24
Aug 19

Let’s Talk About Profit

 

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:

  1. “net income”, or
  2. “the excess of the selling price of goods over their cost”.
  3. “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:

  1. “to be of service or advantage”
  2. “to derive benefit”

Further, as a transitive verb, profit is defined as:

  1. “to be of service to”, with an emphasis on service to

While according to dictionary.com it can also mean

  1. “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?

 

Andrew Crosby
www.developmentprofit.com

References:
https://en.wikipedia.org/wiki/Let%27s_Talk_About_Sex
https://latin-dictionary.net/definition/31786/proficio-proficere-profeci-profectus
https://www.merriam-webster.com/dictionary/profit
https://www.dictionary.com/browse/profit


16
Aug 19

Imagine: Maraenui 2025

Reprinted today because I see more new houses going up in this suburb much deserving of a transformation. 

Below is a little story I put together, in 2013, in desperation, to try and get approval for a kick start renewal project. I remember back then my first visit to this struggling community. To set the scene of just how neglected “The Nui” was, read this: http://shorthand.radionz.co.nz/maraenui/index.html 

I don’t know if my attempt to set a vision made a difference, but back then the first project in Maraenui in a long long time, did eventually get approved. It’s good to see that development is now continuing and that further progress has been made.


Nikau Johnson closes the front door to his 3 year old 2 bedroom terrace home at 27 Bledisloe Road. After a great night’s sleep in a warm sustainably built home, he relishes the fact the heating bill is so low given the solar principles applied and the Maraenui community organised electricity co-operative started in 2017. Plus he also likes the fact he and his partners are living in a reasonably safe part of Napier, a bit different to what he can remember growing up down the road.

Nikau walks down the red brick paved footpath, crosses the bike lane, and picks up the pace as jogs across the road – careful to avoid one of the regular electric buses on the Napier to Hastings route. As he approaches the entrance to the recently expanded Westfield Maraenui Shopping and Community Plaza, he notices a teenager walking in the park adjacent. “Hey Scotty, you are going to be late for school, pretty sure you don’t want a miss a day given how close exams are do you?”  Nikau asked.

Scotty turned around and replied “No probs boss, I am taking some photos of that artwork done by my father 10 years ago that we fixed up, – it was our art class renovation project and I need to put together a portfolio to get into uni.”

Nikau carried on through the sliding doors and rather than turning left into the shopping precinct – which was already bustling with the sound of shop keepers putting their wears out front he turned right into the community precinct.

Napier City had set up in Maraenui their international virtual business and co-learning centre with the sister city of Lianyungang, China  in 2019 and added Tomakomai, Japan and Victoria Canada in 2020. This initiative provided a continuation of the Maraenui student exchange and young business entrepreneur program sponsored by Fonterra that started in 2018 and continues to run.

Nikau thought to himself ‘here’s something that now contributes $12m to the Maraenui economy. Just seems like yesterday my fathers friends were getting in trouble with the police and all that gang stuff and here’s one of them on the webphone talking to some Chinese suit!’

Past the community precinct’s centre for sports excellence office and right alongside the entrance to the elevator Nikau spots a sign on the back door of the Barfoots Maraenui office. The table on the sign reads:

  Average
house price
Last 10 years
average annual
capital growth
Sales this month
Marewa $323,000 2.5% 17
Maraenui $318,000 9% 22

 

Nikau feels good about his home investment off the plans 4 years ago. Whilst his friends who live in Hastings said, ‘yeah Maeranui seems on the way up…..lots of young families taking advantage of the Welcome Home Loan + Renovation package, buying ex state houses and doing them up’ – his uncle living locally on Shackelton street did have reservations – ‘yes a lot has changed over the last few years but I don’t know if it will continue, seems like the place is already getting too busy man’.

Nikau jumps in the elevator and moves his finger to the 3rd  level button that reads ‘Housing Napier’, ‘HNZC’  and ‘Whare Maraenui Inc’.

He notes the 2nd level has a new tenant. ‘Spanner and Fixit Ltd’ had relocated a number of times in Maeranui – first from the vacant office they took over in the old retail center in 2015, then from their temporary office, a renovated home on Geddis Ave and now into plush new premises on  in the heart of the expanded mall.

