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Earlier in this blog series, we covered the strategy of land banking, and discussed the important factors requiring consideration during the planning phase in our 3-part land development series. Today, in the final installment, we’re going to take a look at the last stage of the development process: land development and sale.
Given the fact that land development projects often span several years- or even decades- it’s prudent to remain aware of the various risks that may come into play, even as the project nears completion. Far from being a simple “slam dunk” finish, shifting market conditions, interest rates, and labour issues should all be monitored in order to set the development up for a successful sale.
Let’s take a closer look at some of the most common risks that arise during the development and sale phase:
Risk 1: Interest rates
A hike in interest rates can hurt immediately, and given the long-term nature of a land development project, there is a good chance that a spike could arise during the project’s life span. Thus, developers should always factor in changes in interest rates. This is true regardless of whether a loan is variable or not. Even fixed rate loans can be affected as they will need to adopt the new market rate when the loan term is up.
Fluctuations in interest rates can affect profit margins, cash flows, and loan covenants. Even large, seasoned developers have historically encountered trouble after borrowing too much money on lower interest rates, and then suddenly finding themselves unable to meet loan commitments in the face of a substantial rate increase.
Risk 2: Materials
Raw materials have fluctuating costs. This is especially true today given the instability of political regimes in countries responsible for producing many of the raw materials necessary for large scale Canadian builds.
Though developers budget for certain costs, it is not uncommon for the cost of goods to rise throughout the course of the project. Depending on the situation, it can be wise to purchase certain materials early in the game to avoid paying more down the road.
Early purchasing can also help to avoid undue delays. A holdup on delivery can postpone construction, throwing the project drastically off course. If unprepared, developers may be forced to incur more debt, which could be difficult if they are currently highly leveraged or suffering lower profits than anticipated.
Nick Dukesz, CFO of Plaza Partners, says, “Over the last three years, construction costs in the GTA have increased at significantly higher rates compared to long-term averages. However, many projects are still able to maintain profitability because of the strong growth in housing prices.”
Risk 3: Labour
Many contractors and labourers are unionized. Strikes can impact a project significantly, delaying the completion of work and/or increasing worker wages.
Ontario has raised the minimum wage in recent years, and the increase in labour costs can eat into margins. Further, an indirect issue arises when minimum wage workers receive higher pay, as more seasoned workers also expect a salary percentage increase to match their less-experienced coworkers.
Risk 4: The market
Market conditions are constantly shifting, changing the levels of supply and demand. Real estate experts understand that the market operates in cycles, and developers should plan carefully to coincide with the right timing. For example, hitting the market at the right time, with the wrong price could result in disaster.
Even if contracts and agreements are signed in advance, developers need to be aware of the possibility that buyers/renters may not have the funds to complete the deal, given a variety of societal and economic factors.
Risk 5: Environmental issues
As we discussed in Part 2 of this series land development, climate change and environmental preservation are front of mind for both consumers and municipalities. Careful planning is necessary to ensure that a land development project is carried out using eco-friendly building practices that align with all environmental compliance mandates set out by the local governments. As environmental requirements are constantly changing, land developers will need to be frequently checking in with shifting legislation to ensure success.
Risk 6: Societal and generational preferences
Seniors and Millennials are the two largest consumers of real estate, and each demographic has its own unique needs and expectations. In a recent blog, we took a look at the specifics of those expectations- in particular, the trend of New Urbanism. Developers must keep the desires of consumers front of mind. Ensure that these needs are met, or risk facing low demand for the product.
Enlist the help of an expert
More than in most industries, land developers need to plan for possible contingencies across myriad potential challenges, including environmental, political, financial, and societal factors. Throughout the project, and especially during the final stages, it is wise to have a contingency fund in place for financial protection in the event of an unexpected emergency.
The economy is changing at a far more rapid pace than at any other prior time in history. Long-term projects like land development take time to complete, and that means that developers can expect to encounter a range of shifting economic factors throughout the life cycle of the project.
Nick Dukesz adds, “Real estate development is a very involved process with a lot of moving parts. Being organized is key. Having strong teams of internal and external consultants is crucial to managing the process and dealing with inevitable ‘bumps along the road’.”
To remain profitable regardless of the economic circumstances that may arise, it’s helpful to consult with a trusted advisor. At Zeifmans, our real estate experts have decades of experience providing valuable, actionable insight, helping countless clients to establish safeguards against risk, and strategies to enhance sustainable profitability.
Reach out to our team today to learn more about how Zeifmans can help.
Suggested supplemental insights:
Is land banking an effective investment strategy? Part 1 in a 3-part land development series
Land planning and profitability | Part 2 in a 3-part land development series
Developing a property? Here’s what you need to know at every stage.
Hitting it out of the (Development) park – Issues for emerging real estate players
