Development: Unpredictability in the Process

Development: Unpredictability in the Process

My last blog, “The Importance of Timing on Real Estate Investment,” focused on the unpredictability in investment, on what can happen over time once you own a property. In development, there is the added unpredictability during the process.

For a broker selling a property or an investor buying a property, the complete process can be done in 90 days or less. But that is not the same with development, not even close.

Process Derailment

Developers have many considerations—they need time for inspections, site tests, neighborhood forums, entitlement or zoning processes, permitting, and soil boring tests, to name a few.

While some of these can be controlled, others cannot. For example, everything could be moving forward smoothly and one ruffled neighborhood group at a zoning hearing or one difficult inspector could stop the project dead or at least create a significant delay, with the developer having spent many months and hundreds of thousands of dollars to get the project to that point.

Cost Increases

Cost is another factor difficult to predict. Developers work diligently to budget all knowable expenses in their projects, but they get blindsided by such factors as construction cost fluctuation.

When Atlanta decides to build two massive stadiums, the Mercedes Benz Stadium and SunTrust Park, at the same time, it impacts both the availability and cost of concrete. Throw in an I-85 bridge rebuild, and the impact is even more significant. When something like this occurs, a developer who is committed to a fixed loan amount or construction budget or is facing a rent-sensitive market can suffer a major financial setback.

Financing Uncertainty

The combination of timing and financing also makes the development process risky. During the planning phases of a development, the capital markets can change, causing interest rates to rise and possibly limiting the funds available for the project or the availability of a permanent loan or buyer upon project completion. Being gamblers, developers often utilize floating rate debt, which could make an unforeseeable increase in rates even more damaging to the bottom line.

How to Succeed

To succeed in the development business, you need nerves of steel, a high tolerance for risk and very deep pockets. Even the best developments can be sidetracked, and with little margin for error, you must be able to hang on.

Based on this, most private investors should stick to exiting cash-flowing properties. We find the risk benefit balance in these opportunities much more palatable.