What is development risk?
Updated: Oct 14, 2022
Should you be willing to take any development risk when it comes to earning money from your land?
Property development is a game of risk. But what is development risk? And, as a Landowner, should you be willing to take any development risk when it comes to earning money from your land? The fact that development risk exists should not be the only consideration when deciding the right course of action, especially from a commercial/financial standpoint.
This is a big topic; below I’ll take you through some of the key considerations and hopefully give you an insight that allows you to make the most of development opportunities that come your way. PLEASE NOTE: this article is for information only - always consult your legal and tax representatives for advice specific to your own circumstances.
Risk is a blanket term that covers several different considerations. At Urban R+D, when weighing up development risk, we focus on three questions: What is (A) the level of risk, (B) the amount/value that is at risk, and (C) the potential return/reward for that risk? The below 'Landowner Financial Risk' diagram illustrates the correlation between these factors:
A. Level of Risk
Property Development carries risk. The level of risk is greatest at the beginning of the development process because of the cost and uncertainty surrounding securing planning permission. It wouldn’t be unusual for a single house scheme to have an up-front cost of £20,000 for the production of detailed planning drawings and associated reports. If planning permission were to be refused with no further course of action possible, this money would be lost. We would never advise trying to short-change the planning costs - this would be like pouring money down the drain. If you’re going to pursue planning permission, it needs to be done right.
Once planning for the development is approved, the level of development risk drops significantly. A lot of things can happen during the build process, like discovering site contamination or even contractors going bust, but with the right team and contractual arrangements, these issues are relatively minor in the grander scheme of things. There's no shortage of investors or development financiers willing to lend towards the post-planning development process because there are very few obstacles without solutions at this stage, especially for developments on small sites. The one aspect of property development that remains a risk until the end is selling the completed homes. The Urban R+D strategy for mitigating this risk is to build quality, sustainability and value into every home we build. And in the words of Drew Pritchard - Quality always sells.
B. Amount/Value that is at Risk
All money left in the project until the end of the development process (post-planning, Work Stages 4-6) carries an element of development risk. This includes the development profit margin, any outstanding fees, deferred land payments and the borrowed development finances - they all carry some level of development risk. Within the industry, a 20% Development Profit Margin is considered more than enough to absorb fluctuations and unforeseen expenses arising during the development process.
C. Potential Return/Reward on Risk
For taking development risk, there must be a proportional reward. The development profit margin is set aside as the financial reward of a development project. If there are a number of parties taking development risk, then the development profit will generally be divided amongst them. This usually requires a 'skin-in-the-game' capital contribution to entitle the individuals to their share of the development profit.
In the case of the Urban R+D development process, the Landowner's share of the development profit margin is the return on the risk for the Land capital value left in the project until completion. Urban R+D have created the opportunity for Landowners to de-risk some of the Land Value with the Early Land Payment; to release all available capital from the land at planning and leave just enough in to entitle the Landowner to their share of development profit at the end. The attached example illustrates a 100% return on that risk once the project is completed and sold.
At Urban R+D, we confidently pursue a design dividend for each scheme. 10% above GDV is widely considered an achievable design dividend on quality schemes that are designed and built well. If Urban R+D were to achieve this on your project, then the return on the risk for a Landowners Land capital value left in the project until completion would be 150%.
Urban R+D manages and mitigates development risk in a number of ways throughout the design and development process shown on the below diagram for reference. In the pre-planning work stages 2-3, we focus on site due diligence, due diligence on property markets, and the Architectural site-unlocking strategy before pursuing a complete planning process, making sure to back up a genuine and worthwhile narrative with a formidable consultant team.
The post-planning work stages 4-6 is where there is the greatest amount at risk. Urban R+D ensures a complete package of information is produced during the tender process as well as stringent due diligence on contractors bidding for the work alongside the most suitable procurement route. During the construction process it is essential to manage effectively the contract administration role and responsibilities, always carrying out due diligence on pricing of property, materials, professional fees and all development costs, efficient management of development finance spending and oversight of project budget. Property disposal is the riskiest stage and the most often overlooked. To this end we operate multiple property sales routes/options, always endeavouring to build quality, build sustainably and build value.
Having concerns about development risk is common. But whether development risk exists should not be the only consideration. With the right team observing the correct development process, development risks can be mostly mitigated.
As with any investment, those willing to take a risk can get handsomely rewarded for their efforts. If you own land, have an appetite for development, and want to see how much you could earn by building on it, get in touch with the Urban R+D team for a free no-obligations viability assessment.
This article is for information only - always consult your legal and tax representatives for advice specific to your own circumstances.