I’ve been in the real estate business for over a decade.
There are some mistakes that I made when I just started my career that I see many other first-time real estate developers make now.
Being a successful real estate developer requires far more than buying real estate, hiring a contractor, and supervising the construction process.
You won’t get a gorgeous home that looks like this…
….if you don’t spend some time learning how to become a real estate developer the right way.
You don’t need a degree to become a real estate developer. What you do need is:
- Applied working knowledge (you should get some experience through working with either a real estate development company or other real estate developers)
- Business savvy
- Proper financial management skills
- A network of real estate professionals and lenders
You also should avoid these ten mistakes so that you don’t waste a lot of time and money doing the wrong things.
Before we discuss these ten mistakes, you may want to read my article on how to get started as a real estate developer.
10 Mistakes To Avoid As A Real Estate Developer
1. Not Putting the Proper Business Framework in Place For Success As A Real Estate Developer
Before you start your first real estate development project, talk with a lawyer and tax accountant to ensure you have the right business structure that works for you.
The right business structure, such as a limited liability company (LLC), provides you with some protection against lawsuits or claims being filed directly against you. It also allows you to access tax benefits.
You will also need bookkeeping or accounting services so that you keep proper financial records. This will become important when you need to file taxes, open bank accounts, and access commercial loans. Proper financial records will also help you build trust with potential investors.
It’s also good to have a real estate developer business plan. You aren’t arbitrarily becoming a real estate developer just to work on some random real estate projects and call it a day.
The most critical areas of a real estate developer business plan are:
- Business description and structure
- Financial plan projections
- Market analysis
- Strategy and implementation
- Marketing plan
You may want to speak with a business development professional who can help you put together a solid real estate developer business plan to get you started.
2. Neglecting Proper Market And Industry Research Relevant to Real Estate Developers
Whether your first project is building a single-family house or you’re building a small residential or commercial multi-unit, you’ll need to know about the permits and building approvals you will need and the agencies you have to work with.
But, there’s more to real estate development than the actual construction. A successful real estate developer must have a working knowledge of the real estate market and the economic factors that influence the market.
Real estate development and construction is big business that relies on understanding the market (buyers and sellers), socioeconomic conditions (affordability and preference), and other influencing factors such as government policies, crime, and quality of the labour force.
As a real estate developer, you need to understand how these forces will affect your projects and make forecasts to determine what type of project to undertake, when and where to undertake the project, and who to market it to.
This requires a lot of planning and assessment of your competitors to come up with the right product at the right time and in the right location. You must also understand how to determine whether a project can be profitable and be able to identify and assess the project’s risks.
It’s important to be able to finance, market, and sell the project to yield sufficient positive cash flow that makes doing the project worthwhile. In other words, there is no point in taking on the risk of developing a project when you could passively invest the same amount of money to yield the same return.
The business of real estate development is risky and involves a number of technical and analytical skills. The important point to note is that it should be treated as a business rather than a speculative venture.
3. Trying To Cut Down The Costs Of The Real Estate Development Project By Not Hiring Experts
Success in real estate development requires the right team. Consult and hire experts to help plan, design, finance, and execute the project in the right way and according to your business strategy.
You can’t do everything on your own. Some of the experts you should consider include:
- Real estate analysts
- Construction cost estimators
- Project managers
- Design engineers
- Land surveyors
- Soils Engineers
- Real estate sales agents
- Project managers
- Mortgage Brokers
They should help you make educated projections based on an assessment of the calculated risks about the feasibility and profitability of the project. These projections include preparing a project budget that includes the cost of the design, construction, approvals fees, financing, legal and sales.
Also, ensure that these projections include a detailed schedule for each stage (design, approval, construction, sales). These figures will also help you generate the projected selling prices and total estimated revenue as well as a marketing plan.
I managed a project once where the layout of the house had to be redone because the inexperienced architect completely ignored the client’s budget and wishes. The client wanted to add-on to the unit over time, but the architect’s design didn’t reflect that request. The kitchen had to be relocated and windows and doors had to be shifted.
4. Setting Unrealistic Timelines For A Real Estate Development Project
For small to medium multi unit development projects (5 to 50 units), your development project will take about 2 years from the time you acquire the property, complete the design, obtain approval, raise the funds to finance the construction, and complete the construction. This is why your business is heavily reliant on being able to make good and realistic projections about the project.
Each project should have checkpoints at critical stages and an exit strategy at each stage. The project shouldn’t progress to the next stage unless it meets the established criteria which usually include whether it meets the design specifications and is within budget. It’s critical to perform these internal checks especially if the market changes unfavourably.
Here are some questions you should ask during these critical checks to determine whether you should proceed.
- Are the proposed size and layout of the units preferred in that area?
- Are you able to build enough units on the property to make a profit?
- Is the design compliant with planning and building requirements?
- Is there sufficient margin between the projected revenue and the total development cost?
- Will the units be in demand at the proposed selling prices?
- Are you able to finance the project?
- Are you able to build the project?
5. Lacking The Discipline Necessary To Successfully Execute A Real Estate Development Project
Discipline is the key to success. If your answer is no to any of these questions previously mentioned at any stage in the process, you must address the problem before going to the next stage of the project.
Don’t continue to spend money on the real estate development project hoping the issue will resolve itself, especially if the issues arise at the start. A risky project will only get riskier with time.
One of the ways to deal with these issues is to have an exit plan before starting construction. You could sell the property with practical concept designs or after getting a building permit. (that is if you decide not to follow through with the actual construction. You could also partner with people with the resources and skills that you need.