Nikau knew this maintenance company well. As a teenager, he got his first real break with them…..

Life in 2013 seemed to not offer much. Struggling to stay in school, let alone get passing grades he often skipped class. He would walk down Shackelton Rd past the Housing New Zealand properties and past the private home that seemed to be owned by someone out of town because it was falling down and always had the cops outside. Then he and his mates would break into the two story houses that the government were about to tear down and smash whatever was left to break. Even that got boring, a few times early on the police would drive by but they didn’t seem too interested in a couple of kids, just par for the course for them, kids in Maraenui out of school.

One day, late 2013 things started to change.

Not that Nikau took much notice but everyone was talking about all these meetings and the stuff that the government and council was going to do. Nikau’s dad initially didn’t like them, “we had all these meetings ages ago, nothing happened, all piss and roar and nothing happened”.

Nikau remembered there were lots of flash cars coming into town, even once a silver beemer and the guy in that car stayed for a barbeque. Was funny though some of his fathers out of town mates started yelling at him, but he just kept on smiling.

Nikau did take notice when a lot of signs started to go up around town. It seemed like there were blue signs popping up everywhere. There were signs on Longfellow with a picture of some flash new houses. There was signs on Bledisloe next to the houses the government were going to pull down ‘Watch this space’ and another ‘Home of BMX Hawkes Bay’. There was even one at the corner of Geddis Ave and Chambers, the interesction Nikau and his mates would get out of Maraenui to go into town ‘‘Maraenui – loving it’.

Then the Housing New Zealand office seemed to change. Someone put some pictures of local kids running around on the windows and weirdly there were also pictures of the faces of a couple of guys in suits and some drawings. The steel things in front of the doors were removed and a couple of weeks later it looked like they rebuilt the whole front of the building.

All good Nikau thought, but he had his eye on one of the signs as a target. One night he and his mate decided to create some of their own artwork. They walked done Bledisloe and pulled a spray can out – as Nikau was about to put his signature on the sign, a person from across the park, outside the Housing New Zealand office yelled out – “hey you, what are you doing?”

Nikau and his mate were about to run.

“Aye, you guys wanna earn some cash?  the guy bellows.

Nikau’s mate yelled out “Whaatever man, what you know?”

“Get over here I have $50 bucks for you if you can pick up all the rubbish on Percy Spiller Ave” – the man said – it was the same man with his face was on the window but he wasn’t wearing the flash suit.

And that was all it took.

Nikau quickly found himself in a local maintenance program with Spanner and Fixit ltd, where every weekend he could earn $50 just by picking up rubbish – soon that moved onto mowing the grass where the government had pulled down the houses and then onto fixing fences around town. Not only Nikau, most of his mates also got involved. Some pushed their luck a little too far and tried to not finish properly, but the guy from the office always came round to have a chat – Nikau remembered thinking that guy Bill from the office seemed alright; but really he was just checking up on them!

Spanner and Fixit then opened an office in one of the run down stores where they stored all their gear. Next door a tool shed was opened where anyone could borrow a lawnmower or some clippers and some of Nikau’s cousins helped get involved in that.

Nikau remembered how if it wasn’t for Bill catching them that night when they were about to tag the sign he may of never even passed school let alone become Area Manager of Housing Napier.

….The lift doors open, the receptionist greets Nikau, “good morning Mr Johnson, how are you this morning?”

“Yeah great” he replies. Nikau continues “Although looks like it may be a bit of a tough day. Those guys from Australia are coming to town with the Minister of Property Development  and want a tour around Maraenui, so we have to put on our best performance!”

 “Yes I have prepped the troops, Mr Johnson”,  the receptionist, Sally goes on “Why do they want to see Maraenui, everything seems fine to me, not like we are doing anything much different to what they do in Taradale”

Nikau agrees “Yes I know, I think the Aussies have a few problems and want to change one of their towns back home and think we might have the answer, don’t really know what I should show them – what have done recently besides the best street award?  I guess I could talk about the joint initiative that was started in 2015 where rates relief was granted to private owners who kept their properties to a high standard, but we finished that last year because everyone is doing that anyway now”

Sally quickly looks up Maraenui on Wikipedia to look for some ideas

2012
Maraenui is a suburb of the city of Napier, in the Hawke’s Bay Region of the eastern North Island of New Zealand. It is a lower socio-economic neighborhood with a mix of owner occupied and state owned (Housing New Zealand) properties.

