density, roading, setbacks, storm water, Airbnb rules…to name a few.
Resource Consent to Subdivide
This second stage is where a piece of land is technically subdividable, but you still need to get a resource consent for permission to create new titles. The reason why this phase can still be risky is that although it might be technically subdividable, there could be challenges with connecting to waste or storm water which could add significant cost. Or there could be a problem with the land that you don’t know about until you get a geo-tech report…and even then, you might not know the cost of problems until you submit your resource consent and find out how council will deal with them.
Perhaps most importantly, this phase can be very hard to put a time frame on. Councils can slow the process down by asking for more information – and there are several ways they can get time extensions. That means that if you have debt in the deal, the longer the timeframe, the greater the interest cost.
Other than interest the main costs in this phase are consultants’ costs…planners, geo tech engineers, surveyors, lawyers…and a weekly visit to a psychologist to keep you sane with the seemingly crazy council requests!
Once you’ve got your resource consent the value becomes what a developer is prepared to pay. A developer will approach it by starting with the number of subdivided sites that the property will yield once all subdivision works are complete – multiplied by a square metre rate – which is based on what things are currently selling for. Then deduct all the costs to create new titles – i.e. new individual sites. These costs will include civils costs (earth works, drain laying, roading etc.), legals, consultants and council contributions…which are quite hefty.
Despite these challenges it can be very lucrative. You are taking a big chunk of the risk out of the process. Once you’ve got a resource consent you know with more certainty how much you can make from the deal.
One way to get started down this route is simply to buy an existing home that has a zoning that allows for more dwellings and work through the process of getting a resource consent. First step is to engage a good planner that has had a lot of experience with council. They will take you to council for a pre-application meeting where council will bring along all necessary experts – engineers, roading experts etc. They will give you a good steer on what the main issues will be. Key challenges are often storm water and waste water – do those pipes have sufficient capacity, or will they need to be upgraded – which is normally at your cost.
If you simply do the resource consent on an existing residential property in hot market, you could expect to add at least 20% to the value of the property. In depressed market that value probably can’t be realised.
By way of example, in our Growth Fund we have bought a residential property in Whangarei with an old villa. The land is approximately 3,000 s/m. We have begun the subdivision process as described above.
This is the practical work of creating a new title. It starts once you have a resource consent allowing subdivision to go ahead. There is less risk in this compared to the process of rezoning and resource consent because your costs and timeframes are generally more knowable. Here is a simple example:
- Residential subdivision in Te Atatu Peninsula, Auckland. We had helped a client purchase a 3-bed weather board home on a full site, and he asked us to subdivide it for him. Sure – how hard could that be? We submitted the resource consent and discovered that the site was an old orchard and therefore we had to scrape about 50cm of topsoil off the top and dispose of it. Then…we had the new house completed and submitted for the final 224c. We then realised that the stormwater detention tank that had been planned to sit on the side of the house wouldn’t work as the road was above the level of the tank. We brainstormed and found a company that produced flat detention tanks and we were able to sit it on the roof of the first floor to create a gravity feed to the road. Phew! So…unexpected costs were encountered. However, in the end it was still worth it because the value gain from subdividing was greater than the cost. There was risk, time and some angst involved…but it created more value.
Land developers generally don’t build as there is less profit and more hassle in this phase…. they’d prefer to leave some profit in it for the builder and get the land sold. Where developers do build, it is usually to get the property sold, since most homeowners want to simply buy a finished product rather than go through the build process. In one sense this is the least risky phase because it is the easiest phase to budget cost.
If you are prepared to take the risk of buying a piece of land, building on it, and then selling, in a flat or rising market, there is usually at least a 20% profit. Beware of buying near the peak of the market and getting caught with land you can’t build on because all the buyers have disappeared either because they can’t get bank finance, or they have lost confidence. Or – it could be that the value of the finished product has dropped below what it will cost you to build. Also keep in mind that bare land is the hardest to sell in a depressed market. And…watch out for inflation on building costs.
Builders will often buy in new subdivisions because the developer will give them advantageous terms – for example you might need to pay a deposit and then you get 12 months to settle. That gives you time to get your building consent approved and get underway with the build.
A lot of people might think commercial property is an investment class that you buy when you retire – get a nice big industrial shed with a long lease and watch the rents roll in while you sit on the deck of a Mediterranean cruise ship. Nothing wrong with that. However, the great thing about commercial property is that there a lot of ways to actively increase value.
