Always better to property-develop a decrepit asset?

From OpenArt

Suppose you owned a decrepit property, borderline uninhabitable, requiring substantial cash and effort to fix before it could be put on the market for sale or rent?

If you are someone with few skills in the building sector, is it better to sell off the property as-is to a professional developer; or would it make better financial sense to run a fix-up project yourself and then put it on the market in perfect order?

It always surprises me that a common opinion is that the smart move is the latter: that you would lose money by selling the derelict property as-is and then investing the resulting cash in your own choice of asset-class.

I asked Gemini: "What are the pros and cons of property development as an investment strategy? As compared with, say, investment in equities? If property development offered consistently better returns than equity investment, wouldn't capital move to that sector until returns equalised?"

Gemini:  "You're right. In a perfectly efficient market, with all investors having access to the same information and acting rationally, capital would constantly flow in and out of asset classes to equalize risk-adjusted returns. However, the real world isn't perfectly efficient. Here are some reasons why property development might not always offer the best returns despite its potential for higher gains:

• Higher Risks: Property development involves significant risks like project delays, cost overruns, and market downturns that can wipe out profits. Investors demand a higher return to compensate for these risks.
• Barriers to Entry: Unlike stocks, which anyone can buy, property development requires significant capital, expertise, and connections to navigate the complexities of the real estate market.
• Transaction Costs: Buying and selling properties involve high transaction costs, including realtor fees, taxes, and renovations, which eat into returns.
• Illiquidity: Real estate is illiquid, meaning it can take months to sell a property. This can be a disadvantage if you need quick access to your capital.

So, while property development has the potential for high returns, it also comes with substantial drawbacks that equity investments generally don't have. This keeps some investors away, preventing a complete shift of capital towards property development.

This seems like a good answer to me; also, the right framework to think about the issue. One tends to remember the successful property development projects which - with the risk-premium - paid off well, while forgetting those builders whose projects went bust. And then there's the hours and days of unpaid labour time with the amateur fix-ups...

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Note

Suppose your decrepit asset is worth £X.

Scenario 1: (sell the asset as-is for £X).

Developer spends £X to acquire the property, £Y1 to fix it up, and sells it on the market for £Z.

Developer's net revenue: £(Z - X - Y1).

Your net revenue: £X, ready for onward investment - now.

Scenario 2: (you fix-up the asset yourself).

You borrow £Y2 to fix up the asset and spend it. You sell the developed property for £Z.

Your net revenue: £(Z - Y2 - X) - available at the end of the project.

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If the developer is efficient, his rate of return = (Z - X - Y1)/(X + Y1) will be equivalent to the return any other efficient company makes, and therefore equivalent to standard equity returns.

If your costs (Y2) are greater than his (Y1) then your rate of return will be less than his. You would be better off simply investing £X in a well-judged stock market portfolio.

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In real life there are many caveats: market conditions, local monopolies etc. But in the end, professional competence normally wins out over amateurism when making profits.