2024
Maraenui is a suburb of the city of Napier, in the Hawke’s Bay Region of the eastern North Island of New Zealand. It is a medium socio-economic neighborhood with a mix of owner occupied, and rental housing. Maraenui undertook a positive identity and image transformation from 2013 to 2017 with initial  funding by a government, council and corporate sponsorship through a regeneration programme with extensive resident participation and on the ground management.  Maraenui was presented to the United Nations in 2023 as a case study by the University of California, Berkley Haas School of Business, socio-economic transformation project.

As Nikau walked to his desk Sally enquires

“Also Fa’alele wants to know if they will be attending tonight’s residents meeting of the Maraenui 2035 business growth forum”

Andrew Crosby
September 2013

 

“You’ve got to think about big things while you’re doing small things, so that all the small things go in the right direction.”
 — Alvin Toffler

—————————————-

 

Cheers

Andrew Crosby
www.developmentprofit.com 
Products created for continuous improvement in real estate development. 

Learn about managing real estate development in House, Land, Love & Money and Turnaround Success.

 


03
Jun 19

Pre-sale, Post-sale or No-sale?

I have just read The Startup Way by Eric Ries [http://www.thestartupway.com]. Eric discusses the MVP or Minimum Viable Product approach to Lean development. He quotes David Bland, a consultant and early Lean Startup evangelist “while you decide what’s minimum the customer decides if it’s viable.

In a nutshell, rather than bet the family jewels on developing something that the consumer may never want, you release early, test customer response, refine, release again, test customer response until you get to a point where you persist or pivot.

Persist: because you are on the right track and you can take your product to higher levels of development growing your customer base.

Or Pivot: where customers have not shown suitable interest in what you developed, or where testing has identified a  better/faster/more scalable or valuable approach and you change strategy to quickly build release and test again.

In both cases, persist or pivot, your vision doesn’t change. Think Netflix -who had the vision of delivering movies to customers cheaper and easier- pivoting from mailing DVD’s in the mail, to streaming online.

The book describes how the lean startup way is the opposite to the conventional corporate approach of plan, design, build and release. It is a much lower risk way to gauge product success. It’s all about experimenting with direct customer feedback until you get it right, and not being afraid to try and fail along the way. The approach is low(er) risk because you are not devoting years of resource and millions of dollars into a venture that may fail to gain customer traction and make a dime.  You might have had  a great internally generated forecast based on consumer focus groups and a whole heap of internal design and production based (biased) opinion but no real customer, hand in wallet, feedback.

And on forecasts, you know the ones many of us are guilty of, where vertical bars rise rhythmically into the future, their peaks forming a nicely sloping growth curve based on our leap of faith assumptions, Eric sets the standard corporate scene. “The fantasy plan of the original pitch is often far too optimistic to be used as a real forecast. But management lacking any other system to use, need something to hold onto. Without an alternative they cling to the forecast -even if it’s just made up.

The lean startup way is to build the minimum, release as quickly and as inexpensively as possible to test these ‘leap of faith assumptions’. That way you can try lots of things, lot of times, experimenting in real-time with real customers.  Failure won’t send you bankrupt because you are not relying on this one or nothing endeavor. And because you are not afraid of experimentation and failing here and there you’ll end up developing a much more customer focused product.

That’s what many do in Silicon valley, but (like almost everything) it got me thinking about property development.

Now its pretty difficult to release a small part of a housing development or office building project without fully committing to build it right? Well no. There is a well established approach that real estate developers have been applying for centuries that mimics a lean startup ‘customer experiment in production’ model to deliver profitable results. But it comes with plenty of fish hooks. Let’s delve into the development process to explain.

There are two times you can sell a development project: before construction starts and after construction starts.

