Can Property Development Be Made Less Risky? Hello everyone, I hope you are well. In today’s post, I will be sharing a guest post from property development expert Ritchie Clapson CEng MIStructE, co-founder of propertyCEO. Ritchie will explore managing risk in small-scale property development projects. With small-scale property development now more popular than ever, many people are eyeing opportunities to convert small commercial buildings and shops into much-needed residential accommodations. But there’s nearly always the elephant in the room; property development can make you rich, but it’s inherently risky. If you don’t manage the risk in development, the big profits may not materialise. Managing risk is arguably the most critical task of any developer, new or otherwise. So, how should you go about it?
Can Property Development Be Made Less Risky?
With small-scale property development now more popular than ever, many people are eyeing opportunities to convert small commercial buildings and shops into much-needed residential accommodations. But there’s nearly always the elephant in the room: property development can make you rich, but it’s inherently risky. It’s easy to imagine glitzy new apartments and six-figure profits, but if you don’t manage the risk in development, those swanky dwellings and huge returns may not materialise. Managing risk is arguably the most critical task of any developer, new or otherwise, worth their salt. So, how should you go about it?
First, let me put some cards on the table. There’s no way of de-risking property development completely. Just like most wealth-generating enterprises, it’s a strict risk-versus-reward model. And one of its biggest challenges is that the barriers to entry are minimal. After all, anyone can develop a property by buying a property or some land and then hiring various professionals such as architects and builders to get to work. What could go wrong, they think? Well, the answer they’re looking for is ‘quite a lot’, as many first-time developers subsequently discover.
So, if you’ve ever fancied trying your hand at a spot of property development, let me share a few tips to help you avoid some of the more enormous boulders in your path. There are quite a few smaller ones too, but for now, let’s stick to the whoppers. The good news is that small-scale development is well within reach of most people, and with some essential risk mitigation in place, the process is likely to be more profitable and successful.
The Planning System And What To Expect
Arguably the most significant development risk is what we call planning risk. You’ll need planning permission if you’re developing property, whether a new build or simply converting an existing building. Try building anything without it, and you risk having to knock it down, being fined, or even being imprisoned, so obtaining permission isn’t strictly optional.
The current planning infrastructure originated in the 1950s, and today we’re faced with local planning authorities that are under-resourced, over-stretched, demotivated, and where many of the most experienced people have left. Planning applications that should nominally be assessed within eight weeks (thirteen weeks for larger projects) nearly always take much longer.
These days applicants are frequently told seven and a half weeks later that they need to submit further information, e.g., by procuring various surveys and reports. This stops the clock, and you need to spend more time and money jumping through some hoops without guaranteeing a successful outcome. Some applications have been in limbo for years. And if you’ve already purchased the property in the hope of getting planning permission, you’ll not only be raising finance costs. At the same time, you wait, but the property may even decrease in value if planning is eventually refused.
Permitted Development Rights (PDRs) Can Help You
So, how can you dodge the planning bullet? The answer is to avoid as much of the planning system as possible. Helpfully, the government has given us a tool for the job called Permitted Development Rights (PDRs). These rights allow us to change various commercial buildings into residential use without applying for full planning permission. In most cases, we’ll still need council approval; however, with PDR, there is a short and prescriptive list of things they can object to. So, you know what boxes you need to tick beforehand, plus the council must determine the application within eight weeks. Otherwise, it automatically gets approved. You’ll still need full planning permission if you’re changing the elevations of the building, but that shouldn’t be contentious – the change of use is the important one, and with PDRs, the council’s hands are effectively tied.
My Favourite PDRS That Could Be Your Favourites Too!
Not all PDRs are created equal; my favourites are classes G and MA, which allow us to convert most commercial property types (offices, shops, light industrial, etc.) into residential. Why do PDRs exist? The government has realised we have around four years’ worth of new homes that could be built on redundant brownfield sites. And given that most voters won’t object to developers turning unused commercial buildings into much-needed housing, they’ve been quick to encourage it. So, if you’re looking to de-risk your first project, I would strongly advise you to go down the Permitted Development route as it’s likely to be quicker and more specific.
What If A Property Already Has Planning Permission?
