Challenges in Real Estate Development

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.

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.

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.

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. 

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.