False profits? Why subdividing isn’t always the best option

If you’re empty-nesters still living in the suburban home where you raised your kids, you may be planning to downscale to a lower maintenance home closer to the CBD and cafe culture.

The inner suburbs are more expensive than where you’re currently living, so you’ll need to maximise the profits from selling the family home to get a foothold a different market.

You face a choice. Should you play it safe, do a few cosmetic renovations to bring your home up to scratch and sell it pretty much ‘as is’ in the hope that strong demand from buyers will bring you a good sale price?

Or should you take a more aggressive approach towards increasing your potential profit by demolishing your old home, building two dwellings in its place and selling them on individual titles?

Many people think that subdividing is a sure way to make more money than simply selling a property in its current form — but like many ‘sure things’ in property, it ain’t necessarily so.

Working through the figures is the only way to make an informed decision.

Start by getting a firm quote for demolishing your home and levelling the site. Factor in the cost of obtaining the appropriate council permits, and the fee an architect or draftsperson will charge to draw up plans for the subdivision.

Next, obtain an accurate costing for the labour and materials required to build the two new properties. Add a margin of at least 10% for unexpected changes and costs that may crop up when the job is underway.

Then, calculate the cost of interest. Even if you’ve paid off your home, the chances are that you’ll have to borrow money to fund the subdivision. Remember: the longer it takes to complete the subdivision and sell the properties, the more interest you’ll pay on top of the loan amount. It’s worth adding a margin onto the time you estimate the project will take.

Now, work out the rental cost. You’ll need a place to live while the project is underway, so speak with local property managers to find out the likely cost of renting a suitable property in your desired location. Paying rent as well as interest on the subdivision loan could make things tight financially, so it’s important to work out whether you can afford the additional outlay.

You’ll also need to calculate the cost of selling the new properties, including the real estate agent’s fee and marketing costs. These expenses can be significant, so it pays to negotiate a competitive commission with the agent and to satisfy yourself that the recommended marketing campaign will deliver the best value for your dollar by maximising the properties’ exposure to the right buyers.

Then, consider your tax liability. You’ll incur capital gains tax (CGT) when you sell. This could eat significantly into your profit, so seek advice from your accountant as to the exact liability that will apply in your situation.

Finally, ask local real estate agents for an appraisal of what your home is worth in the current market.

It’s a common mistake to calculate the potential profit of a redevelopment by using the value of the property as it stood when you bought it. The land will have grown in value since then, so using the original value could lead to an over-inflated estimate of the profit margin — and bring you crashing down to earth when you actually sell. Make sure you use the property’s value in today’s terms.

Once you have gone through these steps, you’ll have a clear idea if the project stacks up in financial terms. If not, it may be best to opt for the simpler route, undertake a few cosmetic renovations and sell your family home ‘as is’.

MARK ARMSTRONG is a director of iProperty Plan, which provides independent analysis and tailored advice to investors and home buyers.