What if you bought a property already with planning permission granted – won’t you avoid the planning risk? The problem with this approach is that the planning uplift has already been built into the asking price, meaning there’s less profit for you. As a result, the successful bidder will be the person who will either build it the cheapest, make the least profit, or make a loss because they’ve got their numbers wrong. None of these options should appeal to you. Even if you think you could improve on the existing plans, you’re still back to square one – having to submit a new planning application that may or may not get approved. So, I would avoid these schemes, no matter how appealing the artist’s impression looks in the agent’s particulars.
Avoid Being Overly Optimistic In Your Profit Assumptions
The subsequent significant risk we need to talk about concerns making optimistic assumptions. I know you’ll tell yourself that you’re far too old and wise to fall into that trap, but the problem is you won’t necessarily notice that you’ve done it. There’s no reward in finding unprofitable deals, so we’re predisposed to hope that every deal we look at will be profitable. There are a lot of variables that determine whether a deal works financially, and you need to make a lot of assumptions, certainly at the outset. If you dial every cost assumption to the minimum, your numbers will project a profit. Dial costs to the maximum, and you’ll show a loss. The trick, then, is to be as pragmatic as possible. Don’t fall into the trap of being just a tad optimistic here and there, as it can trip you up.
Also, ensure you can’t see your overall profit percentage figure when you input your assumptions. If you can, as you see your profit percentage figure reduce, there’s a high risk that your subconscious will make your assumptions less prudent – it’s human nature. The solution is to input every assumption reasonably and only enter your target sale values (GDVs) afterwards. That way, you’ll only see your profit percentage AFTER inputting your cost assumptions.
Your Target Profit Margin
My next piece of de-risking advice is always to target a 20% profit margin based on GDV (gross development value, i.e., your selling prices). So, if your units are expected to sell for a total of £500k, you want to target a £100k profit at the outset. You should also include a contingency budget of 10-15% of the construction costs. This lies at the heart of development risk management. You won’t be able to predict the additional costs that will crop up as your project progresses, so you need to build in enough fat to ride out a few storms. And there will be bumps in the road; the trick is to ensure you’re still left with a decent profit once you’ve crossed the finish line.
Fixed Profit Vs A Percentage
Also, don’t be tempted to target a fixed profit figure rather than a percentage. For example, you might think that targeting a £200k profit sounds pretty good. But if the GDV were £5m, you’d only make a 4% profit margin. It doesn’t take too many unexpected costs to wipe out 4%, so make sure that you stick to 20%, not simply a fixed amount of money you’d like to make. While talking about numbers, make sure you’ve firmed up as many pricing assumptions as possible before committing. You won’t be able to fix them completely. Still, a common mistake is leaving too many figures as ‘reasonable assumptions’, then getting lazy and assuming that your initial assumptions will be about right. Instead, firm up as many of your numbers as possible before you commit, and you’ll reduce the risk of expensive surprises later.
Avoid Risks On-Site By Being Very Specific With Your Contractors
Risk can also crop up while your team is on-site. The most common problem occurs when people fail to specify what they want precisely enough. You’ve specified ‘a dozen internal doors’ in the tender and imagined those rather nice oak ones with brushed aluminium handles. And then, when your contractor installs cheap-as-chips plywood doors, you’re up in arms. No problem, says your contractor; they’re happy to change them, but it’ll cost you a few grand more. The lesson? If you don’t specify what you want precisely enough, your contractor will likely install the cheapest available, so be very specific.
Have A Plan B
My final piece of de-risking advice is to have more than one exit for your project at the outset. You may want to sell your finished units, but what if the market has tanked when you come to sell? The logical thing to do could be to refinance the project onto a buy-to-let mortgage and then let the units out until the market rebounds. On the other hand, if you were planning to rent out the units but the rental market bombed, then your plan B could be to sell. Either way, ensure you’ve worked out a Plan B at the start and know the numbers involved.
As I said, property development has many risks. Still, reducing most of them is possible if you have the proper education to learn where they are and the mindset to have risk mitigation as a primary focus. With so many development opportunities, you’ll be off to a flying start if you get that right.
I hope you enjoyed that.
About The Author
Ritchie Clapson CEng MIStructE is an established developer, author, industry commentator, and co-founder of the leading property development training company propertyCEO. To discover how you can get into property development, visit www.propertyceo.co.uk