Part 2 of an eight-part series written by Ian and Ritchie for Property Investor News, featuring some of the key aspects of small-scale property development covered by propertyCEO’s ‘8-Pillars’ system. This article appeared in the September 2021 edition of the magazine.
In Part 2, Ritchie looks at the things new developers should consider when setting up their business structure to be tax-efficient and also considers cash flow and the secrets to having a successful business plan.
According to Benjamin Franklin, nothing is certain except death and taxes, but to be fair to him, he never met my accountant. Now, I’m a keen advocate of the view that paying lots of tax is a good thing because it means you must be making lots of money. But given that property development can see some chunky sums flying around, it’s certainly a good idea to make sure that you’ve taken steps to make sure you’re not paying any more tax than you have to.
The trick with tax is to get things set up properly from the start. I recently spoke to a student who had just joined us, having previously completed a project that bore an all too familiar seat-of-the-pants hallmark. He’d been drawn into the ‘let’s give development a go’ approach and thought it would be a good idea to dive in and learn as he went along. After all, how difficult can it be? Unfortunately, he found out the answer quite quickly.
Everything went swimmingly until he fell down one of the numerous big holes dotted around the development landscape, seemingly designed to entrap the uneducated and unwary. Luckily for him, the experience led to an epiphany and a healthy appetite to understand where all the big holes were located, which we were happy to help him with. After all, minefields are only a major problem if you don’t know where the mines are. However, one of his challenges was the way he’d set up his property development business structure. He’d ended up paying over £80,000 in tax that he would have avoided if he’d known one simple fact at the outset. Education comes at a price, but all too often, ignorance can end up costing significantly more. And like so many tax challenges, he wasn’t able to unpick what had happened and start again. Frustrating, to say the least, and a stark reminder that it pays to get things right from the outset.
So, where should you start when it comes to structuring your property development business and thereby dodging any unnecessary tax bills? I need to mention at this point that I’m not an accountant, so I can’t give you any formal advice. But I can give you some pointers that could steer you in the right direction when you speak to your own accountant or tax advisor (something you should definitely do). The first thing to be aware of is that each development project will need to be set up as a brand-new limited company, known as a special purpose vehicle (SPV). Your commercial lender will insist on it, as it ensures there’s no extraneous baggage, such as previous trading or other shareholders, that could complicate matters for them. It’s a clean sheet of paper through which all of the SPV’s financial transactions and contracts will be run. If you have a joint venture arrangement, you and your JV partner will typically be co-directors of the SPV, with a shareholding to match your respective stakes.
Another key benefit of having separate SPVs is risk mitigation. Were you to have all of your development projects in a single limited company, then if one development experienced a problem, it could affect any others. Limiting the liability to one SPV only stops a bad apple from affecting the rest of the bunch. Also, in the last issue, I talked about creating a brand for your business and mentioned that this brand does not necessarily need to be set up as a limited company. For example, your brand might be called ABC Developments, but since all project activity occurs under the SPV (which isn’t ‘customer-facing’ and could be called 24 Acacia Avenue Limited or ABC Project 1 Limited), there’s no real need for the brand to be an LTD.
One concept you may want to consider is the creation of a holding company. This is a limited company that owns the shares of each SPV, where the profits from each SPV roll up to the holding company rather than being paid directly to you personally. This can allow you more flexibility when it comes to the timing of the drawdown of your profits. It can often be more tax-efficient for the holding company to lend money to an SPV than taking the profits from SPVs 1 and 2 as personal income, then lending the money personally, having already paid income tax on it. Of course, you may have other businesses in the mix too, and these can also potentially be accommodated within the holding company structure. These businesses could include trading entities as well as a company that holds your rental property portfolio.
