What are the Risks in Property Development?
Let me be blunt; there are a lot of risks in property development. But the risks can lead to big rewards if managed well. The difference between a seasoned pro and a novice developer is understanding how to manage and mitigate these risks.
We consider risk on five levels:
planning
finance
construction
policy and
market
Read on for an introduction to the key factors to consider in each of these risk areas. It’s not an exhaustive list, just some food for thought in a large subject area in the world of property development.1.
1. Planning Risk
You generally require planning permission for property development in the UK. You apply to your planning authority (local council) to build, extend and sometimes convert buildings. The planning system is in place to ensure development is brought forward in line with national policies and the public interest by aligning development to the needs of local communities.
Planning risk is the potential the local authority does not approve your scheme. This can stop you dead in your tracks; no planning consent means no building.
You will often see developers buying a site with planning permission to avoid this risk. Alternatively, you will probably have seen the acronym STP. These three letters essentially mean you agree to buy a site Subject to Planning. In other words, if you can’t secure planning permission, you don’t have to buy the site.
When buying something subject to planning, you must assume the costs of removing that risk, i.e., gaining planning consent from the local authority. This will involve professional fees and expenses, including architects, planning consultants, and maybe other professionals such as traffic consultants, surveyors, communications, etc.
These costs are all at your own risk as there is no guarantee you will be successful with your application. However, investing in good professionals can certainly reduce your risk.
Securing planning permission is a complicated and specialist business. The National Planning Policy Framework (or NPPF) has 75 pages of policy that you need to adhere to; each clause is a potential banana skin for developers.
We generally recommend our clients work with a good planning consultant who knows the NPPF inside and out and has good contacts with the local planning authorities. It’s impossible to simplify planning policy, and it pays to work with specialists to reduce your risk.
2. Finance Risk
Finance risk is the potential that a developer does not have access to the money they need to complete their project, or they do, but the finance cost is prohibitive.
You can consider finance risk on several levels:
The cost of acquiring a site. Don’t forget the deposit and senior debt; then there’s development, bridging or mezzanine finance, and taxes and professional fees.
Fees and costs associated with attaining planning permission. See planning risk.
Finance to pay for the construction costs. Do you have enough money to complete the construction of a project?
Achieving your sales target and making a profit. This is about whether you can achieve the correct sales values to ensure you repay your finance and leave a reasonable profit margin to make the risk worthwhile. See market risk for more on this subject.
It’s possible (likely even) that the cost of finance may mean your development does not stack up financially, i.e., you can’t make a profit with the project. It requires careful analysis when you analyse and do your due diligence on a development project to ensure the deal “stacks”.
Accessing finance for property development may be via specialist brokers, and there are many in the market. Find one that understands your business plan, and they will help you access finance at a cost that works for you, whether from banks, angels/private investors, or other lenders.
We’ve enjoyed talking with Michael Primrose from The Property Finance Collective and Martyn Pollock from Hallcroft Finance about past funding of property deals.
3. Construction Risk
There are many risks in construction. As a developer, you must know your responsibilities under Construction Design and Management, or CDM. You can find out more about CDM on the HSE’s website here.
n truth, this is a massive topic, and there are whole books written on the subject, but here’s a summary of some of the critical factors to consider in your risk analysis:
The cost and availability of materials. Increases in material costs can be handled with a fixed price contract. Still, material availability is a common risk, especially when there is high demand, low resources or supply chain risks. If you’ve got building works going on right now, you will probably feel some pain.
Labour risks. As with materials, an increase in labour costs can be handled with a fixed price contract, but labour availability is a common risk, especially when there’s high demand and a shortage of readily available labour.
Below ground risks. It’s often said that it should be plain sailing once you get out of the ground with a new build. By then, you will know what surprises are hiding underground, e.g., drains, cables, rock formations, contamination, archaeology, hidden basements, and waterways. All these can cause havoc with substructure construction.
The health and safety of you and your team on the construction site. In the UK, we have an excellent record for safety on construction sites, but you should never forget there are many hazards, from trips and slips to working at height and with hazardous materials. The primary responsibility lies with the principal designer on a project, which may be you. Don’t assume this is your contractor. However much you plan, accidents can and do happen. When they do, they can result in a site closure while HSE investigates.