From a sales and marketing point of view  ‘after construction starts’ can be further broken down into ‘during construction’ and ‘post construction’. That’s because different sales and marketing techniques are required to sell something where the vision is physically coming into being versus it’s done and dusted and ready to show the customer in all its glory – warts and all.  However, from everyone else in a developer’s organisations point of view it’s the same thing. The commitment to construction has been made, there is no going back, there’s not a lot you can change so you better now sell it!

Selling before construction starts is called pre-selling. You attempt to make pre-sales. If you sell everything you are pre-sold. You might be selling homes, lifestyle blocks, converted warehouses,  leasing office space, or selling storage units. You are selling real estate using plans, images and specifications of what you promise the project will be. In essence you are selling the dream, without yet jumping into bed (with the builder).

Selling after construction starts is called spec-selling. You are speculating what you have started building will be sold. Whether your sales team waits until the final coat of paint is applied and the handrails are polished or they start as soon as the diggers arrive is moot. The commitment to construction has been made.

And in both cases you have a selling price, and a cost to build. Put a circle around each as we will come back to these later.

The start of construction is of course important, because that is when you have committed to spend the majority of the development costs of the project. You may even have been able to delay the commitment to purchase the land until you start building. But once construction starts there is no turning back. Sure there are design and planning costs spent (at risk) already and they may run into the millions, but that is nothing compared to the big ticket construction and the cost of land below it.

The speculative route is definitely not a lean start-up approach. You plan, design and build. You commit significant resources and money. It might be a two hundred home townhouse development, a thousand apartments or 100,000m2 office building. You start construction and then you start to sell. It is only then when you get the real customer feedback. However, except for minor cosmetic changes the horse has bolted. You have either gotten it right or will suffer the (price reducing) consequences. Sure you might have done the same type of project before, even dozens of times, so you believe you have plenty of ‘market research’. But real estate is different to cars, widgets or cell phones, in one key way: the land. That fixed, unbreakable, subject to all manner of unforeseeable externalities, locational quotient makes every project unique. The other thing that is important even if you have done a similar project time and time before is time itself. If there is one thing certain in real estate:  markets change over time.

Take pre-selling though. Releasing, testing customer feedback, giving yourself an opportunity to improve and deciding to persist or pivot with your vision of the worlds next best property development is akin to a lean startup approach when you pre-sell. Yes pre-selling is property developments lean startup strategy.

When pre-selling you can test the market and real customer interest (the signing the cheque book type of interest) first before you commit to construction. If you are a serious deal maker of a developer with a patient land vendor you might have even negotiated buying the land dependent on how pre-sales go. Not enough and you walk away. In some countries, like New Zealand you can pre-sell with binding contracts. That means you can sign a buyer up on a sale and purchase agreement with nothing more than a salacious render, a floor plan and a one page outline specification. This is why it is also called ‘buying off the plan’. The developer is applying a lean startup approach. You can test your market to see if the buyers bite on your marketing. And the feedback is real, as they are putting down a real deposit and committing to closing the deal when the project is finally built.

In fact in Arizona, I first encountered the term ‘register for interest’ with regard to property developments. There developers would test the market using nothing but a basic web page with a price indication and maybe some hastily drawn plans. Enforcing a refundable $1000 or so was enough to get reasonably real customer feedback. Unless registrations were favorably brisk, the developer would can that idea and pivot immediately.

If customers bite real fast you have a real project. Now you can go get some money and start building. If they bite slowly, then you can persist to improve sales using different tactics, like changing the marketing pitch and images, modifying floor plans or revising the specification. If persistence isn’t working then you can decide to pivot the project. Apartments becomes a retirement village. Luxury homes becomes affordable townhouses. But your vision of a great property development still remains in tact. And you have really learnt from the market in the process.

Yes a spec development can be changed after it is built. Apartments can become a serviced apartment hotel. Office for lease can becomes office condos for sale. Large industrial warehouses can be cut up. But it will be painful and cost a lot of money in retrospect and probably never really suit the target market.

If the customers don’t bite at all, then you can ditch the project for a brighter day, or liquidate costs incurred to date to fight another day. If you have already built a spec development and the customers aren’t biting, it is going to get financially a lot more painful.

