5 Types of Risk in Property Development You Must Know Before Starting a Project
It’s no secret that there are all types of risks you need to be aware of when you think about tackling a residential property development project.
It can be a high-risk game if you don’t put the time and effort into mitigating as much risk as possible.
In this article, I’m going to share 5 types of risks in property development that are completely in your control.
They’re practical risks that you can manage from the outset of your development. They are guaranteed to help minimise the overall risk of your project.
1. Time Overruns
One of the first types of risk in property development you need to be aware of is time overruns.
We’ve all heard the horror stories and some of you may have even had some bad experiences.
Residential development projects running overtime is all too common. It’s the type of risk in property development that can be super costly if you don’t have the right risk management mechanisms in place.
The key to managing the risk of your project running overtime is to get your builder to commit to significant but fair liquidated damages in the projects build contract.
Liquidated damages are non-negotiable for all of our build contracts here at Little Fish. No matter how big or small the project or how well we know the builder.
It’s critical you find a builder that is happy to back up their time commitment in the building contract by utilising the liquidated damages clause.
For us, we work out how much rent we would lose on each dwelling per week and times that by the number of dwellings.
That’s the amount we expect all our builders to commit to on every project. It’s fair and significant enough to give your builder every reason to get the project done timely.
Running overtime even with liquidated damages in the contract is still no fun. But at least the funds you’ll receive will absorb some if not all of the financial pressure due to the overrun. Ultimately it could even be the difference of getting your project to the end.
2. Cost Overruns
Make no mistake experienced townhouse builders, contractors and suppliers can be extremely crafty with cost variations.
Especially if you’re a newbie, variations have the power to bring you to your knees if you aren’t careful.
Mitigating the risk of cost overruns comes down to your construction documentation and build contract.
First off you only ever want to enter into a fixed price contract. You also need to eliminate all “assumptions” from the contract before you enter into it.
There should only ever be an assumption or allowance for underground earthworks. Even then you need to be on top of what they have allowed to ensure it’s reasonable.
Builders love “assumptions” they’d litter the entire contract with them if they could. Assumptions means they don’t need to commit to a price.
By the time that they do they’ve already got you on the hook, there is nothing holding them to account.
Apart from fixed-price contracts the second thing you need to do is ensure you include detailed fixtures, fittings and finishes schedules in the contract. You need to make sure nothing is missed.
If you want something to be included in your build then it needs to be specified clearly in the contract and supporting documentation.
Never assume something is included. If it’s not outlined clearly in your construction documentation I can assure you it won’t be included and will become a variation.
A final tip to minimise cost overruns is to allow a contingency for earthworks when figuring out your build cost. This is good practice and will mean you have accounted for absolutely everything.
Once your project is out of the ground there should be no reason for variations if you’ve nailed your front-end planning.
If you are looking for information on development costs, check out this trusty article where we share actual development cost examples.
3. Your Builder Going Bust
The third significant types of risk in property development is your builder going bust mid-project. Or going bust any time after you’ve entered into a contract where money has exchanged hands.
Remember Murphy’s law, if it can happen it will happen so don’t allow yourself to think otherwise.
Do as detailed due diligence as practically possible on your builder before entering into a contract. No matter how they present.
At the very least make sure you get references from previous customers. Paying customers are going to give you honest feedback.
Also, head out to the site and check their work and talk to contractors. Do anything you can that will give you the confidence you need to move forward with a builder.
4. Trusting Third Parties
The fourth type of property development risk is trusting third parties. As the property development project manager, it is your job to have extensive knowledge across all aspects of your project.
At Little Fish we trust no one for anything. We always do our own research.
We’ll talk to relevant professionals and gather as much information as we can. Ultimately we don’t hitch our wagon to any third parties ever. We put the time, effort and resources into our own research because the stakes are too high not too.
You either pay now or you pay later. Either way, you will have to pay so put the time and effort into learning everything you can.
Don’t rely on one source find as many sources as you can and challenge anything and everything because paying later is always more expensive.
At the end of the day you need to trust in yourself (and your team if you have one) and your ability to figure things out on your own.
All decisions you make you need to make them with complete confidence.
5. Rubbery Numbers
The fifth type of risk property developers need to be aware of is working with rubbery numbers.
One of the fastest ways to lose money as residential property developers is by working with numbers that have no science or merit behind them.
Numbers are a massive part of developing. At the end of the day, we are developing for a profit so it’s beyond critical that you get them right.
It’s all too easy to throw numbers around without any science or merit to back them up.
Don’t become a developing statistic, learn what numbers are important and put the time, effort and resources into understanding them.
A key here is to never round your numbers. Financial projections, budgets and feasibilities littered with rounded numbers is a perfect example of rubbery numbers.
Making high-risk decisions based on rubbery numbers is a one-way ticket to project failure.
That’s five types of risk in property development as promised but I’m going to throw in a bonus sixth because it’s too important to leave out.
Be Conscious of Your Emotions
When it comes to types of risk in property development this one had to make the list. That is to make sure that you are conscious of your emotions, emotional decision making is like playing with fire, you will get burnt.
Make decisions based on facts only, not what you think, feel or hope – all decisions need to be backed up with solid facts, period.
Before we wrap up, if you are about to start a project I highly recommend you check out this trusty article on the common pitfalls property developers need to be aware of. And if you have time this one about borrowing for property development.
Both will be worth your time that’s for sure.
Before I wrap up if you are looking to secure a site to develop and you are considering one that comes with plans and permits make sure you check out this video I did first because it can be risky business.
I break down what you need to be thinking about and looking for if you decide to go down that road.
Are you looking for some help? We are a leading property development consultant company in Melbourne and we’d love to help.
Don’t hesitate to reach out to the Little Fish team anytime on 1300 799 277.