Risk in Development: Types, Management and Factors - PDF

Risk in Development 1.1 Types of risk 1.2 Measures to manage risk Dr. Laetitia van der Merwe In case of an emergency Gather at the assembly point AND  EWS 320 Syllabus Syllabus theme 1: Risk in development Syllabus theme 2: Property refurbishments Syllabus theme 3: Resid...

Risk in Development 1.1 Types of risk 1.2 Measures to manage risk Dr. Laetitia van der Merwe In case of an emergency Gather at the assembly point AND  EWS 320 Syllabus Syllabus theme 1: Risk in development Syllabus theme 2: Property refurbishments Syllabus theme 3: Residential property development Syllabus theme 4: Commercial property development Syllabus theme 5: Green building and sustainable developments Syllabus theme 6: City developments and city improvement districts Syllabus theme 7: International developments  Overview What is property development? Creating Value (for owners/users) – what is value? The project must be profitable Developments are not always sold (for profit). Some are retained as income producing properties (for rental income and capital growth) Rental income and capital growth are functions of the current property market Public vs private sector Where is the focus in public sector? The value for the community must be greater than the development cost (a bit tricky because how do you calculate the value of a bridge or dam for the community??  Overview Economic value, development cost & profit Correlation between the quantity of space produced, the cost of producing the space, and the value of the space (i.e. rental income) E.g. Taller buildings are more expensive Participants in the realm of Property Development  Participants in the realm of Property Development (p.11) but extended  Owners  The seller (of the land) Please make sure that  Financiers/mortgage brokers you understand the functions of the different  Developers/promotors role players in detail.  Land sales estate agent/property brokers If not, find out !!!  Letting agents/property brokers  Professional team (example on next slide)  The main building contractor  Subcontractors (employees for specialist work)  Development manager / Project manager  Local authorities (rezonings, plan approval, etc.)  Community (in the catchment area)  Tenants: majors, nationals and locals  Market research company (establishing the demand for the development)  Advertisers and promotions companies  The Property Developer appoints the professional team that is lead by the Developer’s Development Manager (DM) up to the appointment of the main contractor, and then by the Project Manager (PM) during construction with the input of the DM Architect Landscape Architect Town Planner Interior Architect Quantity Surveyor Heritage Consultant Conveyancer and Legal Consultant Security Consultant Civil Engineer (or Structural and Civil) Environmental Consultant Electrical Engineer Green Building Consultant Mechanical Engineer Art Consultant Traffic Engineer Fire Consultant Geotechnical Engineer Property Management representative IT Engineer Commercial leasing representative Acoustic Engineer Waste Consultant/contractor Lighting Consultant Various other consultants as needed Role of the Developer  Role of the Developer What do you think is the role of the developer here? What are all the things the developer needs to take care off? Market research – establish demand Identify the site, Purchase the land, Rezoning and/or consolidate = lengthy process Other?  Role of the Developer 1. Complete traffic studies & geotechnical tests 2. Negotiate road changes & improvements and bulk service contributions 3. Appoint professional team and manage design process 4. Leasing and anchor tenants 5. Arrange finance 6. Appoint contractor and manage construction process (usually from client side) 7. Market property  Due to the potential for large profits, the property development industry is inherently risky e.g. one project could produce R38,250,000 net income per year Net Income = Total Capital Outlay x Return on Investment = R450,000,000 x 8,5% = R38 250 000 net income/year Like we say: “A billion here and a billion there and soon we’re talking real money” MANAGEMENT Theme 1: Development Risks The syllabus theme consists of the following study units: 1.1 Types of risk 1.2 Measures to manage risks What is RISK?  RISK is: The potential difference between what is expected and what happens And in Real Estate, that usually translates to not realizing the expected profit or in worst case, losing money…  What risks do you think is present during the development of this shopping centre? Before  Until it is completed and trading? After  Property Development Risk Let’s investigate risk according to 4 scientific journal articles (and some additional information from local experience): Phillip Mollard Newell & Steglick Strenger Maphalala & Cloete  How to manage property risk MOLLARD Risk 1 – Insufficient knowledge about development process Don’t understand property market sector and development process How to gain knowledge: mentor, reading, course, specific real estate market sector  How to manage property risk MOLLARD Risk 2 – Paying to much for development site Do market analysis and site analysis Do feasibility study before committing to a site Make certain all the extras are accounted for Mistake (only land & construction costs) e.g. Waterkloof marina land (restrictive condition on the title deed)  How to manage property risk MOLLARD Risk 3 – Purchasing a poor development site Make certain about the following before purchase: Rights and restrictions – Title Deed and Zoning Certificate Heritage & environmental constraints Geotechnical issues Flood levels Storm water Proximity of bulk serves to the site  How to manage property risk MOLLARD Risk 4 – Construction Costs & control Contract (lump sum fixed price & time) Price affected by variations Construction management system Manage the project QS  How to manage property risk MOLLARD Risk 5 –Building contractor with financial problems Good reputation Past projects Financial capacity CAR = Contractors All Risk Insurance Policy  How to manage property risk MOLLARD Risk 6 –Poor workmanship Quality builder with good track record Inspections Communication! How to manage property risk How to manage property risk or mitigate against these Risks Risk 1 Insufficient knowledge about development process Risk 2 Paying too much for the site Risk 3 Purchasing a poor development site Risk 4 Construction costs spiral out of control Risk 5 Building contractor in financial problems Risk 6 Poor workmanship  Property development risk factors NEWELL & STEGLICK Identified 34 risk factors Pre-construction stage – 10 risk factors Contract negotiation stage – 4 risk factors Formal commitment stage – 3 risk factors Construction stage – 8 risk factors Post-construction stage – 9 risk factors  Property development risk factors NEWELL & STEGLICK Identified 34 risk factors Pre-construction stage – 10 risk factors Contract negotiation stage – 4 risk factors Formal commitment stage – 3 risk factors Construction stage – 8 risk factors Post-construction stage – 9 risk factors  Property development risk factors NEWELL & STEGLICK Pre-construction stage – RISKS 1. Environmental (heritage, ecology, contamination?) 2. Approvals (zoning, contributions?) New Political 3. Political (support from local community, council?) Risk in SA ! Next 2 slides 4. Experience (with the type of development and ability to manage?) 5. Market (property market, economy, location, etc.) 6. Feasibility (assumptions, financial performance benchmarks, risk analysis?) 7. Other…  How will this change investors’ and developers’ Risk Perception? Section 25 (2) of the Constitution states that property may be expropriated only in terms of law of general application — (a) for a public purpose or in the public interest; and (b) subject to compensation, the amount of which and the time and manner of payment of which have either been agreed to by those affected or decided or approved by a court. This amount may now be R0,00! Therefore, without compensation. https://www.moneyweb.co.za/news/south-africa/expropriation-dont-be-alarmed-court-may-award-nil-compensation-but-is-not-required-to/ The South African Property Owners Association (SAPOA) reacted on the same day! What does this tell you? 24 January 2025  Property development risk factors NEWELL & STEGLICK Pre-construction stage – RISKS 1. Environmental (heritage, ecology, contamination?) 2. Approvals (zoning, contributions?) Next 2 slide2 3. Political (support from local community, council?) 4. Experience (with the type of development and ability to manage?) 5. Market (property market, economy, location, etc.) Next 2 slide2 6. Feasibility (assumptions, financial performance benchmarks, risk analysis?) Next 2 slide2 7. Other…  Why this 10 year long decline? Why is our industry developing less each year while our population is growing? https://tradingeconomics.com/south-africa/gdp-from-construction  Some of the reasons … Macroeconomic and geopolitical challenges e.g. wars in Ukraine and Israel affect all sectors, not just the construction sector. Specific challenges:  Logistics – rail network isn’t trustworthy - transport by road – poor road conditions increase transport time and cost  Risks presented by the SA Ports – delays due to faulty equipment and stormy sees  Disruptions and intimidation by Construction Mafia - demands protection money  Corruptions – but declining – the Built Anti-Corruption Forum (IBACF) is efficient with investigations, arrests and convictions  Load shedding hit us hard - sharp increases in construction costs - off-grid power solutions to keep construction going – additional costs in manufacturing (construction materials)  Failing and insufficient municipal infrastructure (bulk services) – Construction projects can’t be approved without adequate water, sanitation, roads, electricity, etc. Developers must now install these services, but the costs are often more than their bulk service contributions and must be carried by the project – impacts feasibility study  Delays at municipalities with building plan approval and town planning applications (rezonings, township establishments, etc.) – impacts feasibility study  Property development risk factors NEWELL & STEGLICK Pre-construction stage – RISK MANAGEMENT 1. Environmental (consultants, experts, feasibility) 2. Approvals (contribution & rezoning, plan approval, constant liaison with council) 3. Political (work with community) 4. Experience (only deal with experienced builders) 5. Market (evaluate location) 6. Feasibility (decline approach = conservative)  Property development risk factors NEWELL & STEGLICK Identified 34 risk factors Pre-construction stage – 10 risk factors Contract negotiation stage – 4 risk factors Formal commitment stage – 3 risk factors Construction stage – 8 risk factors Post-construction stage – 9 risk factors  Property development risk factors NEWELL & STEGLICK Contract negotiation stage - RISKS Land cost risk (profit margin?) Acquisition terms risk (fair & flexibility?) Building contract risk (control costs?) Financial risk (not burdensome?)  