Before we delve into this section it is important to understand how commercial property is valued. Residential property is valued primarily based on comparable sales. A valuer will look for comparable properties that have sold in the same street within the last 3 months…and keep moving out to similar streets until there enough comparable sales. Adjustments will be made depending on whether the comparables are inferior or superior.
Commercial property can be valued a few different ways, but generally the valuer will take the net income and capitalise that income using a capitalisation rate. For example, if the rent is $100k and the cap rate is 10%, then $100k divided by 10% gets a value of $1m. Where does that cap rate come from? Once again, it is based on comparable sales, but then the adjustment for inferior and superior will be made up of many more variables compared to residential; length of lease; quality of tenant; rent review mechanisms; tenant covenants; industry…
What this highlights is the importance of income – the amount of it, the certainty of it, and the potential for growth. That means a vacant commercial property is usually worth a lot less than if it was occupied. This is unlike residential where it doesn’t matter if it is vacant.
Therefore, adding value to commercial property is all about increasing and strengthening revenue streams. Let’s look at ways this can be done.
Additional Income Streams
It is possible to add income streams separate to the main tenant income that haven’t previously existed…thus adding value. Here are a few to think about:
- Lease out spare land.
We have a block of 5 small industrial units in Frankton Hamilton. When we bought it there was a 600 s/m piece of land at one end that used to have a residential house until it burned down. The previous owner had done nothing with it. We fenced it and leased that area to a builder who stored his machinery on it. That produced about $10k per annum of additional rent. At the time the cap rate was about 8%. So, we added $125k of value – take off $5k of cost and we generated a net capital gain of $120k. We paid $600k for the property. We put no money in as we leveraged other property. Not bad for ½ a day’s work coordinating a fencer and getting the local agent to find a tenant!
- Lease carparks
We purchased a property in Hastings. On the front is a concrete block, single level commercial building leased to a taxi company. We bought it off the taxi company. They had decided they didn’t need to have parking out the back and so they fenced it off and signed a long-term lease with the police. That created more income, and we were prepared to pay more for that building than if it just had the Taxi company lease. Smart move. We didn’t mind paying for it as it helped with our holding costs. We wanted it for another purpose, to put with the building next door which would allow for greater value add, see below.
We’ve never personally done this – but we’ve come close to buying a building where the vendor had bought an office block on Nelson St in Auckland’s CBD and got tenant and council approval to put up a couple of digital billboards. All the 5pm traffic heading for the motorways must sit and look at the billboards. Valuers don’t attribute as much value to this type of revenue as it can be more volatile since billboard companies will pull away in a recession. Nevertheless – over time the cost benefit stacks up.
- ATM machines
Banks charge transaction fees when you withdraw cash from an ATM. That means they are prepared to pay rent to a landlord to get a space in a high traffic area. The great thing is that they don’t take up a lot of space. Of course, you do need to have the foot traffic to justify it.
As we write this, we are planning to attract one of the main banks to put a machine in at our latest syndicated offering at the Brackenfields shopping centre at Amberley in Canterbury. We should get $20k per annum. This property has an 8.5% cap rate – so it should add more than $235k of value to the property.
- Cell masts
Similar to billboards – telco companies will rent space on your roof for the right to put a cell tower there. There is probably less of this new leasing happening now…but worth keeping in mind.
Buy a Vacant Property – Lease it
Remember in the discussion about valuing properties we said that a vacant commercial property is generally worth less than when it is tenanted because it has no income. If we think about it, it makes sense…unless the purchaser is buying it for their own use, then everyone else is an investor looking for income. If there is no income and they buy it…then how long before they must wait to get it leased?
And so… this presents an opportunity. Buy a vacant property and get it leased. Why would a vendor not do the work themselves to get it leased? Because often they have lost the energy for the property – the tenant leaves, the make good clause in the lease is weak, there is no money or willingness to renovate or refresh the property and so the vendor decides to move on. That is your opportunity.
This process will often require some renovation work to attract a quality tenant. This also means it will require a bit of vision. Get on the ground and find out what tenants are looking for. If it is an industrial property, is it that the space is too big and it could be split into several units for which there is more demand, and…where the per s/m rental rates are likely to be higher?