Everyone’s situation is different, hence it’s essential you obtain advice from an accountant or tax advisor. That said, it’s worth knowing that not all accountants are created equal. Like other professions, there are specialisms within accountancy and tax planning that can make a huge difference to the advice you receive. For example, you probably wouldn’t want the solicitor who did the conveyancing on your last buy-to-let purchase to represent your interests in an upcoming divorce settlement. Or what about your Ear, Nose, and Throat specialist having a stab at a spot of brain surgery? They may be ‘solicitors’ and ‘surgeons’ respectively, but they’re certainly not one and the same. Similarly, you need to make sure that your accountant knows their stuff when it comes to property development. Many a new developer has mistakenly opted to stay faithful to their long-term general accountant, not appreciating that they were not up to speed on the intricacies of property taxation and paid more tax than they needed to as a result. How do you know whether an accountant knows their stuff? Speak to other property people whose advice you respect and get references from the accountant from their developer clients; you’ll soon find out who the experts are.
Having a tax-efficient structure can undoubtedly save you money, but it’s by no means the only business-related activity you need to be thinking about. One of my biggest bugbears about many property training courses is that they focus exclusively on imparting property knowledge yet have nothing to say on the subject of business skills. Every property venture is a business, even a simple buy-to-let, and it’s essential to apply some fundamental business principles to ensure that the enterprise is successful.
There are too many essential business skills to cover here, but none of them are rocket science, nor do you require an MBA to get your head around them. You simply need to know what you don’t know. Let me focus on two key elements that will go some way to keeping your property development business (or any other business) on track.
The first is making sure that you manage your cash flow. The industry is rife with stories of development projects that should theoretically generate a healthy profit, only to run into difficulties half-way through because they ran out of cash.There are several potential squeeze points for cash flow in the development cycle. The most obvious arises from the fact that commercial development loans are drawn down in tranches during the development phases. The presence of highly tempting sports car dealerships dotted around the UK has led commercial lenders to avoid advancing developers all their development funding upfront. Instead, they’ll advance you the first tranche and send around a surveyor to make sure that the project has moved sufficiently forward following their first payment before releasing tranche two. But your contractor and other professionals aren’t tied into the commercial finance, and they will still need to be paid even if tranche two doesn’t materialise in time. You need to manage the cash flow between drawdowns and bill settlements to make sure that everyone gets paid; otherwise, you may find that the project stalls and the contractor walks – not a great position to find yourself.
Another cash flow consideration is VAT. In theory, you shouldn’t need to worry about VAT because your SPV will be VAT registered and so you can claim most if not all of it back. It’s a great theory, but this is where reality can bite developers hard if they’re not on their A-game. Being cynical, the taxman knows that property developers generally only claim back VAT rather than paying it to them. As a result, they’re not always in too much of a hurry to process their VAT registration applications. You’ll be paying bills that include VAT, expecting to get the VAT back, but the VAT won’t physically hit your bank account until after you’re VAT registered. I’ve run some developments where the VAT registration didn’t come through until after we sold the units. All roads may lead to Rome, but you’ll need to ensure that you survive the journey and allow for this potential delay in your cash flow.
The last business essential I wanted to mention was the good old business plan. The mere mention of these can often induce yawning, if not instant slumber, mainly because they sound a bit like the homework your bank makes you do before they lend you any money. After all, when you’re starting an exciting, dynamic property development business, the last thing you feel like doing is writing a stuffy old business plan.
Let’s first get clear on what a business plan shouldn’t be. In a previous life, I ran one of the UK’s leading structural engineering firms, and I recall tasking someone with putting together an updated business plan for the company.
What I got several weeks later was a document several inches thick that made War and Peace look like a double-glazing flyer. Business plans need to be working documents that reflect the current goals of the business. They’re next to useless if they’re three hundred pages long and live in a dusty drawer.
The solution is to create a one-page business plan. A plan that gets updated monthly, reflecting all the key elements of the business, including the high-level goals and actions for both the coming month and the longer term. It achieves everything your business needs from a business plan on a single sheet of A4 paper. And because you’re reviewing it monthly, you also end up revisiting your business goals regularly. Business goals invariably change over time, just like personal goals do. Have they changed, and do you need to pivot in some way? Having a useable and highly effective business plan ensures that your business goals and strategy are flexible and always stay front of mind as you move forward.
Remember that every commercial enterprise is a business, and it pays to learn, understand, and adopt some key business principles from the outset to ensure that you have every chance of success. Next month, I’ll be looking at recruiting a professional team that will not only make your new property development business look highly credible you’ll also have the best possible chance of getting your first project completed quickly and successfully.