In the second of our six-part Backyard Subdivision series we discuss how to buy the right property, and the ins and outs of sale and purchase agreements.
Securing your property on the best possible terms is a great start to your development. Buying well goes a long way to ensuring that your investment will pay you back above your required rate of return.
What does an ideal agreement look like?
The ideal agreement for property development might include a small deposit, long due diligence clause, early access and possession of the property, vendor finance and a long settlement date. Making the date of payment as close as possible to the date you can sell is ideal. However, it’s seldom possible unless you are prepared to pay above market purchase price.
Do find out what you can about the vendor. Why are they selling the property? If the seller does not want to shift for a few months you may be able to trade that for a lower price and be able to start preliminary work on the property (such as a survey) as soon as the agreement has been signed.
The top nine considerations when purchasing for property development
Your real estate agent is a vital member of your property development team. They can advise you not only how much your properties can sell for, but also the features and benefits of the property and what factors might be important to the seller when negotiating a deal.
The selling agent will often provide a copy of the title, Land Information Memorandum (LIM), what comes with the property, what doesn’t, and any other relevant information about the property. Your lawyer can review the title and LIM and advise you if there are any problems.
Record your name with the agent. Because they know you are serious about finding a property they will keep you informed about this and other properties on the market. If you put in an offer, they will also know you are serious about buying – but remember, the agent is there for the seller not the buyer.
Auctions always get the blood pumping! The difficulty with auctions is you have to do all of your investigations before knowing if you have an agreement with the seller. Unless you happen to know the property very well, an auction may not be suitable for a property development acquisition.
3. Back up agreements
Be careful with backup agreements and agreements conditional on another sale. The backup agreement should include conditions for a building report, meth test and other due diligence so that if a problem is found in the first agreement and it does not go ahead, you are not caught with an unconditional agreement. Your lawyer can guide you through this.
The legal reason for a deposit is if you enter into an unconditional agreement and then don’t go ahead, the deposit will cover the seller’s actual costs (like agent’s costs, legal etc.).
Make the deposit payable only when the agreement is unconditional – not on signing (other than an exception for a condition relating to issue of title). That way you are not exposed to the deposit holder going bankrupt and you will have no hassle getting the deposit back if the agreement does not go ahead.
5. Building report
When buying an existing house, get a building report. If issues are found in the building, you will get an opportunity to require the seller to fix them.
If the house if old (pre-1945) you should get the electrical wiring checked by a registered electrician. Insurance companies have different rules about what they will insure, but will probably require this inspection and an electrical certificate to show that the wiring is safe, at a minimum. Fireplaces may also need to be checked.
6. Methamphetamine contamination
There was a instance recently where an elderly couple built their dream home, and then later decided to sell it. However, the buyer’s test found the house was contaminated with meth. What? How? It turned out their grandson had stayed over some weekends and was smoking “P”. Insurance paid for the clean-up costs, but not the loss in value of the house.
We recommend to every purchaser to include a “P” test in all agreements, regardless of who the vendor is. You cannot include meth tests in a building report because builders are not usually skilled in meth detection. The cost for a specialist meth test is about $200.
The rules about acceptable levels of “P” have changed since the problem first became known. The Ministry of Business, Innovation and Employment, in consultation with the Ministry of Health & others, has updated the standards for “acceptable/contaminated levels” for methamphetamine (refer NZ Standards NZS8510:2017) with the acceptable limit/level now being 1.5µg/100cm2 in high use areas.
However, if “P” is found in a house and cooking has taken place, then that may be recorded on Council files and will appear in the LIM.
A LIM can alert you to any problems with unconsented building work, stability issues and other information about the property. But this only part of its value.
A LIM comes with one thing nothing else can – a promise from Council they have told you all the relevant information they hold. If Council fail to do this and your property is affected you may have a right to compensation, for example, if Council did not advise you of a flooding risk, but they should have. If your name is not shown on the LIM then this does not apply. You cannot get compensation if you get a copy of the LIM from the vendor or the agent.
A LIM report currently costs around $380 from Whangarei District Council. You should review the LIM with your lawyer.
You can instead just get a property report (you’ll need to complete a Property Information Application) from the Council for $45 and do your own investigations, but this comes with no guarantees of accuracy.
Just to make things harder, subdivisions and earthworks are subject to the Environmental Standards regime (HAIL) which concerns soil contamination (for example, pesticides if the land was used for an orchard, sheep dip on farms or an old dump site). A soil report may be required to prove the land is not contaminated and is suitable for a residential dwelling to be constructed. Contamination may not, and does not have to, show up in a LIM.
Your bank’s requirements about financing developments change rapidly. You must get written confirmation of the finance you require if you wish to rely on it. If your bank considers that you are an investor, then its LVR (Loan to Value Ratio) restrictions may apply.
For most backyard subdivisions people use the equity in their existing house to obtain finance.
Banks will often require a valuation at the start of the project, so you need to leave sufficient time to obtain this.
You also need to make sure you understand your bank’s requirements on construction loans, insurance and how the bank will allow you to draw down the loan as you require it.
There are many risks with property development. Interest rates can increase, as can construction costs. There may be a property market downturn before you sell. Disputes with contractors, delays, changes in law or council policy can be costly and reduce your return. Improvements you make to the property may not increase the sale price enough. Building defects and problems can be costly. The property may have unexpected features such as incorrect boundaries, title issues, hazards that increase costs and difficult ground to build on.
You need a decent return for the risk you are taking. Minimise the risks by buying well and having an agreement that suits your needs, and by carrying out investigations on the property and house before committing unconditionally.
In part three of our Backyard Subdivision series, we look more closely at titles and boundaries.