The most successful real estate developers take big risks, but knowing the right ways to manage those risks is key.
Key Takeaways
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5 big risks for real estate developers:
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Market swings
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Delays
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Changing laws
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Going over on cost
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Unreliable contractors or consultants
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How to balance risk and reward:
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Be realistic about updates
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Know the market
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Pay attention to legislation
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Conduct sensitivity and scenario analyses
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Create a risk management strategy
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With any investment, there’s a risk you take in order to get a reward. Usually, the higher the risk, the bigger the potential for profit.
For property developers, that risk could be taking on an expensive building project when the market isn’t doing so great. Or, maybe the intended use of a property isn’t well suited to its geological area. Perhaps a developer went ahead with a contractor without asking for references or viewing their license.
The right combination of risk and reward will ensure the projects you take on will not only succeed but also lead to the profit you are depending on. Here’s an overview of the top risks for real estate developers and how you can find that delicate balance.
Top 5 risks for property developers
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Market swings: The real estate market always ebbs and flows, so any investment you make could be a risk if the industry experiences a downturn. A big swing could mean lower property values or high holding costs until the property is sold. Another impact of a market downturn is high interest rates for buyers, so people may hold off on making a purchase.
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Delays: Because there are so many moving parts to development, a project can end up taking a lot longer than you planned for. For example, a bout of bad weather could delay building or renovations. Or, parties could become involved in a dispute about a contract or unions could get involved.
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Changing laws: Laws can greatly impact a property’s value and thus the viability of your project. For example, laws related to zoning, environmental controls, land taxes, and others could make it harder to earn a profit on the property or proceed with plans.
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Going over on cost: Cost overruns can majorly affect success. You never want something unexpected to come up with a property, whether an increase in construction costs or an expensive discovery about the property down the line.
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Unreliable contractors or consultants: Unfortunately, sometimes it’s other people you work with who get in the way of success. An unreliable partner, contractor, or consultant throughout the process can mean you’ll have delays and higher costs, not to mention having to find someone new to help you get the work done.
These risks exist for any real estate developer, but those just starting out may not realize what they’re up against. You always want to ensure that the projects you’re taking on are feasible, with realistic budgets and timelines. Watch for these risks from the beginning to mitigate them.
How to balance risk and reward
There are a few other things you can do to still take on a little risk but reap the rewards, too. After all, no one would take on property projects if there was no potential for a big profit on the other side. Let’s walk through a few other ways to carefully balance risk and reward.
Be realistic about updates
First, it’s easy for developers to take on a project thinking that all the money they spend making updates to a property will pay off with an increase in value. However, remember that this doesn’t necessarily happen. The home or building could have the same or a slightly higher value with an update, and the increase isn’t going to be a dollar-for-dollar match to the expenditure.
Know the market
It’s important to carefully study the market when you’re a property developer. Research should be an ongoing practice. You need to know what’s been happening in the industry and what experts are predicting for the near future. Of course, not all downturns can be predicted, but knowing where everything stands will help you avoid big surprises. Talk to other developers, attend conferences and meetings, and connect with reliable market news sources.
Pay attention to legislation
Always pay close attention to changing laws that could impact you. The more you’re aware of the risks of pending legislation, the more you can factor it into your plans. Awareness is key.
Conduct sensitivity and scenario analyses
A sensitivity analysis shows you how your project will be impacted by variable factors. You can test out what would happen if construction costs increased, for example, to see what you’d be looking at financially. A scenario analysis allows you to test different combinations of situations to see if the project would still be feasible. For instance, you could focus on potential environmental factors or a market analysis.
Build strong relationships
Property developers need to work with reliable, experienced contractors who won’t disappoint them or cause a project to fall through. Make sure you check licenses, ask for references, and sign robust contracts so you can build long-term relationships with great people behind your projects.
Create a risk management strategy
Finally, make sure you clearly outline your risk management strategy to others, whether an investor, a prospective buyer, or a lender. You need to show them that you’ve planned for setbacks in advance. Explain how you would deal with them, and the processes in place to support you through more challenging times.
If you’re unsure where to start with a risk management plan, turn to the experts for assistance.
Why work with Franco Blueprint?
Franco Blueprint can help you start your business and mitigate risks. We also ensure you get paid more efficiently and set up a better accounting system. The right financial systems can make or break a property development business, and we make sure you have everything you need to succeed.
We understand your business model and can help you increase profits. Our qualified team can deliver strategic guidance for job costing, risk management, and much more.
Reach out to Franco Blueprint today and schedule your free consultation to learn how we help real estate developers like you.