Challenging Times for Real Estate Developers - Let's focus!

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Real estate development has always been a high risk/high margin business based on the developer's mastery of many different issues. These range from land acquisition, financing, marketing and construction issues to legal and strategic and political issues such as dedications.

Developments in recent years have posed major problems for small and medium-sized real estate developers in particular. Increases in land prices, increases in construction costs and construction risks, increases in financing risks, the list of negative influencing factors is long.

Due to these developments, smaller developers in particular, who do not master all subject areas at the highest level, easily come under pressure.

What can smaller developers do now to still achieve appropriate results under the current conditions.

In my opinion, the answer to this question is focusing, i.e. concentrating on those points in the value chain that the developer masters best.

There are two main approaches to implementation.

  1. Partnerships

By jointly developing projects with a partner with complementary strengths, not only competencies but also (financial) resources can be pooled, thus increasing project volume and project profit.

Since the overhead is better allocated in larger projects, the result can even be additionally increased. However, working with an (unknown) partner naturally brings challenges.

Typical issues are the decision-making process in case of disagreements regarding strategic decisions as well as the appropriate price for the respective service provided by a partner.

Best practices approaches include:

    • Defining the project strategy as precisely as possible in advance
    • Definition of a decision-making and separation process in the event of irreconcilable differences ("shoot out")
    • Strict division of tasks and non-interference in the sphere of the other party
    • Appreciation for the other part (one's own part always seems more difficult, no matter on which side of the table one sits)
  1. Phase Focus

If one decides against a partnership, there is still the focus on a project phase, which one is particularly good at.

Typically, the following phases can be roughly distinguished:

    • Land acquisition and dedication
    • Project development (project strategy, submission, possibly securing anchor tenants, possibly forward deal)
    • Construction & letting out

If a developer has all the strengths to successfully complete a phase, a later entry and/or earlier exit may be the right strategy. Significance, and therefore likely overall profit distribution, varies by use type as well as over time. For example, in a 2009 office project, finding an anchor tenant and closing a forward deal was more challenging than construction. For a residential project in 2021, the difficulty is more in managing construction costs and risks.

Another disadvantage of this approach is the multiple transaction costs that may be mitigated by the sale of partnership interests.

An inherent problem without a patent solution is the different estimation of value creation. Best practice way out is to make improvements at a later stage, although these require a high degree of transparency and trust.

Which of the approaches works better for a company depends on the strengths of the company on the one hand, and on the characters of the decision makers on the other.

At the beginning of the decision-making process, the decision-makers in the company should therefore ask themselves the following questions:

  • Can I trust competent partners in their respective areas of expertise (financially unrestricted) or do I ultimately have to make all decisions myself?

In answering this question, honesty towards oneself is required. I know many people who would answer this question with yes and then, in an emergency, (have to) take all decisions themselves. Personally, I always find it psychologically interesting that many of these people put their lives in the hands of a doctor or a pilot without further thought...

If the honest answer is yes, partnerships are almost always the better solution because of the advantages described above. If the honest answer is no, they should not be entered into because they almost always end in strife.

  • Am I good at achieving re-zoning?
  • Do I have an easy time raising venture capital?

If these questions can be answered with yes, the focus on rezoning and the subsequent project sale can be a profitable business. Dedicated properties are always in demand, especially in times like these.

  • Can I handle the construction business (construction costs and construction risks)?

If the answer here is yes, then the focus should probably be on buying ready-planned and approved projects. How promising such deals are, however, again depends on the assessment of the previous developer's performance. Often, the opinions of developers differ with regard to the submission and/or execution planning that has already been done. If this has to be redone, the pie to be distributed becomes smaller again.

Based on these questions, the right strategy can easily be worked out in theory, but for successful implementation there is still a world of difference. In any case, a certain basic trust in other experts and potential partners increases the chances enormously.