Risk Management in Property Development – What You Need to Know
Developing residential property can be a sure-fire way to generate some serious amounts of wealth. If you do it successfully, you can essentially create large amounts of equity, almost out of thin air.
Sometimes two plus two can equal five, that’s how aggressive it can compound if you get it right.
In this article, we’ll discuss what you need to know when it comes to risk management in property development.
We’ve previously discussed topics such as the benefits of becoming a boutique property developer in Australia, the step by step process to developing real estate and explored what a dual occupancy subdivision is.
However, a property development project is like any major project in any field, there are risks involved.
We don’t say this to scare you off. But to let you know all the possible hurdles along the way. It’s important that you are fully informed and aware of how to mitigate these risks.
Side note – you might also be interested in these five common pitfalls of developers that you need to understand before you start your next development project. And if you’re new to the game I explain in great detail what a property developer is here.
So, without further ado, let’s check out everything you need to know about risk management in property development.
We’ll start by explaining the common risks, and finish on how to avoid them.
Financial Risks – Interest Rates
A few would-be property developers sometimes fail to have enough capital as a buffer in case of interest rate rises.
This is a real possibility with variable rate loans. A rise in interest rates results in higher loan repayments and increased holding expenses.
This can negatively impact your profit margin once the project gets completed. Don’t operate too close to the line.
You never know when hard times are going to hit so you need to keep your tyres pumped up and be prepared for all scenarios.
Construction Cost Blowouts
While sometimes everything goes according to plan, occasionally construction costs can balloon out, catching you unaware.
Particularly at the beginning of the project during the excavation, as its anyone’s guess what will be found underground.
Understanding this and allowing a contingency for this part of the project will help soften the blow. It’s the variations throughout the remainder of the project you need to avoid.
Builders love variations make no mistake. This is where builders think they can scoop up some cream and good builders are experts at sending them out.
So it’s your job as the developer to make sure your documentation is bulletproof from the beginning and that everything has been considered leaving no loopholes for the builder to exploit.
Your goal as a developer is zero variations which can be achieved if you put enough time into your front-end planning.
The two key to achieving zero variations are firstly the bulletproof construction documentation where all fixtures, fittings and finishes have been considered.
The second is not making changes on the fly. If you nail both of these it will go a long way to avoiding cost overruns and avoid a stream of variations throughout the build.
Here are some detailed development cost examples you can expect to incur if you were to undertake your own dual occupancy development project.
Are you looking for a builder? Check out our curated list of Melbourne’s best dual occupancy builders.
A Downturn in the Property Market
Like any market, property values can fluctuate. A downturn can see your property fall in value, impacting your final settlement figure and cutting into your profit margin.
Property downturns aren’t even favourable for buyers, as a slump is often in line with stagnant wages and increased costs of living, making it difficult for potential buyers to get credit.
That all said, there isn’t anything specific you can do about it, it’s out of your control but you need to be aware of it.
The best way to mitigate a property downturn is by being really good at what you do. Successful property developers make money in all markets. So never stop refining your own systems and processes and continually striving to improve.
Side note, check out this handy little resource with some killer tips on how to become a successful property developer.
Even if it is raining money for you right now, there will come a time when things will tighten up.
The last thing you want is to become another developing statistic. So be a proactive developer, NOT a reactive developer.
Supply and Demand of the Market
An oversupply of a particular type of dwelling can drive prices down. Reduced property values mean reduced profit margins for developers. A great example of this is the inner-city apartment glut in Sydney and Melbourne.
With so many small, inner-city apartments values have dropped and they’re currently not a significant investment for either developers or investors.
It’s much wiser and risk-friendly to do a side by side dual occupancy development in a favourable suburb – there is a reason why you are seeing these smaller dual occupancy development’s popping up everywhere.
Disputes Delaying Project Completion
Unfortunately, during construction projects disputes can and do occur. You could wind up in a dispute with the builder, due to missed deadlines, late payments or simple disagreements. Builders could wind up in a conflict with trade contractors over similar topics.
Any dispute has a severe implication for a development project. It means that work stops and your completion date shifts.
If you’re selling off the plan (which we recommend), then your buyers will have to wait longer to settle on their property, upsetting them and meaning you won’t see your profit when you expected you would.
The best way to minimise real estate development risk such as time overruns for is to include significant liquidated damages in your construction contract, most things related to time overruns are out of your control so for you as the developer it’s about minimising the impact if such occurs, so be smart and think laterally.
Changes to the Law
Finally, changes to legislation need to be considered as part of your risk management in property development plan.
Governments love to change the law. After all, it’s what they’re meant to do.
However, changes to town planning restrictions, residential zoning, landlord and tenancy act, stamp duty, income tax, capital gains tax, user restrictions and land tax can all impact on the property development industry resulting in delays and decreased profit margins.
So it’s important you keep your finger on the pulse. If you want to make industry expert level profits. You need to operate with the skill and knowledge of an industry expert.
Remember, knowledge is not only power its also profits.
Finally, before I discuss how you can mitigate a lot of the aforementioned risks another notable risk worth mentioning is purchasing a site with plans and permits.
How to Mitigate These Risks?
If you’re informed, savvy and know all the hoops to jump through, you can effectively mitigate these risks. But it takes a lot of front-end planning and knowledge.
Lucky for you here at Little Fish, we specialise in both educating regular people about how to successfully develop a property.
And we also offer our tailored development project management service.
Give us a call on 1300 799 277 for a free consultation and to learn more about how to mitigate risk when developing a residential development site.