Going down this route means allowing for architect costs as well as renovation costs. But don’t be put off. Sometimes it is just a matter of a renovation that is relatively cosmetic…fresh paint, carpet and amenities always make a property more appealing.
This is like the above – but with an existing tenant. Just because a tenant is in the middle of a lease it doesn’t mean you can’t renegotiate it. Why would you do that? Well…let’s suppose they are coming to the end of their 6-year lease – e.g., there is 2 years to run. You always want to start the “what are you plans” conversation at least a couple of years out to secure their tenancy. A great way to do that is to understand what their pain points are and see if you can fix them.
For example – we looked at buying The Warehouse site in Alexander, Otago pre-Covid. The lease was coming to an end, and we found out that they wanted new lighting. We knew that if that was done the Head of Property would be prepared to engage in a lease re-negotiation. Great! However, she then said…she couldn’t start that process until the consultants McKinsey had completed the new group strategy. So, we let that deal go…but we do know that eventually someone bought the property, did the lighting and now there is a longer lease.
Sometimes it might be simpler than that – it could be a lick of paint is all they need. Or…it could be more complex. One of our team members was manager of a shopping centre and the café set up wasn’t working. They designed a food hall that didn’t feel like a food hall – check it out…Eastridge Shopping Centre in Orakei in Auckland. It is a massive success.
In our Growth Fund we have bought an office block in Christchurch at an 8.4% yield. The carpets and bathrooms are a bit tired. Our intention over time is to refresh the interior and in turn negotiate higher rents as rent reviews come up. We are also planning to make the building ‘greener’. Banks love this at the moment and are prepared to offer a discount on interest rates and prioritise the lending if your building is ‘green’. A new carbon emissions programme the government has signed up for means that corporates are measured on how ‘green’ they are. If they are lending on green assets – that is good for them. What that means is that if we make this building green it will make it easier and cheaper for the next person to get bank funding…and thus increase buyer demand. Additionally, we are anticipating that as we continually get back to ‘normal’ post covid we will see more businesses spend more time in the office. Anecdotally we understand that one of the largest recruiters have told all their staff to return to the office full time, and one of the banks is now requiring staff to be in the office at least 3 days a week where previously they could work from home whenever they wanted.
We are absolutely aiming for a return of 20% on equity from this project.
Repurpose for Higher Value
Let’s jump straight into an example. Remember the Taxi site in Hastings I mentioned? Our Growth Fund bought that site and purchased the corner site next door which has an old run-down two-story villa on it with a commercial tenant and a small amount of residential. To look at, it’s a bit of an ugly duckling. However…we currently have a government department asking for accommodation and if the site is signed off the government will buy the finished product off us. The price will be cost plus an agreed margin. So that takes a huge amount of the risk out of it.
There are things that can be done with a lease that can have big value impacts. When signing a new tenant, or agreeing renovation works with an existing tenant – take time to negotiate each term.
For example, if you are renegotiating a lease, you could agree a higher rent in exchange for a rent-free period and some capital works meaningful to the tenant. The benefit of this is that a higher rent will increase the value of the property. And – the rent-free period doesn’t necessarily have to cost you over the term of the lease.
Let’s look at an example. Scenario 1 below is simply increasing the rent and the tenant exercises its 5-year right of renewal. So $1m of rent and the valuer puts a 10% cap rate one it, and therefore the value is $10m.
However, that’s not exciting, so you take the tenant out for coffee and chat about where they are going with their business, understand the vision they have and where they want to go. It’s a growing manufacturing business and you find out they have a separate operation elsewhere and they want to bring the office staff across to your building. You get your architect in and find you can knock some walls down, create a more open workspace and thereby get your tenant space for 10 more desks. You also paint the reception and board room and replace their grotty Formica board room table. In exchange for this you negotiate a rent of $1.1.m – $100k more per annum than the base case…and critically you get the lease term up to 10 years. This is easily justifiable – if you are going to spend the money on the property, you need to know you are going to get a return on that, and 5 years won’t do it. Then, to soften the blow you offer to give the tenant 6-months rent free. You also highlight to them the saving they make from not having the other premises and the productivity and culture benefits form having all their office staff under one roof.
The financial result?
- Value increase: The rent increases – which increases the value. And…the valuer sees the juicy 10-year lease and knows that the buyers love long solid leases and will pay a premium., so she puts a better cap rate of 9% on it. The combined impact of the increased rent and lower cap rate means the value goes up by $2.2m. We’ve spent $250k to get that result so the net gain compared to Scenario 1 is just under $2m.
