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Right now I am organizing a design build vertical construction retail project, in the middle of a design build civils project (yes they do exist!), and recently was looking at hiring subbies direct versus main contractors on a luxury apartment project. Prior to that I ran a vertically integrated development and construction company doing 200 to 400 mult-unit homes a year. AND over the last five months on behalf of construction company and developer clients have looked at hundreds of CV’s and have interviewed dozens of Project Managers, Site Managers, Commercial Managers, Quantity Surveyors – and all the key roles that comprise ‘construction’ – so have a few different perspectives on this subject.

BUT back in the day the first development company I worked for was a private developer who had started out (as many do) by renovating individual homes and flipping them. Although he was an ex-real estate agent he now acted as main contractor, directly employing subcontractors. As his company grew and he moved into multiple-dwelling new build terrace projects he hired a construction manager, then two of them, to do all the management of the building work. This is about the time I came aboard. The next project was a larger and more complicated apartment project and the decision was made to use an external main contractor. Over the next few years the projects became larger and more complex and there was no longer any work for in-house construction managers as everything was done externally.

This is a common pathway for a private developer — start out building yourself and then pass on construction to external main contractors. This is not the only journey though. Some developers go down the spec (as in speculative) builder route. Buying land or developed sections with a construction team in-house and then selling completed homes, shops, offices (or whatever development product). Others grow into large construction companies and then diversify into development companies, becoming a similar one-stop shop.

Once again, it does depend how you are currently set up. Are you a developer or a developer/builder? To explain the pros and cons of in-housing versus outsourcing construction, let’s take the example where you are a developer who intends to also adopt the main contractor role — i.e. in-housing construction.

Essentially you need to set up a construction business. The most important first step is to hire someone who has experience in running a construction business! The business will require systems and processes. At a minimum you will need to fill the roles of a quantity surveyor/cost estimator and a construction manager. Maybe they can be the same person if it’s a small project. Preferably their experience includes the type/scale/value of project you are taking on. You might need a site foreman (the hands-on site guy or gal) and an assistant or two.  That’s the minimum for a small project (like a 10-unit terrace home development). If it’s a large project you can be talking about dozens of directly employed staff. Significant back office financial management resource will also be required. The question becomes do you have the fortitude to go down this track?

To help you answer that you will need to weigh up the reward versus risk dynamics. And by dynamics, I mean the plethora of issues that can easily sink your new construction business and sink your project. You haven’t inherited this project because the previous contractor went broke, have you?

The main reward is obvious. You grab the contractor’s profit margin. This could be anywhere from 4% to 15% of the total construction cost. All the costs to run the construction business, including salaries and office expenses, are typically paid by you anyway. Whether it’s in-house cost as described above or passed on to you in a tender via the Preliminaries and General expense item. There might be a small percentage saving here as well if you in-house, albeit for a single project you will have initial set-up costs to first absorb.

Other benefits are control, flexibility and legal simplicity. I have grouped these together because they all act in unity. Using an external main contractor means a main construction contract. A construction contract creates an adversarial relationship. Changes and mistakes can be painful, expensive and litigious. If you build yourself, you don’t have to endure such a relationship. It’s not like you are going to charge yourself an exorbitant extension of time claim.

On the other hand, the risks of in-housing construction are numerous. Firstly, let’s look at the risks that are a function of company-wide experience (or lack thereof):

