Let’s talk about profit, baby.
Let’s talk about you and me.
Let’s talk about all the good things.
And the bad things that may be.
Every time I see a news article stating developers are ripping off the public, making huge profits and are being treated like the enemy to modern society, my blood boils. I saw one just yesterday that was particularly misinformed.
But the propaganda is rife, throughout the media, in movies, television shows, and often at the mercy of naive politicians: developers being portrayed as the bad guys. To the bigotry collective and do-gooders, a developer is seen as nothing more than someone who takes a cash windfall from the needy and produces a development that seemingly benefits no one else but themselves.
The truth is property developers are creators. There is no other vocation that can create profit in so many different ways. And unless you have been on the front line of a property development (that’s real estate development to you Americans) project you simply cannot understand what it takes to create a profit. I will go further, you can’t even comprehend what the word profit means, let alone understand who is actually making all the profit!
But, luckily for you, I am going to do my public service, free of charge to tell you everything you need to know – in the world of property development – about profit.
Let’s dig our foundations then. The word ‘profit’, as far as I can tell, is derived from Latin words prōficiō and prōfectus which means to “make, accomplish, effect”, and then later early 14th century this evolved into “to advance, benefit, gain.”
Today, according to the Merriam-Webster dictionary ‘profit’ can be either a noun or a verb. As a noun profit, is defined what many a business person would expect it to mean, with a purely financial focus:
- “net income”, or
- “the excess of the selling price of goods over their cost”.
- “the compensation accruing to entrepreneurs for the assumption of risk in business enterprise as distinguished from wages or rent.”
As an intransitive verb though, the definition of profit expands beyond commercial gain and includes:
- “to be of service or advantage”
- “to derive benefit”
Further, as a transitive verb, profit is defined as:
- “to be of service to”, with an emphasis on service to
While according to dictionary.com it can also mean
- “to take advantage”
So now we have seven different definitions. Definitions 1 & 2 are clearly commercially related. Definition 3 is also financial but introduces the term ‘risk’. The first two definitions carry no emotion whereas some might be excited and others scared by the word risk in definition 3. Definitions 4 & 5 carry a positive tone and 6 almost implies a servitude or sense of duty to others. On the other hand, definition 7 could be construed as a negative, especially in the context where no one likes to be taken advantage of.
“Why does all this matter?”
Well as I will show, profit means different things to different people. And it also means different things if you are on the giving, receiving or taking side of the equation.
“I mean, why does it matter to a property developer?” you ask.
Yes, property development is all about the profit. You simply must extract more value from your project than it costs. As I am fond of quoting, no profit = no project. On the face of it, it looks like the profit generated in property development is firmly covered by definitions one and two.
But how far do you go? How much excess profit, as in definition 2, does a property developer want?
The easy answer is to say, as much as possible – and most bias anti-developer commentators conveniently believe this means robbing the seemingly innocent for every cent.
Now I do admit, I am always challenging the team to extract every last ounce of profit out of any project feasibility. When the team is new to a project it goes something like this: Let’s look at another scheme, and another, can you do five different options? How do we fit more units in? Can we get rid of the access-way? What about reducing the size of the homes? Can we fit more car parking spaces on? Do we even need car parks? Higher? Wider? What happens if we turn it from terrace homes to live-work? Look at that competitor down the road, how does their concept work on our site?…..And it goes on and on and on, typically until everyone is completely sick of me which is about the same time as we have exhausted every conceivable option – although you never really know if you have tried everything. (Can the AI hurry up in this space to help us out please!).
Of course, sometimes you don’t have any choice but to persevere to increase profit, if you can’t meet the financiers or board hurdle rate and especially if you already own the land. The hurdle rate is the term referring to the minimum financial profit (typically expressed as a percentage return on costs) required before you are allowed to start spending money on things like consenting, selling and construction.
For most developers, in all but extremely uplifting markets, the minimum hurdle rate becomes profit they aim for. Once you reach the goal of having enough profit (say 20% return on costs) to get funding approved, it is time to draw a line in the sand. No point trying to extract further profit – at least as defined in 1 & 2 – now we just have to get on with it.