6. Not Doing Any Due Diligence Before Buying the Property
Don’t jump into a deal ‘feet-first’ without doing some critical checks on the property you plan to buy. An experienced lawyer, real estate development advisor, or building contractor will be able to help you at this stage.
The real estate lawyer would do a title search on the property to determine whether there are any legal or physical restrictions on the property. If you’re buying single family lots, you would also be competing with potential homeowners. So, you should have at least 14 days to do the necessary checks.
Some properties are zoned for single family use but could be reclassified for the development of multiple units if they’re large enough (say more than 2,000 square metres or about half acre).
Additionally, legal work would be required to convert the property’s use to fit your planned use if it differs. You would also have to check with planning agencies.
In Jamaica, some of the agencies you would contact are the National Environment and Planning Agency (NEPA) and your local parish council to see if your proposed use would be considered. The agencies you would contact would differ from one country to the next.
You may not have time to wait for their response before closing the deal so ensure that you have a workable exit strategy in case you decide to still close the deal.
Some projects I’ve worked on required the homeowner to install a lengthy water line to connect to the nearest public system. I’ve also worked on larger projects where we had to build a bridge, sewage lift station, and even upgrade a well on the property to supply potable water for our planned subdivision.
7. Paying Too Much For A Property
Sometimes, you can get involved in a bidding war with other developers for the same property. Whilst this is confirmation that you have found a good deal, this deal can quickly sour for you if you ignore the advice of your team and overpay for the property.
The temptation is to think that you can simply raise your selling price, but this can make your real estate development project unattractive to buyers. You may also have to reduce your budget in other areas and limit how much you can spend on features and amenities.
Stick to your strategy for developing this property but adjust your budget if you realise that you were too conservative in some of your estimates. Consider also looking for less competitive market niches.
8. Underestimating The Project Schedule and Budget
So, you’ve finally closed the deal on a decent property with lots of potential. Your team comes up with a good design. The schedule is aggressive, and the budget is based on cheap construction rates and building materials.
Quick and cheap. Doable right? No. Actually, you discover that it takes longer to get the building permit, you couldn’t find the right building materials for your budget, some of the work had to be redone, and you didn’t include any contingencies in your budget! In the end, you’re lucky if you can break-even.
So, how do you set a realistic schedule for your real estate development project?
- Get advice from your designer and estimator, as well as from contractors and other experienced developers.
- Use their feedback to identify the shortest timeline.
- Bear in mind that the shortest timeline is likely to attract high rates for the items of work because it requires more resources and is the most difficult to achieve. The longer timeline is often preferred by the contract because it brings with it less pressure.
- Factor in the relevant risks such as holding costs, additional interest costs for the extra time, and the time of year when you open the real estate development project to the market.
- Use the average of the shortest and longest duration.
Follow these steps diligently until you have enough experience to determine the most realistic duration without going through this rigorous process.
Get advice from your designer and estimator. Also, seek advice from other contractors and more experienced developers. Based on their feedback, identify which timeline is the shortest.
This is likely to attract high rates for the items of work because it requires more resources, and is the most difficult to achieve. The longest duration is preferred by contractors because they are not under too much pressure. They should quote you reasonable rates to complete the job. However, whilst the construction cost may be reasonable, you will pay more in holding costs such as additional interest costs for the extra time.
If you have no other project risk, such as the time of year you need to put your project on the market, then you could use the average of the shortest and longest duration. Do this until you have enough experience to determine the most realistic duration for each of your projects.
9. Not Having a Good Design
A good design is one that makes best use of the property. The efficiency of the layout, as well as the total area of what you’re building, will determine whether you can optimise your profits while complying with planning requirements (provision for open spaces, amenities, and water and sewage services).
Also, a good layout is determined by the preferences and lifestyle trends of your target market. This will determine whether it takes long to sell or has to be sold at a lower price. Some of the factors to consider are the:
- Number and size of bedrooms and bathrooms
- Amount of commercial rentable space
- Number of parking spaces
- Whether the facility has an elevator and water storage tanks
- How the building looks from the outside.
10. Bad Financing
Just like it’s important to have the right business structure to operate and scale your business, it’s also important to have the right type of financing for your project. In addition to your budget, it’s important to prepare your cash flow projections for your project so that you can organise how you will pay for the expenses of the project.
The right structure for your financing will also optimise your returns, net cash flow from income properties, and profit on the sale. The components of your financing to consider include the:
- Amount borrowed as a percentage of the value of the property
- Repayment period
- Interest rate
- Penalties for early repayment or late payment
- Mortgage amount and frequency
But, don’t forget to work on the relationship with your financier. This is important because a lot of things can go wrong with the project.
There could be a delay in starting construction, construction could take longer than planned, or it could take long to sell or lease the property. So, it’s important to have a good relationship with your lender so that you can negotiate the financing terms.
Final Words: Becoming A Successful Real Estate Developer Requires A Lot of Planning, Foresight, Strategy, and Collaboration
Real estate development isn’t as easy as it looks on HGTV. It’s a risky investment that can create major financial losses if not done correctly. Remember, you need the right:
- Real estate developer business plan
- Financial and Exit Strategy
- Research skills
Be patient and look for your first deal that will work for you based on your capabilities and risk tolerance. It’s always better to say no, especially to seemingly good deals that would stretch your financial resources or are outside of your comfort level or expertise.