• Will the bank let you do it? Your funding line might be contingent on getting a fixed price contract from a reputable contractor, a performance bond and even a tripartite agreement.[1]
• Staff turnover. Project managers, construction managers and site foreman become recruitment target commodities when construction markets are buoyant. If you have created a construction business for a one-off project, then near the end of the project you need to make sure you retain your key staff. Six months out from completion they will be looking for their next gig.
• Pricing mistakes. In a new company one of the biggest risks is incorrectly pricing a job. The person doing the cost estimating is new. Subcontractor and supplier relationships are new — trust is yet to be established. It is more difficult to simply ring someone up and get an indicative price. With all the new business systems being set up, the business focus may not yet be on pricing accuracy. Further, to make it all work you might suffer from optimism bias.[2] This issue hit a construction company specifically set up to work on a development I was involved in by our joint venture finance partner.[3] They were optimistic on their pricing. It went downhill from day one, including miscalculating quantities and appointing site management without the requisite experience. Effectively the development made money, but the contractor went broke, on their first project.
• Subcontractor and supplier management. Beyond all the skills, systems and processes required to manage a construction project an established company has trusted enduring relationships, sometimes through thick and thin market conditions. History shows whose pricing you can trust, or who is variation hungry. You know who will maintain capacity for your job and who can return a quick but reliable subcontractor tender price. When the going gets tough during, you can appreciate who will stick it out, who will absorb price inflation and who will solve problems on their own. Similarly, the subcontractor also has trust in the main contractor, that they will get paid on time and change requests will be dealt with justly. When setting up a construction business from the start, none of this exists. Even if the people you hire say they bring all these subcontractor relationships with them, the very fact it is a new entity will dilute that trust. This can easily mean you will pay more for work and encounter more teething problems. Yet another area where a very experienced person at running a construction company is paramount — don’t promote someone into this role flippantly. Consider an old head on broad shoulders.
• Cashflow management. If you hire a main contractor, then you will have one construction related payment claim to process each month. You will have an estimated cashflow and know approximately what that amount should be. If you run construction management in-house then you take on 20 to 50 new suppliers, each with their own payment claim, complete with variations and mistakes. You must vet each claim when you pay them, and you might have to pay them out of sync with your funding. Software will help, but cashflow management is an important and difficult aspect of running construction.

Then there are the risks that a main contractor takes on that a developer can (try to) contractually opt out of. These present reasons to consider outsourcing construction if you already build in-house:

• Unfixed price. If you are a developer, typically you strive for a fixed price from your contractor. If you are the developer/contractor then you will wear any cost inflation, pricing mistakes, onsite measurement mistakes and the like. You might be able to fix some of the prices with your subcontractors down the line, but that is not always possible.
• Legislation. Building codes change. Changes need to be interpreted and implemented. This can happen mid-job. You may find that a new ruling means inspectors look at details differently. One of our contractors had this example, overnight, even with a building consent stamped, the inspector decided a bracing detail needed to be modified. It required a lot of rework (and dollars) from the main contractor (who did try and blame the engineer’s inspections), but at the end of the day it was the main contractor’s responsibility.
• Cost inflation. This deserves its own bullet point. When the market is busy costs can rise quite rapidly. If you are a developer with a fixed price contract, or a schedule that has fixed rates for each element, then you are contractually protected, for the entire duration of the contract. For the main contractor, suppliers may only hold pricing for a few months. Subcontractors, even if they have fixed the price, may be prepared to just walk away from their commitment and leave nothing worth you legally pursuing. Now, occasionally, it works the other way. For example, a main contractor acquaintance priced a government prison job and agreed to a fixed price. This was just before the global financial crisis. During the three-year project, their input costs from primarily unfixed subcontractors steadily reduced (there wasn’t a lot of other work on). The government price was fixed so the contractor’s margin increased.
• Liability. As the main contractor you are usually the first port of call when something goes wrong. At least when you are the developer only, you can (try to) blame the builder. Contractors have increasingly complex and stringent ‘health and safety’ obligations. There are also practical items to deal with like contract works insurance (in case construction catches on fire), employee safety and site security.

The other main reason why you might outsource construction is when you lack the experience in the type of project you are about to embark on. If you are an experienced residential home builder, but now grab the opportunity to save a commercial office project, the skill base in your existing team may not suit. Or the project may simply be too large for your in-house construction team.

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[1] A tripartite agreement provides the bank with step-in rights to finish the project if the contractor or developer fails. A good source of failed projects for you to pick up!

[2] You have embarked on setting up a construction business for this project after all, so it must work!

[3] Although the intention was to build other clients’ projects and grow a successful construction business.

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Over the years, I have worked in three different developer design environments:

1. Architectural design and documentation completed by external consultants.
2. Architectural design and documentation completed by internal staff.
3. A mix of both, including freelance contractors.