Extreme weather events. This is a tricky subject because contractors should plan for bad weather. Sometimes weather events can be very disruptive; for example, cold weather can stop concrete from being poured. Make sure your contractor has considered all the angles.
Contractor skill and liquidity. Can they deliver your project to a high quality and within the programmed timeframe? Slippages in time or quality of workmanship can be very expensive and erode your margin. How stable are they? Contractors are businesses and are subject to normal commercial pressures; often, this can lead to credit problems or bankruptcy. This will cost the unlucky developer time and money while finding a replacement.
Fire risk. Just as with a finished building, an incomplete building is also vulnerable to fires, especially as the construction process involves lots of fire hazards such as welding and soldering. Make sure you have considered how to mitigate fire risk in your development plan.
As with all the other risk areas, specialist consultants can help you manage and reduce your construction risks.
There is a lot to consider on this subject – we are barely scratching the surface here. Proceed with caution.
4. Policy Risk
Policy risk is the potential for changes in government legislation which could adversely affect your development and profitability. These may be changes to planning policy, which affect the likelihood you will achieve planning permission in the first place. They could also be more significant changes, like the route of road and rail projects and how these impact land and property sale prices.
I once heard an experienced developer say that you should follow policy, not prices, to make money in property. This developer had made a lot of money when the Commonwealth Games was awarded to Glasgow. The property he had acquired before this announcement made considerable gains in value overnight. But, of course, there was no guarantee this would happen.
There are also changes to the Building Regulations that specify the minimum standards you must use when you build, extend or refurbish properties. They include factors such as the energy efficiency of buildings and the materials you might use. Don’t confuse Building Regulations (B Regs) with planning permission.
Let’s also not forget about changes related to significant market disasters that affect all development. The Grenfell Tower disaster is an example of where past deficiencies in construction are having a dramatic impact on the delivery of new homes. Fire safety policy in high-rise buildings has driven up development costs considerably, but for good reason.
5. Market Risk
Market risk is the potential for changes in house prices or customer expectations.
With house prices, we seem to be on an ever-upward trend in the UK. But historically, that’s not always been the case. There are times when house prices have fallen, generally at times of recession or other significant changes in the market, such as the 2008 credit crunch.
At the time of writing, we have the highest inflation rate in 40 years, a war in Europe, tax rises and a predicted recession in the second half of the year. How will this impact your target market and their ability to buy a property? Are we in for a house price roller coaster over the next few months or years?
Development projects often take years to complete. Could prices have swung downwards when you get your product into the market, eroding your profit margin? Have you built enough fat in your business plan to accommodate a negative housing price shift?
Equally, there’s the possibility that more considerable macro factors will change the market demand. Think about the impact of the pandemic on people’s living environment.
More people are now working from home and will want a home office and some outdoor space. Less commuting may reduce demand from traditional commuter hotspots around the big cities. The possibility of other lockdowns may depress demand for one-bedroom apartments.
Changes in market conditions may be easier to predict, but they are no less impactful on property developers.
What can you do to manage risks in property development?
With all these laid out, you may think property development is not worth the risk. Yet, there are significant gains available if you manage your risk well.
So how can you do that?
At a top level, you have four options for managing risk:
Avoid
Contain
Minimise
Transfer
Here are some examples of each.
You might avoid planning risk by acquiring sites with planning in place or subject to planning.
You might contain finance risk by working with a good broker, someone who knows the strengths and weaknesses of the finance options available. It’s not always the case that the lowest rate is your best option.
You might minimise market risk by factoring in a good contingency in your budget to accommodate any market swings. You could also work with a competent estate agent to help market your properties well.
You might transfer construction risk by employing a principal designer and a main contractor rather than hiring individual sub-contractors.
Risks in property development and construction projects are complex. I’ve laid out the more common risks in property development that should help you in your property journey. If you would like some considered advice for your specific needs, get in touch, and we will be happy to help.
