5 Major Risks in Property Developments

 

Builders beware - proper planning in your finances goes a long way/

Builders beware – proper planning in your finances goes a long way/

In Australia, there is a general love of property – its tangible and over the past 60-70 years since WW2, it has underpinned wealth creation for many Australians.

Nowadays, there are greater demands for property located in highly urbanised areas and as a result, a lot of local councils have been more lenient towards subdivisions, duplex and townhouse developments, especially in New South Wales, Australia.

With a large block of land (600+ sqm) and the possibility of creating value in your principle place of residence, the idea of developing a block of townhouses or duplex might sound tempting.

Below are some of the risks you need to be wary of, because the bank will be:

Completion Risk

One of the more obvious risk but maybe overlooked is how are you going to ensure that the project will be completed in a timely and quality manner. Most banks will not lend unless you have a fixed priced contract with a quality builder, someone who has experience in developing a project similar to the size of your project.  If you are going to engage a builder, ask them for their portfolio of projects done in the past, how many projects do they have on at the moment and whether they have capacity to take on more work.  The last thing you want is for a builder in the middle of the project to be missing in action because they have another project that pays better.

Project Management Risk

Depending on the size of the project (maybe 6 or more properties), you might need to employ the services of a project manager.  The project manager’s role is to ensure the project is going ahead in a timely manner, engaging the services of different tradies and consult on potential pitfalls.  Why are they essential to any projects? You are not only paying them to manage the project while you are at work or wherever, it’s their expertise you need when the proverbial poo hits the fan. How are you going to manage the 15 day rain forecast etc ?

Design Risk

When building, its important that you get the design right and the locals accepts it. More importantly, without getting an approval from your local council, no bank will lend you the finance as getting the approval is usually one of the mandatory documents you will need to provide. From my understanding, without getting proper statutory approval, you run the risk of having your pet project reversed and a costly amendment process to meet the council’s expectation. Time and money you really can’t afford especially when you are in the middle of completion.

Market Risk

Here’s a question: Once you have completed the project and is expecting to sell each unit/townhouse for X amount, but instead the market is only willing to pay a lower Y amount, what do you do? This is a very real risk, especially nowadays when the pricing of properties have gone backwards for different areas. Bank’s recognize this risk and will often ask for presales of the proposed properties to lock in your profit margins. Without presales, you and the bank run the risk of possibly reducing your profitability and making a loss from this endeavour.

Interest Rate Risk

Lastly, during the project time frame, interest rates may fluctuate and this will either positively or negatively impact on your ability to meet interest costs. Logically, the concern would be when the interest rate moves against you during the build and its important to understand what other sources of income you can draw upon to meet these increasing interest costs. Banks usually have ways to hedge against the risk, but the best thing to do is integrate a solution within your feasibility report so you minimize the risk in squeezing your profit margin.

 

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