Property development can produce huge profits, but it can be a risky business. If you are thinking of turning developer, here are a few thoughts on the five biggest risks.
Planning risks
Current planning infrastructure originated in the 1950s. Today we are faced with local planning authorities that are under-resourced, over-stretched and demotivated. Planning applications that supposedly should be assessed within eight weeks (thirteen weeks for larger projects), nearly always take much longer.
It is best to avoid as much of the planning system as possible, and Permitted Development Rights (PDRs) allow us to change a wide variety of commercial buildings into residential use without having to apply for full planning permission. In most cases, we'll still need council approval, however with PDR's there is a short and prescriptive list of things they can object to. So, you know what boxes you need to tick beforehand, plus the council must determine the application within eight weeks, otherwise it is automatically approved. You will still need full planning permission if you are changing the elevations of the building, but that should not be contentious – the change of use is the important one, and with PDRs, the council's hands are effectively tied.
Assumptions risks
You may believe that you are far too old and wise to fall into the trap of making optimistic assumptions, but the problem is you won't necessarily notice that you've done it. We are predisposed to hope that every deal we look at will be profitable. There are a lot of variables that determine whether a deal works financially, and you need to make a lot of assumptions, especially at the outset. If you dial every cost assumption to the minimum, your numbers will project a hefty profit. Dial costs to the maximum, and you will show a loss. The trick, then, is to be as pragmatic as possible.
Margins risks
An important piece of de-risking advice is always to target a 20% profit margin based on GDV (gross development value, i.e., your selling prices). So, if your units are expected to sell for a total of £500k, you want to target a £100k profit at the outset. You should also include a contingency budget of 10-15% of the construction costs. This lies at the heart of development risk management. You won't be able to predict the additional costs that will crop up as your project progresses, so you need to build in enough fat to ride out a few storms. And there will be bumps in the road; the trick is to ensure you are still left with a decent profit once you have crossed the finish line.
Also, don't be tempted to target a fixed profit figure rather than a percentage. For example, you might think that targeting a £200k profit sounds pretty good. But if the GDV were £5million, you'd only make a 4% profit margin. It doesn't take too many unexpected costs to wipe out 4%, so make sure that you stick to 20%, not simply a fixed amount of money you would like to make.
On-site risks
Risk can also crop up while your team is on-site. The most common problem occurs when developers fail to specify precisely what they want. A developer may have specified ‘a dozen internal doors' in the tender, imagining (but not stipulating) nice oak ones with brushed aluminium handles. The builder can't be blamed for installing cheaper doors, and while the doors can be changed, that involves extra expense. The lesson? If you don't indicate what you want exactly, your contractor will likely install the cheapest available, so be very specific.
Exit risks
Always have more than one exit for your project at the outset. You may want to sell your finished units, but what if the market has tanked when you come to sell? The logical thing to do could be to refinance the project onto a buy-to-let mortgage and then let the units out until the market rebounds. On the other hand, if you were planning to rent out the units but the rental market bombed, then your plan B could be to sell. Either way, ensure you have worked out a Plan B at the start and that you know the numbers involved.
By Ritchie Clapson CEng MIStructE, co-founder of propertyCEO
ABOUT THE AUTHOR
Ritchie Clapson CEng MIStructE is an established developer, author, industry commentator, and co-founder of leading property development training company propertyCEO. To discover how you can get into property development, visit www.propertyceo.co.uk
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