16 March 2021

The importance of the right business structure for property development

Sectors:

Property and Construction

When you start out with a new property development, it’s important to think about the underlying structure of the project from the very outset. By thinking about the business structure at the beginning, you can prevent many of the budget issues, legal hurdles and tax worries becoming problems at a later stage.

Daniel Morgan outlines the key elements to include in your property development business plan, and how forward thinking around your structure can alleviate many of the common pain points.  

 

When we talk about ‘structuring’ a property development business, what do we mean?

When it comes to the structuring of your property development project, there are three main things to consider:

  1. The legal side
  2. The commercial impact
  3. The tax implications.

Good structuring ensures these three elements work together, along with the financial side of the project. For example, one consideration is how you, the developer, will get paid.

Payment questions may include:

  • Will you only need your money at the end of the deal once the development is sold?
  • Do you need money along the way from the project to provide an income to live on?
  • Do you take money out as a salary or a company dividend?
  • And do you have a limited company for the development of that site that will incur the costs?

With a development company set up for the project, you can then take a payroll out of the company, or potentially take out a management fee on a monthly basis via another entity. That monthly money becomes a project cost that becomes part of the project budget.

You need that management fee to be agreed at the beginning, and it has to be factored into your overall costs when you fund the project so you have enough funding to complete.

Any money you take out has to be accounted for. You need a plan, a funding forecast and the ability to monitor your costs throughout the development.  

 

What are the main advantages of this business structure, as the property developer?

Everyone starting a development thinks they will make a pile of cash, and won’t necessarily plan for losing any money. But property development is like sailing a big ship; it’s not nimble and you can’t just suddenly change direction.

The market is changeable for many reasons, and those elements are normally out of your control. As with everything in life, you have to plan for the worst-case scenario and create a strategy for dealing with it. This will increase your professional fees at the start, but that’s well worth doing when you look at the advantages.

Understanding the benefits of structuring is vital, especially at the moment, with Brexit and the pandemic. You have to look at what the worst-case scenario could be and how you would react.

You might have a development business that’s set up between family members, or a married couple, where there’s no agreement on the legalities.

You need to agree these key structural elements when the situation is in a good place, not when things are bad.  

 

The importance of working with lawyers and tax specialists

Working with a lawyer to set out the legal documents is a sensible idea. When working with our property developers, we either work alongside existing lawyers, or with the team from HW Business Law (our sister firm) on all the relevant paperwork.

You should set up the legal side at the same time as buying the site and going through the purchase process. The legalities should be sorted before you buy the land or property, so you’re reducing some of the risk factors.

Tax is another important area. Some developers will take money out of the project to live on, but won’t think about the taxes that are due on that money. You may be charging a management fee, plus VAT. This can get complicated, with invoicing, VAT, other business taxes and income tax to factor into the equation.

VAT for property developments can be complex. It’s worth carrying out a VAT analysis before you start.

New builds are simpler for VAT considerations, with VAT reclaimable on build costs, however certain costs are restricted. Often you may have a mixture of conversion and new build, particularly when converting pre existing structures for example. You will need to know what happens with the VAT treatment of your residential build, or new build, and what the correct classifications should be.  

 

How do you measure performance and profitability?

Managing performance over the course of the project is a vital part of the process. Generally, you would have a cost variance report (CVR) in place, which monitors the different parts of the build. This would include columns for your original budget, your spend to date and the forecast remaining to spend.

The outputs from the CVR will dictate whether the remaining budget will cover the completion of the build, or whether you need to spend more.

If there’s a funding gap you need to know about it early on, so you can take the right action. You may need to raise finance to meet this gap, whether this is back to the equity investor, mezzanine funder or senior lender. Not having this information early enough can cause lots of stress and pressure towards the end of the development.  

 

How can Haines Watts help me get this structuring right?

As your advisers, we can help you manage both the tax side and the risk elements. We’ll help you to ask the right questions and get a robust structure in place.

Having a good structure will limit your exposure to risk, In a way, it’s very similar to the physical build: you need to set out the right groundworks, build solid foundations and create a structure that’s able to withstand the pressure you put on it.  

 

Come and talk to our specialist property accountants about your property development business structure.

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