The first thing to consider is when it is a one-off project. Unless it is a multi-year development, there is probably little point in hiring and managing an in-house architectural design team. There are set-up costs and your ability to attract good staff (who want a career path, not a one off) will be severely hampered. The possible exception is a potential prize-winning project — where working on it is an attractive status symbol on an employee’s résumé. However, even in that situation you would probably look to contract out to individuals for a fixed term than to in-house them.[1]

Assuming the project is of sufficient size or nature that recruitment won’t be a problem, then it’s a relatively simple equation. First calculate these internal costs:

• Salary and potential bonuses, including annual increases
• Office space
• Software licensing and requirements
• Managing the employee — is this you? Do you have time?
• All the admin, HR and employment law

Then, compare those costs to what an external architectural firm will charge you. More than likely you will save money — if you can recruit the right people. However, there are intangible qualities and pitfalls that need careful consideration.

• Capability. Can the people you hire undertake all the architecture that is required? From concept to developed design to specifications to working drawing documentation and BIM modeling. In a professional architectural practice, the concept is done by a senior architect, the developed design by an associate and the working drawings by juniors or specialist CAD technicians (i.e. they may not even be architects). An option is to hire external architects for conceptual design and in-house consent and working drawings.
• Control. You lose control by outsourcing and gain it by in-housing. Being able to keep tabs on costs and delivery program is another reason to in-house consent and working drawings.
• Creativity. Your project is not likely to attract the sort of creative candidate who is best suited to a high-end architectural practice. This doesn’t matter if your product is relatively benign but can become important if your product depends on spectacular design.
• Mentor. Are you, as developer, a closet architect? Many think they are. Do you have the flair and artistic inclination to drive a somewhat less creative architectural employee to the result you want? If so, then you may not need the all-out creative type in the first place. Be realistic about your abilities though!
• Network. An architectural practice has established relationships with engineers, town planners and other consultants that you may want to tap into. Especially if your project is in a new market where you don’t have those contacts yourself.
• Capacity. Often touted are the benefits of hiring an architectural firm because they bring a wealth of experience, across disciplines and across people, to your job. In my experience, it is the individuals that are of prime importance and any beneficial cross-fertilization of ideas is secondary. However, on several occasions, I have had a situation requiring a specialist and it was easy for the architectural practice to throw another expert onto that problem. On one job the third-party landscape architect had gone AWOL, so we asked the current architectural practice if they could oblige with landscape signoff inspections.
• Quality. With an inhouse architectural resource you must make sure you have suitably experienced managers to check and double check drawings. You also must think about the capability of in-house staff to do onsite construction inspections.
• Fees. External architect’s fees may be exorbitant, but you should also be able to obtain a fixed fee agreement, capping costs. And from there on they will be under pressure to perform to meet your budget. The corollary though, is if they are over their own internal budget, they may not be throwing the right resource onto your job in the latter stages.
• Insurance and liability. Running architecture in-house means you are responsible for the output of your architectural staff. If you use an external firm, then they have the responsibility and the professional indemnity insurance to go with it. In practice though, as developer, you will be one of the last ones holding the baby. It is often difficult getting much out of other’s professional insurance without an expensive lengthy legal battle.

The above scrutiny also applies to other design professions, like engineers. But liability is the main reason why I wouldn’t consider in-housing engineering functions. For items like fire, acoustic, structural, civil infrastructure, services, surveying and geotechnical engineering the inherited liability — and lack of ongoing work — makes it less likely to be worth in-housing. Of course, if your background is engineering (so you know how to deal with the risks), and the work is substantial enough to justify full-time internal resource, then by all means consider it.

Town planning is a design profession where it might be cost effective to in-house this resource, but you would have to be a large organization or project to justify dedicated town planning staff (the same applies to most specialist engineering functions). It’s unlikely you can fill someone’s day, every day, on a single project. In addition, it may be counter-productive. Often in the eyes of the people you are trying to convince to get zoning changes or planning dispensations, an external consultant will appear more at arm’s-length. External town planners also absorb valuable experience from all their different clients’ work. Since they are dealing with multiple projects they can (usually) establish more consistent relationships with local authority planning departments.

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[1] Although that gets confusing in reality, as many contractors are essentially employees if this is their only client.

Download Xpect 2 Connect profile + references for your next recruitment
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We introduce the concept of the effective real estate neighbourhood. This neighbourhood can be different to established political, postcode or school boundaries. It is an area or collection of areas which is very comparable (as far as real estate attractiveness to your target market) to your site’s specific location. Using your effective real estate neighbourhood prevents you assuming a target market and buyer profile that actually does not see your location as being in the neighbourhood.