- Additional cashflow: You give up $450k of rent in year 1 – but over 10 years’ time you get an additional $450k of rent from the annual increase. See the table below.
So, let’s recap – for a coffee with the tenant and a few subsequent phone calls, coordination of some works and perhaps financing for the $250k, you have managed to improve your financial position by $2,422,222 (The value increase of $1.972m plus the additional cashflow of $450k). That’s worth getting out of bed for.
If you want to learn more about how you can maximise the value of you commercial property, read this article by our sister company, Point Property Management.
This is perhaps the lowest risk approach. We won’t talk about subdivision, as we’ve discussed that above. The main way to make money out of residential property is simply to buy a property needing work, renovate and increase the value.
Before we started Erskine Owen, we spent 3-4 years trading residential property. The key was buying as cheaply as we could. We would spend a good chunk of the day driving around and inspecting South Auckland property and making offers. We’d attend mortgagee sales, and we’d jump whenever an agent rang saying she had a vendor highly motivated. We were in a position to make offers that were completely unconditional, that was of value to some vendors who needed to sell fast.
Usually such properties needed work – so we’d get the trades in pronto. We only bought simple 1960s weather board homes, so we knew exactly the types of issues we’d face. The building works were limited to rot in the subfloor underneath the kitchen and bathroom, and rot in the bathroom walls. Sometimes the roof needed some iron/tiles replacing.
As soon as the works were done, we’d get the valuer in. Then we’d take the valuation back to the bank and they would let us refinance and get our deposit out so we could go again.
The numbers? Hmm – this will date us. We’d buy for $120k, spend $10k and get a revaluation at $170k. Yes – that is a 3-bedroom 1,000 s/m property in South Auckland – I told you it would date us. So $40k gain and we put down a 10% deposit of $12k. All in say 3 months. That is better than 20%. You’ll say that you can’t get finance with a 10% deposit these days. No – but there are other ways to do it.
The reason you’d start with this approach is that it requires less capital and its generally easier to sell residential – as you long as you buy well and don’t get caught in a downward moving market.
How to Get Started
We hope that this paper has opened your eyes to how you can generate wealth from property in a more active way as compared to a simple buy and hold strategy. Or, it may simply have expanded your bag of tricks. The challenge with reading any kind of material is the ‘now what?’ question. Will this paper give you a sense of hope and excitement that slowly fades with the busyness of life, or will you accept the challenge…and take action?
My experience is that people often get overwhelmed with the enormity of achieving a goal and that can drain the motivation. So, the way to solve that is to develop an action plan and make the first step a really simple thing to do…that way you get moving. And as we know – getting something moving is often the hardest part.
Here is our suggestion:
- Develop the plan. At Erskine Owen we have Financial Advisors that are qualified and experienced to help you develop a workable action plan to achieve the above.
- Promise yourself you will act on the plan
- Action the first step
Here is an alternative – as you will have realised from this paper, we at Erskine Owen are in the business of delivering 20% plus returns. We do that through our Growth Fund. The benefit of joining the Growth Fund is that:
- Capital required
For as little as $100,000 you can participate in these opportunities. To get into commercial property as an individual requires a lot more capital. Most people don’t have the millions required to access meaningful commercial property opportunities like the examples we have provided.
I can confidently say that it takes years to build up the knowledge and experience to find, analyse, negotiate, and execute the kind of deals discussed in this paper. It may well be a journey you want to go on…in which case I hope this paper has helped motivate and encourage you. But you maybe someone who ‘gets it’ but decides you don’t have the passion or skill set to do it yourself. Why not leverage the combined experience we have as a team – one person can’t be great at everything – but as team we can be great at it all. It has taken us decades develop our knowledge, but also our networks. Agents know us and feed us deals constantly, remembering that a lot of commercial deals – perhaps 50% or more are never advertised. Don’t forget the network of consultants/ experts you need to build up that want to work with you and you know are great.
It takes time to find good deal. You have to kiss a lot of frogs to find a great deal. Do you have that time…and patience? After doing this for decades it is fascinating how a deal you look at that you can’t make work comes back around a few years later. That only happens if you stay in the market buying for years.
Click here to find out more about our Growth Fund.
*NZ Department of Statistics – average of median house price data from 1992 to 2023