Ask first to avoid costly disasters

By Colin Taylor

Investors can lose their money in failed property developments if the right advice is not sought

Good planning is key to making a profit in property development. Photo / Thinkstock
Good planning is key to making a profit in property development. Photo / Thinkstock

Aspiring commercial property developers and investors are being warned about the risks of not obtaining independent advice on their new projects.

Doug Osborne, joint managing director of the New Zealand branch of global property services company, Savills, has recently taken on an independent advisory role to major projects that were on the verge of collapsing and losing investors millions of dollars.

He says building project failure has become more prevalent since the global financial crisis (GFC). "There have always been failed property projects, but nothing on the scale of the past few years and it is disheartening to see. Innocent investors often lose their savings by investing in financiers who fund the developments."

He says investing in strong leadership and setting high standards with good planning and advice is money well spent.

"A group of investors buying a $2 million site are not making a $2 million decision. They are making a $15 million development decision and can come unstuck if they don't plan for this properly as they need to exit with a profit when it is completed."

Independent advisers charge, on average, about 4 per cent of a project's total costs. Margins are usually 15 per cent to 20 per cent.

"Any developer or investor contemplating a project upwards of $5 million needs to have sound governance in place at the front end as well."

Osborne says there are no shortcuts in property development. "All projects are time and cost sensitive. Often developers don't get the right advice and end up with inferior or failed projects. When we look at why projects fail and ask what is missing, it is often the lack of specific research and information.

"Developers will go on their gut feel and get carried away ... while some clients reach a fixed view too early. Unsuccessful developments suffer from an information gap."

Osborne says too often a development starts with an entrepreneur who has a sizeable block of land. "They engage an architect who comes up with a scheme and pretty pictures of what it will look like.

"This becomes set in concrete often ahead of testing the market.

"They forge ahead to the resource consent stage where changes might have to be made. They have little idea of mounting costs and the impact on the viability of the project."

Osborne says it is difficult to come in half-way through a project and try to rescue it.

"A developer could spend $30,000-$40,000 on advice about the feasibility of the project to be told it is a no-go.

"This is far better than spending $700,000 to get a third of the way through the project planning and come to the same conclusion."

Prudent developers or investors usually ask an independent adviser to prepare a feasibility study and also obtain an independent quantity surveyor's report on the project's costs and an independent valuation, says Osborne. "Financiers now require this as a minimum. Unless they do their homework, banks won't support their applications for funds as they have rightly tightened up their own internal credit controls considerably since the GFC.

"Because of the low interest rate regime and perceived shortage of residential development sites, the market is already starting to overpay for some sites.

"Novice developers and investors forget or are not aware their profit is in the viability of projects at the front end, although they cannot release that profit until completion.

"We are seeing pressure on land prices and people paying more because of a perception about demand. While it hasn't reached a critical stage, there are a numerous projects at the embryonic stage that might come together in the next couple of years.

"Combined with Auckland infrastructure and residential growth as well as the Christchurch rebuild, the timing will mean a likely shortage of contractors and sub-contractors contributing to inflated construction costs, so budgeting for those contingencies is required."

Osborne says the Auckland Council's Unitary Plan will also give different perceptions of land prices and people will begin speculating.

"So at one time there are going to be higher land and materials costs and a premium for labour and contractors. That is a slew of ingredients people putting projects together will need to think about. Using independent advisers to prepare a business case makes good sense."

- NZ Herald

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