And as soon as the funding is approved, the rest of the developer’s time on the project is spent protecting that profit. The one time (and the moons really have to be aligned because it doesn’t happen too often) when you can take a little breather, is when you have units still to sell and the sales market is still going up much faster than construction costs are rising. Except for that super-lucky situation, a developer’s key focus will be managing all the risk that can seriously erode the project’s profit. Sometimes to the point of bankruptcy, simply through a change in market conditions.
That’s where definition number 3 kicks in: developers assume risk and because of risk developers deserve compensation — a profit. And property development is all about risk. Lots of it. Whilst experienced developers know this, the inexperienced and many outside the industry simply don’t appreciate the fact that property development requires the assumption of substantial exposure.
Development profit means dealing with development risk. There is so much risk I have written two books on addressing this verifiable reality and I’m still learning – every single day. Is it not enough to stress the point that my website www.developmentprofit.com also carries the clone address www.developmentrisk.com?
You see, the anti-developer brigade simply ignores risk and views a developer trying to make a profit as definition seven: to take advantage. To these people development profit is evil. How dare they charge home buyers? How dare they buy land, draw a couple of pictures, build a building and generate a profit. How dare someone risk their own livelihood trying to create places for other people to enjoy!
However, like I said developers are creators. This quote sums it up:
“We used to call them our founders and we honored them by erecting their statues in our town squares. Today we just call them ‘developers.’” — Andrés Duany, Cofounder and leader of the New Urbanism. Urban planner of Porta Norte
And being creators, developers, far from taking advantage of others, create advantage as defined in number 4, for many. Developers derive benefit, as per definition 5, not just in remuneration and civic pride for themselves but in tremendous quantity and quality for wider society. Indeed, this leads us to definition 6: developers are of immeasurable service to their communities, cities and nations.
“Who else profits then?” – I can hear the cynics of you ask.
Let me tell you then, baby.
First there is the obvious candidates. These are the people the developer pays to progress a project. All you have to do is check the developer’s accounts. This includes everyone on the development company’s payroll, every employee from the receptionist to the board members. They get a cut of the profits via a paid job complete with salary, perhaps a bonus, certainly experience and if they are motivated career advancement.
And second there is every professional consultant that is required. When reading this list, just bear in mind, none would have much of a job, nor would their families have too much in the way for dinner each night if developers didn’t exist.
– Architects, designers, draughtspeople
– Engineers, (civil, geotechnical, structural, mechanical, hydraulic, acoustic, traffic, facade & many more)
– Town planners, surveyors
– Quantity surveyors, cost consultants
– Project managers, development managers
Third, everyone involved in construction:
– main contractors, construction managers, site forepeople, health & safety advisors
– plumbers, electricians, carpenters, tilers, concrete layers, carpet layers, drainlayers, roofers, scaffolders, fencers, and a hundred other subbies
– window joiners, kitchen makers, appliance manufacturers, every building product ever invented makers and suppliers.
Fourth, everyone involved in approving, policing and serving a project: inspectors, consent administrators, council officers, city officials, utility and infrastructure providers.
Fifth, banks don’t lend funds out of public duty, they lend funds to make a profit. And with them also profiting is the appraisers, valuers and engineers to the contract.
Sixth, most developments are leased and/or sold. An army or marketers, designers, realtors, property managers, agents and sales consultants benefit from the developers creation.
Phew! That’s a lot of people. Then again, now think about all the associated services that profit. The ones that exist because everyone above, who works on a development project needs to get around and simply live – all those truck and car retailers, grocers, restaurateurs, clothes and flatscreen television merchants. Profit multiplication en-masse.
And it’s not just financial profit. It’s much bigger than that.
“If it’s not just money, how else does anyone profit then?” you question.
Look at the symbols of humanity, all those new iconic buildings that create inspiration. The ones that deliver places of community gathering in town centers. Buildings that protect and support thriving families, tourists and workers in all aspects of their pursuit.
And unlike many other business pursuits, development profit is not just a one off, short-term event. It reaches far beyond the instigating developer’s wallet, it keeps on being generated, for generations. The developer creates an asset that delivers advantage and benefit for years to come for all who come to the land a building sits on, and many who never even step close.
So the next time you think that it’s all plain sailing developing a house, an office building, an estate or a town centre, and the next time you jump to the conclusion a developer is profiteering at the expense of others, consider this very carefully while you look around: have you and your family benefited – profited – from a developer lately?