Let’s take a look at some of the risks of property development. Undertaking your first property development project is more demanding and involves more risk than buying your first investment property. But although there are more things that can go wrong, there is also opportunity for increased rewards. The greatest risk I believe to the first time developer is inexperience or lack of knowledge.
The good news, however, is that with the help of experts and the advice of specialists the risk that inexperience or a lack of knowledge bring, can be overcome and common pitfalls avoided.
This will fast track you on the road to becoming a successful developer. Now let’s take a deeper look at what I call the 11 big risks.
Risk 1 – Inexperience
The key to eliminating this risk is to always ensure you have the input of a professional property development specialist, especially on your early projects. Not having this assistance could affect your ability to borrow funds. My company has helped many property developers start their careers by setting them on the right path from the very beginning, and helping them to become great.
Risk 2 – Borrowing Risks and Interest Rate Risks
When you borrow funds, you need to be aware of the possibility of interest rates rising during the term of your development or long-term holding of your investment. This can create higher development and holding costs. However, this need not be of concern as the actual increase may not be too high. Of course, on the other end of the scale, you could also increase your profit if interest rates go down.
Risk 3 – Market Value Risks
Based on the fact that property values can fall as well as rise, you can have no guarantee of the value of your project on completion, or even how much demand there will be should you decide to sell. Smaller, quicker, turnarounds will be less risky and there will be less time for values to fall. But on the whole property values rise more often than they go down and in the long term if you are holding on to some of your properties, you will make money. Property values would need to drop by about 15% before you would tend to lose money.
Risk 4 – Risks during Construction
There are several reasons construction costs can increase. Disputes, unexpected delays caused by labour or material shortages, and bad weather, can all delay the construction period and result in increased holding charges. Using a lump sum fixed price and time contract can help decrease the risk of construction costs soaring, as well as making sure you conduct thorough due diligence on the builder before you engage them.
Risk 5 – Financial Risk Factors
The main risk here is not having enough spare capital as a buffer or contingency fund, in the event that costs increase more than you have anticipated. I believe it is important that you allow for and retain a contingency fund for when this happens. Property development involves financial risks and the earlier you realise and understand these risks, the sooner you will become successful as a property developer. As a rule of thumb, I work with a 5 % contingency buffer on all my projects. As I mentioned, you will run into problems, as it is part of the nature of the beast, but a buffer will help to ensure they don’t bring you undone.
Risk 6 – Risk of not conducting thorough Due Diligence
It is essential to have a comprehensive due diligence checklist. Correct due diligence should be carried out prior to buying your property. In order to avoid buying a property that will cause you problems in the long term, you need to work through your list thoroughly including all details relating to the local Council regarding town planning, engineering, the builder and financial analyses.
Risk 7 – Paying too much for the Site
It is true to say in the property business that ‘you make your profit when you buy the site’. Market knowledge, especially in the area of land values, along with the ability to negotiate a good deal are important assets when it comes to ensuring you buy right. Study your market and area wisely; keep your ears to the ground and keep your head out of the clouds. It will save you burning your cash.
Risk 8 – Under-estimating the Costs
Getting an idea of the costs involved in relation to the income side of the feasibility study (the sales), from real property agents and valuation specialists is reasonably easy. However, getting a handle on the expenditure side is much more difficult, especially if you are new to the game. You need to be very aware of all the costs relating to both the income and expenditure sides of the development and how much to allow for each. If you are well-informed regarding your costs, you will be less likely to under estimate them.
Risk 9 – Setting your Borrowing Limit
Do not make the mistake of borrowing to your full capacity as this leaves you no room for movement should you strike unforeseen circumstances, such as interest rate rises, sales slowing, or construction delays. Know your borrowing limit and stick to it.
Risk 10 – Engaging the Wrong Consultants
More and more frequently, clients call me to look at plans that have been badly designed. Approximately 95% of these plans were designed by draftsmen, and almost every time the money the client saved by using less qualified designers, was doubled and sometimes tripled in extra costs associated with construction problems and time delays. If you pay qualified people to do their job, the outcome will be a satisfactory result and you will ultimately spend less money and make more profit. It takes an architect an average of five years to complete a degree and two more years for registration, as opposed to three years in total for a draftsman.
Risk 11 – Disputes with trade and construction contractors
Disputes with trade and construction contractors can cause prolonged holdups, which overstretch the budget as the developer has to cater for the delay costs. When contractors quit before completion a substitute contractor has to be found and in most cases contractors who are called in halfway are more costly. This is because the developer’s negotiation power is weak as contractors are aware you are in a difficult situation.
• The greatest risk I believe to the first time developer is inexperience or lack of knowledge
• If you pay qualified people to do their job, the outcome will be a satisfactory result and you will ultimately spend less money and make more profit
• Know your borrowing limit and stick to it.