A whole town may represent the effective real estate neighbourhood if all the houses are very similar and there are few features that differentiate one part of town from another. In contrast, if your site is located in a gentrifying urban area on the fringe of a city centre — where everything is changing from old houses to new terraces — then your effective real estate neighbourhood may include all the city fringe areas that are experiencing similar gentrification. For some locations the effective real estate neighbourhood may be difficult to define, especially if there are no dominant characteristics. However, the deeper you dig and the wider perspectives you take you will find some discernible comparators to define your boundary. For example, if your site is in a location where it changes from a mixture of apartments and small homes to larger leafy streets and large homes, but all in the same school zone, this could be an indicator to look at other parts of surrounding suburbs that have similar variability in the same quality school zone.  You may have to accept that your neighbourhood has so much variability that you need to consider a range of buyer profiles.

You may also discover that your effective neighbourhood is not one contiguous area. If your site’s location has no particular unique characteristics from other similar areas around town, this may point to your effective real estate neighbourhood being a collection of separate but similar areas. If your site is a greenfield on the edge of town where everything is new and next to a shopping centre then you may have to compare yourself to other new greenfield locations near city limits with similar shopping amenity and socio-economic populations.

Different factors will help you define your effective real estate neighbourhood:

• Are you in a particular school zone or combination of school zones?
• What is the defining geography, like hills or a river, that physically define the neighbourhood?
• Are you on the sunny slopes or the shady ones? 
• Do you have views equal to others in your neighbourhood or are you in a gully?
• How do transport links, like the motorway or train tracks, affect the neighbourhood?
• Is your site on the right side of the train tracks?
• What is the proximity to key amenities like a park, a shopping centre, a high street or the central city?
• Are you close to the amenity or are you at the edge of your neighbourhood?
• Is your site surrounded by expensive homes or cheaper ones?
• Are the homes all very similar near your location or is it highly variable with a mixture of apartments and homes?
• Are you surrounded by leafy green streets lined with trees or is your street more urban?
• Are you surrounded by commercial or light industrial compared to others?
• Is your site in an established older area, a new area or a mix of both?
• Do the same planning and zoning opportunities exist for your site compared with your effective neighbourhood?
• Are there significant negatives like a busy intersection or rundown neighbouring streets?
• Are there similar demographic profiles comparably strong in other areas which you may need to include?

The effective real estate neighbourhood is a conceptual construct, so you think about your target market in terms other than just those people who want to live in your suburb. You are looking to identify the potential people who would be interested in your location, and they may have alternative options to your suburb, or never previously considered your suburb. Demographic profiles and trends help you to refine your boundaries.

The Conditional Purchase Contract

Now that you have found your house and land development site you need to make an offer to buy it. The objective is to tie up the property before you spend too much time or money investigating it in great detail. To do this you want to include a due diligence condition in your offer that allows you a period of time to undertake detailed investigations and gives you the option to proceed with the purchase without the seller being able to sell to someone else. 

The due diligence clause in the sales and purchase contract will be easier to achieve in a soft market where the seller may be more willing to give a free look period. It is also more common in a commercial transaction (like vacant land or a large property with an alternative use) than in a residential home transaction. In a hot market you may have to compete at auction where you won’t be able to secure any free look period at all. In a tender some developer buyers will write in a conditional due diligence period. Others will purposely bid high to secure the opportunity and still retain the option to pull out if they can’t make the numbers stack.

            You have to put a price on your offer so you will be relying on rules of thumb and any detailed analysis you have managed to cobble together without spending too much time or money. For the novice it will be difficult to establish what price you should pay, so most of your due diligence will have to occur before you put a contract on the property. Sure you can put any price down, as you have not committed to the purchase simply by signing a conditional contract; however, it is a dubious strategy to put a high price down in order to secure the contract and then try and go back to the seller and try to reduce the price down. If your due diligence uncovers nothing significantly negative you have no argument to stand on. The seller may also be doing their own due diligence on you at the same time. They may want confirmation that you have access to the funds to settle before committing to providing you with a due diligence period that effectively ties up the property.