There are also three benefits enticing buyers to purchase off the plan. One, if the developer lets them, they can customise interior finishes and make adjustments to layouts. Two, they get the opportunity to buy into a project, or their preferred location in that project before others (the ones who wait until it is complete, who indeed could miss out). And three, they are the beneficiary of price rises between the day the contract is signed and when they take possession. For an apartment/condo project this could be two or more years. In a hot market buyers fear of missing out can sell out projects in days. I recall one project we did where about 100 apartments were sold out in the time 100 contracts could pass through the fax machine (about a weekend of constant faxing!).

So why -with this already experimental leading edge lean startup methodology- doesn’t every real estate developer take the pre-sale approach?

Well it all comes down to risk. And not for the reasons you might think.

Go back in this article and take those two items I told you to circle. They now come into play. When you pre-sell a development project you are in effect locking in your sales price. Now you have to build at a cost where the pre-agreed sales price allows you to pay for construction and all the other costs like design and financing and still make a development margin – your profit, your payday. When you start pre-selling, assuming you know what you’re doing and have a good handle on costs that should not be a problem. But even if you sell out quickly, the time it takes to secure all the necessary consents (and you might have started selling well before even achieving a basic planning permission) and a construction contract (or subcontracts if you are building yourself) can be long. The bigger and more complex the development, typically the longer it takes. But even small projects can have monumental external hiccups that incur substantial delays. During the delay the construction cost can go up. If it goes up enough, there goes your margin!

Unless your project is remarkably unique and awaking a dormant buyer pool, selling out fast typically indicates a buoyant appreciating real estate market. If that is the case soon, as it always does will follow an appreciating construction market. That’s when costs can escalate dramatically. Time is not the pre-selling developers friend in these circumstances. When you have pre-sold, you have fixed your revenue and every day you take to fix your construction price (and that is never really fixed until the day construction is completed) could mean another day of eroding margins.

OK so pre-selling has its downfall, but can’t you just a pre-sell a few, that will test the market and hold the rest whilst prices rise?

Yes and no. Once again it comes down to money – this time how much you as the developer have. If you are cashed up you can choose this strategy. If banks are falling over themselves to lend to you because your balance sheet emulates one of a small oil producing nation then you can go down this route. But for most private developers, if you want to develop the bank will want pre-sales to cover their risk before they will lend you funds (at least at an affordable interest rate). They will want you to ‘show them the sales.’They will also want a fixed price construction contract. That is why so many development projects, even in boom times, even when fully sold out, and endorsed by celebrities never get built. The developer has fixed their revenue too early and cannot get it built cheap enough to leave a margin or satisfy their bank manager. And as time goes on it gets harder. Early in the cycle banks may only require 30, 40 or 50% of the product to be pre-sold. By the end it can easily be 100% of the funding or even 100% of the units.

The spec developer by definition is counting on sales prices to continue to rise whilst they arrange construction and start building right up until the day they choose to  start selling (and even then they might stagger listings it to take full advantage of a rising market). And because they don’t sell until after they have started construction, they have a good idea of their costs (incompetent management or unforeseen disaster excluded) so can price to cover costs and maximize their margin. As long as sale prices are going up faster than construction costs they are increasingly in the black.

Rare is the situation where sales prices are going up and construction costs are going down – every developers dream. Unfortunately, all too common at the end of a property cycle, it’s the opposite, sales prices are going down and costs are going up, that can hit the spec developer harder. The benefit to a pre-sales  no-go funding valve is that you don’t build a project (at least with the banks money) to find out there are no buyers and have to take a substantial haircut.

OK but some spec builders who have the funds -to pre-sell and test the market before they commit- don’t even do that. Why not?

Well that’s where Eric’s book comes into play again. This is typical of the large corporates. The ones who have a production mindset first and an experimental sales mentality much further down the priority list. Pre-sales is all about sales first, worry about construction later. Spec is all about build it now, build it and they will come, build it and then we worry about selling. The large companies take a lot longer to feel the pain. Their balance sheets on the face of it can absorb a lot, until one day they can’t. To them selling off the plan is leaving money on the table and putting their margin at risk. When times are good and property is selling they are willing to risk getting it built first then worry about the customer later.

