Real Estate Development Risks
Real estate development risks and there control is the number one priority of professional developers or maybe they never get to do another development.
I am continually amazed to find after six years of teaching developers that the first thing most do is buy some land with some of their own cash and borrowing the majority from the bank.
To new developers getting control of the land seems logical and yet is the last thing a professional does. So beginning a real estate development by doing the complete opposite to what you should do is putting yourself behind the eight ball from day one and send the ‘risk’ indicator rising.
From a real estate development point of view land is only worth what you can do with it and that is determined by the Town Plan of your City or Town and the particular zone that applied to the land you are considering.
For example, if you were to buy land that is zoned Rural and you wanted to develop some townhouses or residential houses, you would not be able to do so and so add to your real estate development risks.
If you bought some industrial land and your idea was to develop some shopping on it you would not be allowed to do so by the Town Plan.
Professional developers learn the Town Plan, as well as all the regulations that control development activities in certain zones that are of interest to them.
I mentioned another real estate development risk in the second paragraph that is overlooked in a most cases and that concerns the type of finance selected by a new developer when incorrectly he/she buys land as part of their first action.
In one way it is easily understood because the only kind of loan the average person knows about is a mortgage over 25 or 30 years. But a mortgage is the absolutely wrong type of loan to take out when you are a developer.
Why is that? Well, mortgages have to be paid back every month and that means cash coming out of your pocket every month. That is not what developers’ need or only the very wealthy would be able to develop anything.
Developers don’t pay the lender of development finance every month out of their cash flow (pocket). The amount of interest is calculated on a monthly basis on the amount a developer draws down from the lender. That interest is then added to the pay back amount required at the end of the development.
The next reason mortgages are the incorrect finance tool is the length of a development project can be anything from say, one year to maybe three years and then we pay all the development borrowings back to the Lender.
So as mortgages on property last for a longer period of time, they are clearly not the correct product for a short term developer.
So by not being educated in real estate development a new developer is committing to land without knowing “exactly” what can be developed on it and then buys it with the wrong finance package.
So as I said earlier, putting yourself behind the eight ball ‘twice’ at the very beginning of a development is a rotten way to begin your development life.
A few more items of real estate development risks to consider are market knowledge and the lack of a development system blueprint.
Looking at market knowledge many new developers don’t appreciate that they are really a ‘manufacturer.” For example, when you buy any product in a shop it must have many features for it to be bought and successful.
It must be priced right for its target audience; it must be great value; it must do the job it is supposed to; it has to be designed; it has to be researched before it is designed and many other sub items that make up the profile of any product.
A real estate development product, irrespective of whether it is residential, commercial or an industrial product has to go through the same process.
Because as I teach my development students ... you are a manufacturer of a real estate product that the market must “love” in order for you to make a profit, develop a reputation and build a business.
It is for this reason that the single most important thing you can do in preparing for a career as a developer is to study the entire process from another professional who has been down the track on which you wish to trod.
The last example of the kind of real estate development risks to consider is entering into the development business without a development system.
Let me refer back to the beginning of this article and the buying of land that may be incorrectly zoned and buy it with the wrong finance. Let’s say that has happened.
Can I tell you that from that day forward ... that is every day ... the question asked is ...”What Do I Do Next?”
By not knowing what to do next you are adding ‘Time’ to your development project and Time is costing you mortgage money that you incorrectly have to pay every month out of your disappearing capital.
Can you see how bad it can get by not be educated in the business and having a development system or as I call it a Development Road Map. No more asking ... “what do I do next?”
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