For real estate investors understanding what a residential developer does and what drives them is key to the sort of deal you are going to be able achieve.
Some people may think that walking into the room and doing a deal Donald Trump style might sound great. But the reality is the quality of the sort of the deal you are going to be able to get is more realistically linked to the key risks that they have; and how you can help them mitigate those risks. There are 5 key risks for developers and you can only have direct influence over two and indirectly influence a third.
What do Developers do?
Just like other businesses, private developers exist to generate a profit first and foremost. Developers generate their profits, by achieving the maximum sale price possible for the properties they sell whilst keeping their costs for materials, staff and financing as low as possible. These costs can be broadly categorised into 5 key risks:
5 Principal Development Risks
|Land Cost||Land is essential to all residential development; you can’t develop a new development or build without it. Developers have many options in terms of how they procure parcels of land for development; each will have a different cost and risk implication. These range from buying Options all the way through to buying parcels of land which are ‘oven ready’ for development.|
|Obtaining Planning Consent||Planning can be a long and challenging process. One of the greatest issues with planning is that governments and planning authorities rarely provide definitive directives about what type of planning application will or will not achieve planning consent. They merely provide guidance as to the broad objectives that planning policy is looking to achieve. And the process of obtaining planning consent can be more of a process of trial and error to negotiate what will obtain planning consent. The issue with this process is that by itself it can be very costly and consume a huge amount of time.|
|Construction||Construction is broadly about the type of construction ‘system’ which is procured by the developer; traditional procurement, design and build or construction management. Each of these methodologies has different costs and risks associated with them, as well as the ability to make changes to design and rights associated with cost overruns and delays.|
|Sales and Marketing Risk||The sales and marketing campaign is where the rubber hits the road for investors, you are in fact the subject of this process. Risks associated with pricing, sales (or lack of them), timing and costs associated with extensive marketing campaigns, particularly those with an international aspect to their campaign all create risks for the development. Additionally, ensuring successful completion (settlement) and after-sale customer management create additional elements of complexity, particularly in an environment where social media and corporate reputation is highly important.|
|Finance||The cost of financing is like a ticking clock (or timebomb) for developers. The way in which they procure debt and the cost of development capital can be extremely challenging and involves walking a tightrope to balance risk and cost versus having the capital required to effectively fund development throughout construction (a costly process). The specific risk and how developers access capital (both debt and equity) will depend on the corporate structure of the developer. For smaller developers, specific financial performance, paying down as quickly as possible several layers of debt and driving project IRR will be key priorities. Whereas for larger listed companies, they will have access to cheap debt, for these developers choosing the right projects to invest capital into in and meeting key sales targets by quarter dates will drive their reporting metrics and share performance.|
So where can investors mitigate developer risk and benefit in the quality of deal they drive?
As an investor you will have no ability at all to influence the first two risks a developer has, you cannot influence the land they buy nor help mitigate their risks or costs associated with getting planning consent.
3 Ways purchasers can reduce Developer Risk
However, in your negotiation with developers, there are three key areas you should be thinking about when you are considering purchasing off the plan property. Those specifically are:
You obviously cannot get involved with the cost of the main construction project. However, you can influence fit out costs, the reality is most fit-outs are designed for owner-occupiers rather than investors. Most tenants will not pay a greater rental for branded appliances or upgraded worktops, etc. Why not negotiate with the developer to specify your property as an investment and agree a discount.
Sales and Marketing Campaign
Sales and marketing campaigns are expensive – I know I have planned thousands. Developers may spend several hundreds of thousands or in some cases millions of dollars on marketing campaigns. For the developer and the investor, this is dead money, agents love them because it is good for their profile. However, for everyone else they are just an added cost which the developer doesn’t get in their bottom line and the investor ultimately pays for in higher purchase costs. Why not try and buy a scheme that doesn’t have an expensive marketing campaign or buy before it has started and help the developer save costs and ask for all of that saving as a discount.
Buying early in the sales and marketing campaign on key financial dates (such as the end of financial year) or from a developer who has completed stock are all things you can do as an investor to drive developers financial performance.