Property development risk factors NEWELL & STEGLICK Contract negotiation stage – RISK MANAGEMENT Land cost risk (negotiate price that allow for adequate contingencies) Acquisition terms risk (negotiate adjustment mechanisms) Building contract risk (fixed price, proper feasibilities, architectural information beforehand) Financial risk (use corporate funding facilities instead of property specific funding facilities)  Property development risk factors NEWELL & STEGLICK Identified 34 risk factors Pre-construction stage – 10 risk factors Contract negotiation stage – 4 risk factors Formal commitment stage – 3 risk factors Construction stage – 8 risk factors Post-construction stage – 9 risk factors  Property development risk factors NEWELL & STEGLICK Formal commitment stage - RISKS Scope & adequacy of insurance cover All legal documentation executed Binding pre-commitments to lease and purchase (pre-let and pre-sales agreements) RISK MANAGEMENT: Insurances must be in place and all necessary legal documentation has been concluded  Property development risk factors NEWELL & STEGLICK Identified 34 risk factors Pre-construction stage – 10 risk factors Contract negotiation stage – 4 risk factors Formal commitment stage – 3 risk factors Construction stage – 8 risk factors Post-construction stage – 9 risk factors  Property development risk factors NEWELL & STEGLICK Construction stage - RISKS 1. Time delay risk (weather, force majeure, strikes) 2. Cost increase risk 3. Solvency risk 4. Project management risk 5. Experience risk 6. Environmental risk (dust, noise, surface water)  Property development risk factors NEWELL & STEGLICK Construction stage – RISK MANAGEMENT Time delay risk (insurance cover, penalty to builder) Cost increase risk (fixed price contract) Solvency risk (rights to allow replacement) Project management risk (use in-house) Experience risk (check past performance) Environmental risk (site environmental management plan)  Property development risk factors NEWELL & STEGLICK Identified 34 risk factors Pre-construction stage – 10 risk factors Contract negotiation stage – 4 risk factors Formal commitment stage – 3 risk factors Construction stage – 8 risk factors Post-construction stage – 9 risk factors  Property development risk factors NEWELL & STEGLICK Post-construction stage - RISKS 1. Timing of delivering the development 2. Changes in market value 3. Changes in demand and supply 4. Leases/sales fail to complete 5. Branding and image incoherent 6. Changes in interest rates 7. Political changes (inflation, laws)  Property development risk factors NEWELL & STEGLICK Post-construction stage – RISK MANAGEMENT In-house management of critical processes Quality assurance procedures Contractually allocating risk to other parties  Property development risk factors MAPHALALA & CLOETE Homework Read in detail ‘Strenger’ (in Notes)  Property development risk factors MAPHALALA & CLOETE Prof Chris Cloete who wrote your textbook A study of 15 property development companies in Gauteng (Maphalala & Cloete 2014) indicate that the most common risks and uncertainties were: 1. Downturn in property markets and variations occurring in real estate markets 2. Lack of expertise in terms of estimators and decision makers 3. Purchasing a poor development site 4. Construction costs escalating out of control 5. Limited project information 6. Shoddy construction work 7. Building contractor going bankrupt  Remember - each project is different and unique You may run into different risks on different projects There are no Risk-free projects !  Some good news … “Infrastructure South Africa (ISA) is a program in the Ministry of Public Works, mandated as the single point of entry for accelerated infrastructure development. In the 19 March 2024 edition of Engineering News, it was reported that ISA aims to “unblock” 12 major projects in 2024. These projects are:  The R2.1-billion liquid natural gas import terminal in KwaZulu-Natal.  The R38-billion Durban Container Terminal (DCT Pier 1) project in KwaZulu-Natal.  The R2.2-billion Berth A100 liquid bulk project in the Eastern Cape.  The R7.5-billion Ukuvuselela rail project between Gauteng and the Eastern Cape, aimed at assisting car and component manufacturers and exporters.  A R16-billion project to refurbish health facilities.  An R8.5-billion school project in Limpopo and KwaZulu-Natal.  The R30-billion Eskom Mossel Bay gas project.   The R35.8-billion Eskom Tubatse pumped hydro storage project.  The R35.8-billion Rooiwal Phase 2 wastewater project in Tshwane.  The R5.5-billion Amathole water bulk supply augmentation project in the Eastern Cape.  The R8.4-billion Nkhomazi Special Economic Zone (SEZ) in Mpumalanga.  The multi-billion Rand Namakwa SEZ in the Northern Cape.” “The scale of these projects is exciting, and their " unblocking " can potentially create substantial direct and peripheral construction opportunities. Closing thoughts The South African construction industry has given many of us a place to live out our ideals, and it continues to be a source of life for so many in our country. It is often not an accessible realm, but it can be advantageous. New opportunities are presenting themselves; hopefully, we will all be fortunate to share them soon. Here is to meeting each other on a construction site and celebrating that we did not stop believing!” Prof Giel Bekker, Director: Graduate School of Technology Management, University of Pretoria https://www.up.ac.za/graduate-school-of-technology-management/news/post_3232518-the-construction-industry-in- south-africa-caution-and-optimism Western Cape Province – Red Tape Reduction Unit Thank you for watching Risk in Development Dr. Laetitia van der Merwe