And pre-sales can deter buyers anyway. Just because pre-sales doesn’t work doesn’t mean the project wont eventually have buyers. Some buyers will be skeptical that the project wont get off the ground. They stay out of the market until they see concrete trucks and carpenters. Others have concerns about the quality the developer is promising. Or they don’t want to be subject to the threat of facing price rise requests from a developer in trouble and being stuck in a contract waiting for years for their property to be finished as delay after delay ensues. Other buyers can’t imagine an avocado from guacamole so they aren’t in the market until the property is built and they can see and feel what they are buying.  The buyer has plenty to worry about when pre-buying. And all for very good reason as this article sums up https://propertyupdate.com.au/buying-off-the-plan/

But when the market turns, the spec developer can be caught out, whereas the pre-sale developer never made it past the starting gate in the first place. That’s when the no sale is better than a (negative margin) post-sale.

So what does a developer do then if they do have a choice to pre-sell or not and the market has changed?

That’s what our team will be debating in the upcoming weeks.

Cheers

Andrew Crosby
www.developmentprofit.com
www.developmentrisk.com

Read more about pre-sales and real estate development in House, Land, Love & Money and Turnaround Success.


22
Apr 19

Turnaround Success

Another one done.

Click here to get a copy https://www.amazon.com/dp/1790590884? or contact publishing@aenspire.com

 

 

Real estate development is a risky business. When everything is going well the project can be incredibly profitable. But throw in delays, softening sales and rising construction costs and the profit can be completely wiped out.

That’s when you need the tools to perform a resurrection.

This book provides practical advice to turn around failing real estate development projects. Tap into two decades of residential and commercial development experience in challenging markets. This is where both the novice and seasoned will learn insider secrets of the developer’s trade.

Can you take on a project where others have failed, and reconfigure, de-risk, re-brand and manage it to profitable success?

“After successfully developing high end homes throughout the eastern suburbs and a subdivision estate down in the capital, with our tails up, we saw the development opportunity of a lifetime. But we didn’t see the risk, and this site, it turned out, had every risk imaginable. Now we are working with the author and his contacts to find a profitable way through. This book is essential reading for real estate developers, both aspiring and experienced, and those who do business with them. Learning lessons from this author, is a lot less financially painful, than making the same mistakes yourself!” 
Raj Jeram – CEO, Parkside Living Limited

I builds upon my book ‘House, Land, Love & Money’ with complementary and valuable new material for developers – a must read for any consultant, financier, contractor, agent and manager in the real estate development industry.

Cheers

Andrew Crosby

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Real estate development books now available via Amazon or direct from publisher in New Zealand. Contact publishing@aenspire.com for special rates. Go to www.developmentprofit.com to view publications available.

 


14
Jul 18

Micro Seminars – Thought Provoking Market Intel

Custom, fast paced, 30-minute corporate seminars. Individually tailored to your business and presented interactively with the audience.
Drawing from Andrew’s (COO at Universal Homes) broad international experience, your team will benefit from valuable market intel delivered via a partisan and somewhat unique developer’s perspective.

 

Take this recent micro seminar presented to one of Australasia’s leading valuation and property consultancy firms.

Titled: “The Ghost of Valuation Past, Valuation Present & Valuation Future”

Within a snappy, thought provoking 30 minutes, we covered these five topics:
1. How bad can the market get? (War stories and amazing opportunities from the GFC in the United States.)
2. How do you value housing with social housing next door?
3. Is a prefab less valuable?
4. What really caused the housing crisis and what are we doing about it? (The latest market dynamics in house development)
5. Will you have a job? (Change coming with AI, computer vision and machine learning)

This micro seminar involved plenty of too and thro with the audience and not a power-point slide in sight.

 

Mark Davidson from Opteon had this to say:
“Andrew provides knowledge, experience and relevance to his audience. His presentation was well received by our team of valuers who appreciated his real-world application and market insight.”

Organise your micro seminar now. Suitable for government, corporates, not-for-profits and industry associations. Go to developmentprofit.com for details.

 

 

Cheers

Andrew Crosby