Property Development - Key Points to Consider
Like any other business, the primary objective of a property developer is to derive a return on investment when considering a project. Given that structuring and planning are crucial to the success of every business, the same rigour must be applied, in my view, to a property development project. To that end, the following are the key points to consider...
Asset and liability protection
The entity or entities to use to undertake the project will need to take into account the potential risk profiles of those involved. For instance, it may not be prudent to run a property development business in the same entity that is holding valuable property. Otherwise, if the business is sued, the property will be at risk.
These issues will need to be considered on various levels, eg, should one development be quarantined from another in different entities? Should a particular person be held out as a director of a trading company when that person holds significant personal assets?
Any debt advanced by banks or similar financiers will involve security, which is usually property. However, banks will only advance funds to the extent of a predetermined lending to value ratio, which may change with prevailing economic conditions. Therefore, other sources of funding may need to be considered, eg, the use of mezzanine financiers, etc.
Also, the manner in which funding is obtained is important as the legal form of the lending arrangement has a direct bearing on the tax deductibility of the interest on the loan.
While it is possible to set up a complex structure that resembles a DNA strand, it should be noted that the more entities are involved, the more expensive it is to establish and maintain the structure. Putting aside the issue of administration and maintenance, there is also the qualitative costs of stakeholders (eg, banks, shareholders) not being able to understand the structure. In other words, there must a point where the costs of running the structure will start to outweigh the potential benefits provided by it.
Another major cost to consider in setting up a new structure is stamp duty on land transfer. It may be advisable in many occasions to leave the land in the hands of the owner and structure the development project around it.
Admission and exit strategies
A flexible structure allows the admission of new future partners easily and at a minimal cost. It should also provide for contingencies in case a party decides to exit the arrangement. In this regard, contractual terms (eg, a shareholders agreement) dealing with these events will help protect the interests of the respective parties.
Tax should never be the dominant consideration in structuring and planning but it is far reaching and must certainly be considered in almost every facet of the development. For instance, if land is held by a company, the CGT discount will be lost; therefore, it may be prudent to hold the land in a trust, which may have an impact on issues such as control if multiple unrelated parties are involved.
Other taxation issues to consider include: GST, stamp duty, recoupment of tax losses, eligibility for the small business CGT concessions if an active business is involved, availability of roll-over relief upon restructure, etc.
The above is just a snapshot of the potential issues that must be considered when starting a property development project. While many developers will be able to deal with the commercial aspects of the project themselves, professional advisors, including a reputable accountant and lawyer who specialise in the property sector, will provide an invaluable technical resource and support to ensure that all the important issues are covered.