Real estate risk assessment 101

As a new real estate developer, one of the big challenges you’ll have to overcome is learning the ins and outs of risk assessment.

Compared to construction alone, you’re going to have a lot more risk categories to contend with.

Before committing to a project, you’re responsible for evaluating:

• Financial risk

• Regulatory hurdles

• Shifting market conditions

• Land acquisition

• Operational challenges

And that’s just the tip of the iceberg!

So the goal of today’s newsletter is to give you a clear picture of the basics you should be aware of as you begin your development career.

There are 3 main factors that will have the biggest impact on the profitability of your real estate project:

1. Financial risk

I.e., what are you paying for the land?

The two main questions to ask yourself are:

• Are you paying too much for land?

• Are you entering at a point that gives you a clear path to the upside?

2. Construction risk

I.e., what are you paying for construction?

Figure out the costs of similar projects in your area.

(Or to put it in real estate terms — what are the comps?)

You don’t want to be the developer who thinks they can build something for $350/sq ft, when it’ll actually cost $450/sq ft!

3. Market risk

I.e., what’s the market doing?

What do interest rates look like?

This will impact your ability to lease-up or sell, what your payment schedule looks like, and whether or not the banks will find your project palatable.

In your proforma, you should ideally aim to try and hit 15% of IRR (Internal Rate of Return). But, you should also have enough of a buffer built in so that if interest rates end up spiking, it won’t totally bankrupt you.

Those were the main 3 risk categories to watch out for.

Now let’s take a quick detour into operational risk assessment:

Operational risk

This falls under the umbrella of “construction risk,” but it’s worth unpacking separately.

Consider whoever’s responsible for overseeing operations on the project and ask yourself:

• Do they understand this asset class?

• Do they know how to manage the asset?

• Do they know how to build the asset?

• If they don’t have a lot of experience, who on the team does?

• Have they hired somebody to run operations?

• And, what kind of risk assessment are you doing on that person?

It’s essential to get this right the first time, because having the wrong leader on site can severely mess up a job.

But on the flip side...

Having the right people on staff can be a huge financial advantage.

We recently saw a situation where a development team made a slight alteration to a sprinkler system, saving $160,000 on their project — and it was simply because the syndicator had an experienced person on their team who understood the local building code.

(Side note: when we hear stories like this, it’s a big green flag that the project is likely a good investment — the developer clearly knows what they’re doing!)

A case study from Stafford Township, NJ

One of our coaching clients recently evaluated a potential project in Stafford Township, NJ.

They were considering buying some land there, so we helped them do a risk assessment. And we saw there was some operational risk.

The land was partly owned by two sisters, and partly owned by other family members.

Everything looked good on the surface at first.

They all said they’d work together to help the developer develop the land, and then take their payout, and walk away.

But, our risk assessment indicated that we should talk to the previous building owner, to figure out why the current owners wanted to sell the business.

And as it turns out...

Most of the family was actively fighting with each other behind the scenes, and couldn’t agree on the long-term vision for the property.

The thing is, this was actually a great project:

• The purchase price was fair

• The township wanted development

• And the operator knew for a fact they could build this building at the prices quoted

But to make it work, you’d need a world-class conflict resolution guru to smooth over the family drama.

So it was just too much risk.

In the end, the developer ended up buying another similar property with fewer complications, and they’re doing well on it now.

The moral of the story is:

Thorough risk assessment will save you from bad investments. Never neglect it!

Ready to start building your own real estate development legacy?

This was just a taste of the strategies we teach inside Highspire.

If you want to learn more, our premiere coaching program will give you the blueprint to:

• Transform your construction business into a profitable, self-managing entity

• Learn (and master) real estate development and investments

• Build a profitable real estate portfolio over the next 5-10 years

We’ll help you leverage your current construction experience into creating true generational wealth.

And you’ll learn it from industry experts with decades of experience, who carved their own paths to success.

If you’re interested in applying:

Schedule a consultation with us here.

Forward always,

Highspire