In this article, Yasir Ismat, Property Develoment Speciatist at Geelong Property Consulting talk us through the risks involved in property development so you know how to manage them.
Many investors approach property development with rose coloured glasses. Still, to minimise your risks and maximise your chances of turning a good profit (remember you want at least 15 per cent on the development cost), you must understand the potential risks as a developer associated with the development process. Here are some common dilemmas developers can face on any given project.
- Reducing acceptable profit margins.
- Taking on too much too soon.
- Increase in construction cost due to an increase in the price of building material and labour.
- A downturn in the property market.
- Not conveyancing the neighbourhood.
- Overlooking the feasibility check.
- Ignoring the legalities.
- Not paying attention to site purchase.
- Lacking a qualified team of professionals.
- Choosing an unreliable builder.
Reducing acceptabale profit margins
When the market is booming, it becomes harder to find the cheaper land; the developers tend to reduce their profit margins.
As a general rule of thumb, with any development project, you should always aim for a 15 per cent return on your total development cost (which translate to a much larger return on your invested capital) to maximise potentials profits and minimise the risk of losing money.
If you work on a 15 percent margin you will;
- Make good money in a good market
- Make sufficient money in a bad market
If you firmly believe that the property market is about to crash, you wouldn’t enter into a development; if you stick to the 15 per cent rule, you will learn to be highly disciplined and effective in your negotiations. Crucially you will learn to walk away from a deal when it is too risky.
Taking on too much too soon
One of the most common mistakes with multi-unit developments is attempting them far too soon. Generally, what happens is first-time developers get too easily swayed by what agents are telling them. “You can easily fit 12 units on this block. No problem at all, the Council is a joy to work with, too, so think of the returns!”
It is no surprise that greed comes into play, and the result is generally not a good one.
When it comes to financing, many novice developers do not factor in funds for infrastructure, including surveys, road works, and connecting utility services to the lots.
Most first-time multi-unit developers also think construction will start much sooner than it generally does. The reality is it is likely to be on to three years before the first sold is turned. One way to get around this is to hold the site over at least one cycle and that way, the properties have increased in value along the way, so you have more equity, and the banks will be more friendly to you.
Increase in construction costs due to increase in the cost of building materials and labour
This is another common trap developers fall into. They account for set construction costs in their budget when commencing their project, without having any contingency in place for a potential rise in these costs, which commonly occur annually in the construction industry.
They are then forced to borrow more money (if the bank will allow them to – and this rarely happens) or sell their unfinished project and cop a loss in doing so.
You must always have a contingency fund to allow things like an increase in the cost of building materials and labour.
A downturn in the property market
For reasons such as increases in interest rates, cyclical movement in the real estate market and depression or unstable economic conditions resulting in lowered property values or increase holding costs until properties are sold.
We are all too familiar with this in recent times, yet it never ceases to amaze me that people who have worked within the industry for decades still do not allow for this natural occurrence.
The most important thing to remember as a developer is that property markets move in cycles. You need to understand all of the fundamentals that drive booms and busts to time the start and finish of your projects accordingly.
Ideally, you want to be looking at acquiring sites during quieter times and marketing your completed project during times of heightened buyer activity and demand.
Not conveyancing the neighbourhood
Maintaining good relations with the neighbours is very important because ill-feeling in the community can hinder your project regarding approvals and permissions from the local Council. Keep in mind the councillors are elected by the community to be inclined to give the voters’ preferences a great deal of importance.
Communicate with the neighbours well in advance to get a feel for the neighbourhood’s stance about your development project and invest in building good relationships with them. One objection from your immediate neighbour can stall you development for months.
Overlooking The Feasibility Check
A feasibility study tells you whether the price you set to pay for a property is accurate. A common mistake is underestimating the cost of constructing your project while overestimating the price you can get on your completed buildings. Undertaking feasibility analysis right from the beginning helps you make a purely objective, accurate financial assessment. I often do two Financial Feasibilities. The 1st one being a one-minute feaso or quick feaso that I conduct using a feasibility software. The second feasibility that I work on a project is full-scale financial feasibility eyeing out all the possible costs involved in the project.
Ignoring the legalities
Going through the legal stuff can be tedious and time-consuming, but it is a necessary part of the property development activity. Legal agreements like option agreements, building contracts, pre-lease agreements, JV agreements safeguard your interest in the development project. Loopholes in these can be proven very costly indeed.
Not Pay attention to the site purchase
Sites that present build-ability issues with legal or regulatory complications in the disaster-prone area can all spell doom for your property development project. Even buying a simply unattractive site can force you to sell your completed building at a far lower price than you want to. Invest enough attention in assessing a site, its potential and possible issues before you purchase it.
Lacking a qualified team of professionals
A property development team of skilled professionals lays the foundation for a profitable, successful property development venture. You need a solicitor, architect, financial expert, town planner, project manager etc. to advice you on various aspects. Choosing the wrong people for these key role can result in either skewed numbers or plans that set your project on the track for disaster right from the beginning.
Choosing an unreliable builder
Having to replace your builder while your project is midway can be a costly affair that can drastically reduce your profit margin or leave you with huge losses. Avoid choosing the builder just because they are the most affordable. Reliability, experience, commitment and reputation are all key factors to consider during builder selection.
Now is the time to take action and set yourself for the opportunities that will present themselves as the market moves on
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