the risk profile of the project, these risks may be mitigated by fixing interest rates, imposing pre-sale requirements or investing only after development approval has been obtained.
Liquidity risk
Unlike other commodities such as shares or bonds, property cannot be traded on a daily basis. A developer may plan to develop a property for a quick sale but may be stuck with the property if the market is in a downward trend. Property is generally sold with conditions and these could delay the flow of funds and hence the developer's cash flow. To mitigate this risk, it is advisable that the developer has a contingency cash reserve for this eventuality.
Borrowing risk
Borrowings will magnify gains or losses and increase the volatility of returns. Volatility will result from fluctuations in interest rates and risks associated with refinancing loans once the terms expire. A way of mitigating this risk is for the developer not to leverage or gear too highly. Depending on the project's risk profile, the developer should aim not to exceed debt levels of 65 per cent of the final asset value or 70 per cent of the total development cost.
Risk of bad purchase
A developer will always face the risk of paying too much for a development site, buying in the wrong location or failing to obtain the development approval (DA) for the type of building they envisaged. This can happen if the developer is impatient and does not obtain the correct market information or is influenced by an overzealous real estate sales consultant. The risk of a bad purchase can be reduced by better negotiating skills, more extensive market research and making settlement conditional on securing a DA.
Construction risk
During the construction phase of a development potential risks can include the following:
• The construction costs for a project may exceed the budget, which will reduce the potential profit from the project.
• The construction period may exceed the projected building schedule, delaying settlement of sales and/or leasing of the building.
• The builder may run into financial problems and may not be able to complete the building, requiring the developer to employ another builder, which could ultimately increase costs.
To reduce these potential risks, the developer should appoint reputable and experienced contractors who have adequate insurance cover and sufficient financial resources for the type of works for which they are engaged.
Business failure
All types of business are subject to the risk of business failure and property development is no different. It can be a result of bad management, a decline in the local economy, change in consumer tastes or bad timing, for example. Good management, careful market research and creative marketing can help to reduce this type of failure.
Minimising risk
The aim of the developer is to minimise these risks as far as possible. Some additional strategies that can be applied are listed here.
• Allow for contingencies: To protect against financial risk during the purchasing stage, prepare for various contingencies in the contract.
• Diversify investments: Diversification of development and investment activity into different building types as well as localities will assist in the mitigation of risk.
• Limit ownership liability: Property developers should select a special purpose vehicle (SPV) for each project to protect themselves from personal liability in relation to tenants, consultants, contractors and the general public.
• Limit financial liability: Developers should aim to effect non-recourse financing for all loans and use an SPV to shield their personal assets. Another approach is to find financial equity partners who will help to carry any financial losses.
Summary
This chapter provides an overview of property development and the risks and rewards in both residential and commercial development. You must decide whether you have the motivation and personality to take up this profession or whether the industry carries too much risk for you personally. If you conclude that it is worth your while you need to understand that success will not be achieved overnight. It will take several years of learning and experience, and some hard knocks, to build up a full understanding of what it means to be a property developer. The following chapter offers some key insights into being a successful practitioner.
CHAPTER 2
Characteristics of a successful developer
The property development industry offers boundless opportunities for those who are prepared to take the time to acquire the knowledge that most buyers and sellers of established real estate do not have. It is not a business that will reward those who act quickly or spontaneously or who operate purely on gut feeling. Only a few who depend for success on luck alone will profit by it. It is a risky business, in which the stakes are often high when compared with other ventures. But with high risks come potentially higher returns. The successful developers I know work on strategies to reduce the risks associated with their projects as well as their personal financial exposure.
What makes a successful developer
Property development is an innovative and rewarding entrepreneurial activity that attracts a diverse range of people with various backgrounds and skills. In a development project of any size, a team of people with different skill sets is required from start to finish, and for the project to succeed there must be a leader, a highly motivated visionary and entrepreneur who drives the team. As in all businesses, there are good, principled entrepreneurs and unethical ones. Consistently successful developers take a professional and ethical approach to their business.
The successful property developer has a full understanding of the development process from the inception of the project to the final operation of the building(s) and understands the roles of the various participants in the process. As leader, he or she must have the ability to analyse, conduct and test the feasibility and financial aspects of the project. Other prerequisites for success are good management skills in development planning, development management and project management and a good understanding of construction methods. As with all entrepreneurs, the property developer must have the ability to read the market. Last but not least the developer has to understand the various risks involved in the project and develop strategies to mitigate these risks. In summary, successful property development requires the following interacting components.
Successful developers are passionate about property and thrive on all aspects of this stimulating industry. They talk about property constantly and read voraciously to build on their knowledge and skills. They relish the challenges that property development offers and are prepared to take risks. These developers have a passion for excellence and an eye for detail. A failed project or new building with poor quality standards reflects a developer who does not possess these qualities. In addition, the successful developer follows a very simple formula, which is to listen carefully to the needs of the market and deliver a product suitable for that market.
It takes years of hard work and hands-on experience before you can lay claim to being a developer. Successful developers build their knowledge through reading and attending various courses. They undertake their own development through hands-on experience. This experience can be gained either by working with a seasoned developer or by employing a professional development or project manager. Once you have a full understanding of the