As you gain negotiating experience you may want to make purchase agreements more to your advantage by inserting other developer-friendly conditions. One is a conditional period in the contract where you attempt to secure milestones (such as a zoning change) before you are obliged to settle the property. You can put any condition in your offer, but, of course, the seller does not have to accept it. Unless you offer a substantial price premium or the market is depressed you will likely not get away with some of the more aggressive conditions. Unfortunately there is often no shortage of buyers who make decisions on less information, make more aggressive assumptions of where the market is heading or simply have the luxury of lower costs because they build themselves or have a cheap line of credit. When the market is hot, many will happily overpay for a site without significant due diligence and when it is cold, no one else will be interested. Similarly, when the market is hot, finance will be easier and when it is cold, you may never find anyone who will lend.

Nonetheless, there are many ways to structure a deal. Here are some aspirational conditions to consider when negotiating to purchase:

• Long due diligence ‘free look’ period
• Settlement of purchase price based on buyer achieving milestone conditions (like planning consent, presales or individual section titles)
• Minimal deposit or staged deposits
• Low purchase price plus profit share
• Long period to settle/close, or staged payments over time
• Access to the site prior to settlement to undertake invasive due diligence (for example, drilling holes for geotechnical analysis)
• Access to the site prior to settlement to undertake works. This is commonly called builders terms, where you don’t have to pay for the site until you have completed the homes you intend to sell
• Purchase price based on seller achieving milestone conditions (like achieving zoning or individual section titles on behalf of the buyer)
• Purchase price to be discounted if buyer discovers issues between unconditional period and settlement (like ground conditions which cannot yet be quantified).

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Benefits Marketing in Property Development

This is not a sales and marketing real estate 101 book, as there are scores (times a thousand) of considerations for each different product type in each different market. However, let’s spend a little time looking at benefits marketing.  It’s easy to list all the features of your property. It takes more brain power to conceive and describe the benefits. The difference between benefits and features is not always that obvious. It often gets confused and to be fair they can start to merge into one another. One definition is that a feature is a thing and a benefit is what that thing allows you to do. The more emotional, valuable and topical the benefit, the greater the marketing impact. The degree to which you spell out the benefit should be based on not treating the recipient of the marketing like an idiot and stating the obvious, but creatively explaining how it will ‘benefit’ them.

            For example, you could point out “this house has a second living room.”  That’s a great feature for many families. Going further you could say “this house has a second living room with enough space for kids to play with all their toys.” That is a feature within a feature and alludes to a benefit. But what about “escape your children on those wet Sundays. A separate living area for family growth and peaceful solitude.” That is unquestionably describing a benefit.

Dispelling people’s fears can help you formulate benefits. Instead of “close to the local primary school” try “no roads to cross on the short distance to the local primary school.” Rather than just “secure second level apartment” what about adding “lock and leave, secure at home, safe while traveling lifestyle.”

Benefits can be ascribed to people’s desires, aspirations and enhancing their self-image. From “large flat backyard” to “the yard your neighbors’ kids will want to play in.” Alternatively, “so much space your friends will be impressed during summer barbeques whilst your neighbors hide their envy.” “Fabulous city view” becomes “contemplate achieving your next goal, peering into the city lights.” This works at a corporate image level as well. Don’t merely sell “the five-star restaurant in the office foyer”, sell “the luxurious enclave to impress during your most important client meetings.”

Topical considerations might be the latest fad or the result of fear mongering (real or perceived) in the media. “R2.7 insulation” becomes your peer pressured civic duty: “Do your part for climate change, in a green certified thermally efficient home.”

When you discuss value, investments and costs you can pitch it two ways. Take “best value in town” for instance. One, embrace the future potential positively like “your new neighbors have experienced 300% capital gain over the last thirty years, but your new house boasts even higher quality construction.” Or two, frame in terms of the psychologically more powerful loss aversion (fear of loss): “this suburb has never gone down in value over a five-year period.”

Benefits also come in the form of the real estate business problems your project solves. “50,000 square feet for lease” — an admirable feature (but who would know), transforms to “we provide the largest contiguous office space floor plate in the CBD, vitally important for large companies wanting to promote internal collaboration.”

I think by now you get the picture. And that’s a good way of thinking about it. Paint a picture of the benefit in the mind’s eye of your buyer or lessee.

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