Posted on January 21, 2023

Real estate development (aka property development) is the process of building new structures and modifying existing ones to increase the property's value. In general, that means developing the property into commercial or residential buildings—ranging from apartment complexes and multi-family homes to restaurants, offices, and retail spaces. Developers handle the project from start to finish: They plan, design, and finance the venture, as well as assemble a team to execute the plan. Once the project is completed, the developer usually sells the property to a real estate investor. If the project is individual houses, a real estate developer could sell directly to the consumer.

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.

Misreading 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 evaluate the trade area and a wide variety of factors, including economic, educational, employment, and environmental considerations.

Choosing the Wrong Site

You've heard it before: location, location, location. Every successful real estate development project starts with a great 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 like:

Accessibility
Competition
Environmental risks
Applicable fees
Design requirements
Planned improvements
Neighborhood 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 fears of the project's impacts on traffic congestion, noise, a neighborhood's character, conflicts of interest, and conflicts of values (e.g., 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.

Project 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 potential 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

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 construction costs. Examples include adverse weather, buried debris, unexpected utilities, unanticipated rocks, high- 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.

Design 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 where significant construction projects (e.g., $50+ million) are concerned. That means the developer could end up bearing a devastating loss.

Fortunately, 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.

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 inevitable delays.

What Is the Difference Between a Real Estate Developer and a Real Estate Investor?

Real estate developers buy land and distressed properties, build on or renovate them, and then sell them for a profit. Once a project is completed, real estate developers sell the property to real estate investors, who typically hold the properties for cash flow.

What Do Most Real Estate Developers Study?

While no formal education is required, most real estate developers have at least a few years of real estate experience. Additionally, it's helpful to have strong analytical and research skills and network-building skills to help with funding, land acquisition, marketing, and the like.

What Do Real Estate Developers Do?

Real estate developers buy land and distressed properties to create value by building new structures or modifying existing ones. Real estate developers handle the project 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, a developer typically sells the property to a real estate investor.

The Bottom Line

Real estate development isn't for the faint of heart. While projects can be rewarding and yield impressive returns, developers face numerous challenges from start to finish. The most successful real estate developers are the ones who know how to acknowledge, plan for, and reduce those risks.

Source: Investopedia