Author: Jean Folger
Source
Real estate development is the business of building new structures and modifying existing ones to increase their value. Developers may specialize in commercial or residential buildings, ranging from apartment complexes or single-family homes to restaurants, office buildings, warehouses, and retail spaces.
Most developers handle a project from the earliest planning stages to the product completion. They plan, design, and finance the venture, assemble a team, and manage the project to its completion. Once the project is completed, the developer usually sells the property to a real estate investor. An exception is the single-family home. Many developers sell houses directly to consumers.
While property development can be a particularly lucrative area of the real estate industry, developers face numerous risks and challenges that can derail projects and profits. Here’s a look at some of the primary challenges in real estate development.
Key Takeaways
- Real estate development is the business of building commercial or residential structures or improving them to increase their value.
- Many real estate developers start their careers as real estate agents, while others start in construction.
- Challenges in real estate development include reading the market accurately, responding to local opposition, and handling local bureaucracy.
Reading the Real Estate Market
In the real estate development world, it can be a costly mistake to assume “If I build it, they will come.” Developers should pursue projects driven by current market needs—not by hoping to create a need.
To get a good read on the market, developers study a wide range of factors including economic, educational, employment, and environmental data that determine what kinds of structures are needed by a community.
Note
Real estate development includes three main phases: pre-development, construction, and post-development.
Choosing the Right Site
You’ve heard it before: location, location, location. Every successful real estate development project starts with a site that aligns with the developer’s target market and main demographics. Because choosing the right property can make or break a project, developers must find the best real estate opportunities. To help assess potential sites, developers consider factors including:
- Accessibility
- Competition
- Environmental risks
- Applicable fees
- Design requirements
- Planned improvements
Responding to Opposition
It’s easy to underestimate the potential for neighborhood opposition. Projects can be derailed if neighbors successfully pressure elected officials to kill a project—even when the law is on the developer’s side.
There are various reasons that the neighbors of a project might oppose it, including concerns about traffic congestion, noise, changes to a neighborhood’s character, conflicts of interest, and conflicts of values (such as ecological preservation vs. economic growth).
To limit potential problems, developers should first determine why there may be opposition to the project and then build an outreach strategy that responds to the concerns.
Getting Approvals and Permits
One of the first steps in development is obtaining plan approval from the appropriate municipal office. Then there are the permits, which are required for new construction, reconstruction, alteration, repair, movement to another site, and the removal or demolition of any building.
Separate permits are needed to install, extend, alter, or repair electrical, mechanical, HVAC, and plumbing systems.
While getting the proper approvals and permits can be a straightforward process, there is always the risk that it will take significantly longer than expected or that the approvals and permits won’t be granted.
To limit headaches, developers should start the permit and approval process early and communicate effectively with the local municipality’s permit center.
Job Site Risks
Construction sites are inherently risky, and those hazards need to be identified and evaluated. Appropriate safety plans and procedures need to be put in place.
According to the Occupational Safety and Health Administration (OSHA), the fatal injury rate for the construction industry is higher than the national average for all other industries. The most common injuries are:
- Falling
- Slipping and tripping
- Airborne and material exposure
- “Struck-by” accidents (when a worker is hit by a vehicle, falling object, or flying object)
- Excessive noise
- Vibration-related injuries
- Scaffold-related injuries
- Electrical incidents
- Burns
- Material handling injuries
While worker safety falls on contractors, the developer who hires the contractor is ultimately responsible.
Other job site hazards are conditions that can lead to project delays and added costs. Examples include adverse weather, buried debris or utility lines, higher-than-expected groundwater levels, and soil with inadequate bearing capacity.
There’s a chance that these conditions can trigger contract clauses that shift risk from the contractor to the developer.
$417,000
The median sales price of all homes sold in the United States, as of the end of 2023.
Minimizing Defect Losses
Architects generally maintain professional liability insurance to protect against mistakes like specifying the wrong type of concrete or miscalculating a structural load. However, the losses caused by design errors can far exceed policy limits, especially in large-scale construction projects.
That means the developer could end up bearing a devastating loss.
There are ways to limit the risk of design defect losses. For instance, the developer can increase the project’s insurance coverage—both with the architect and through a project policy— and buy an Owner’s Protective Professional Indemnity (OPPI) policy.
Of course, the best way to reduce risk is the avoid design errors in the first place by selecting highly qualified architectural firms with stellar reputations and low claim histories.
Managing Cost Overruns
Real estate development can be highly lucrative, but profits can quickly erode due to cost overruns. From fluctuating labor and material costs to unexpected snags and change orders, budgets can be blown.
The developer takes all the risk of cost overruns, and the best way to avoid them is to over-budget in the first place by adding a buffer of 10% to 20%. It’s also a good idea to add an extra 10% or 15% in time for each project stage to account for unexpected delays.
What Is the Difference Between a Real Estate Developer and a Real Estate Investor?
Real estate developers buy land and build or renovate the properties on them. They then sell the finished properties to real estate investors, who buy them for their cash flow or, down the road, their resale value.
That’s a bit of an oversimplification. Many properties are sold by developers directly to their users, for commercial or residential purposes. However, developers build structures, sell them for a profit, and move on to the next project.
What Education Do Real Estate Developers Need?
While no formal education is required, most real estate developers have at least a few years of real estate or construction experience.
It’s also helpful to have business management skills. Developers do business with architects and other contractors, deal with local government bureaucracies, acquire land, buy equipment, hire workers, and more.
What Do Real Estate Developers Do?
Real estate developers buy land or distressed properties and create value by building new structures or modifying existing structures.
Real estate developers handle construction projects from start to finish. They plan, design, and finance the venture, and they assemble a team to execute the plan.
Once a project is completed, the developer usually sells the property to users or investors.
The Bottom Line
Real estate development can yield impressive returns, but it’s a significant challenge to see a construction project through from start to finish. The most successful real estate developers are the ones who know how to acknowledge, plan for, and reduce the risks.
Read the original article on Investopedia.