"The smart move is to avoid as much of the planning system as possible, and the Government has given us a tool for the job called Permitted Development Rights (PDRs)"
Property development can produce healthy profits, but it is an inherently risky business. Managing risk is arguably the most important task for any developer, whether new to the business, a seasoned veteran or anywhere in between.
One of the great attractions of property development is that the barriers to entry are minimal.
Anyone can develop property by buying a property or some land and then hiring various professionals such as architects and builders to get to work.
However, the people who make the most money from their projects are those who know how to manage risk. There is no way of removing all risk from property development—like most wealth-generating enterprises, it is a strict risk-versus-reward model—but if you know what you are doing you can significantly shrink your exposure to a variety of risks.
Planning
Arguably the most significant development risk is what we call planning risk. If you are developing property, whether a new build or simply converting an existing building, you will need planning permission. Without it, you could face fines, even imprisonment, and you don’t want to have to watch something you have built being knocked down. Obtaining planning permission is not optional.
Our current planning infrastructure originated in the 1950s, and today we are faced with local planning authorities that are under-resourced, over-stretched, demotivated, and where many of the most experienced people have left. Planning applications that supposedly should be assessed within eight weeks (thirteen weeks for larger projects), nearly always take much longer.
These days it is not uncommon for applicants to be told seven and a half weeks down the line that they need to submit further information (e.g., by procuring various surveys and reports). This means spending more time and money jumping through hoops with no guarantee of a successful outcome.
Some applications have been in limbo for years. And if you have already purchased the property in the hope of getting planning permission, not only will you be racking up finance costs while you wait, but the property may even go down in value if planning is eventually refused.
How can you dodge the planning bullet?
The smart move is to avoid as much of the planning system as possible, and the Government has given us a tool for the job called Permitted Development Rights (PDRs).
These rights allow us to change a wide variety of commercial buildings into residential use without having to apply for full planning permission. In most cases, we’ll still need council approval, however, with PDR there is a short and prescriptive list of things they can object to.
So, you know what boxes you need to tick beforehand, plus the council must determine the application within eight weeks, otherwise, it is automatically approved. You will still need full planning permission if you are changing the elevations of the building, but that should not be contentious – the change of use is the important one, and with PDRs, the council’s hands are effectively tied.
Not all PDRs are created equal. My favourites are classes G and MA which allow us to convert most commercial property types (offices, shops, light industrial, etc.) into residential. PDRs exist because Whitehall has recognised the need to repurpose the glut of unused brownfield sites across the country as this would create up to 1.3 million new homes.
And unlike building on green belt land, converting existing buildings is usually a vote-winner rather than a vote-loser. So, if you’re looking to de-risk your first project, I would strongly advise you to go down the Permitted Development route as it’s likely to be quicker and more certain.
Planning permission already granted
You may be wondering about buying a property that already has planning permission granted – surely this is a way to avoid the planning risk?
The problem with this approach is that the planning uplift has already been built into the asking price, meaning there is less profit for you. As a result, the successful bidder will (a) have to build the cheapest way possible, (b) make less profit, or (c) make a loss because they get their numbers wrong. None of these options should appeal to you.
Even if you think you could improve on the existing plans, you are still back to square one – having to submit a new planning application that may or may not get approved. So, I would avoid these schemes, no matter how appealing the artist’s impression looks in the agent’s particulars.
Assumptions
The next significant risk we need to talk about concerns making optimistic assumptions. You may tell yourself that you are far too old and wise to fall into that trap, but the problem is you won’t necessarily notice that you’ve done it. There is no reward in finding unprofitable deals, so we are predisposed to hope that every deal we look at will be profitable.
There are a lot of variables that determine whether a deal works financially, and you need to make a lot of assumptions, especially at the outset. If you dial every cost assumption to the minimum, your numbers will project a hefty profit. Dial costs to the maximum, and you will show a loss. The trick, then, is to be as pragmatic as possible.
Do not fall into the trap of being just a tad optimistic here and there, as it can really trip you up.
A good tip is when you are putting together your spreadsheets, ensure you can’t see your overall profit percentage figure when you input your assumptions. If you can, then as you see your profit percentage figure reduce, there is a high risk that your subconscious will make your assumptions less prudent – it’s human nature.
The solution is to input every assumption reasonably and only enter your target sale values (GDVs) afterwards. That way, you’ll only see your profit percentage AFTER inputting your cost assumptions.
Margins
An important piece of de-risking advice is always to target a 20% profit margin based on GDV (gross development value, i.e., your selling prices). So, if your units are expected to sell for a total of £500k, you want to target a £100k profit at the outset. You should also include a contingency budget of 10-15% of the construction costs.
This lies at the heart of development risk management. You won’t be able to predict the additional costs that will crop up as your project progresses, so you need to build in enough fat to ride out a few storms. And there will be bumps in the road; the trick is to ensure you are still left with a decent profit once you have crossed the finish line.
Also, don’t be tempted to target a fixed profit figure rather than a percentage. For example, you might think that targeting a £200k profit sounds pretty good. But if the GDV were
£5 million, you’d only make a 4% profit margin. It doesn’t take too many unexpected costs to wipe out 4%, so make sure that you stick to 20%, not simply a fixed amount of money you would like to make.
While we are talking about numbers, make sure you have firmed up as many of your pricing assumptions as possible before you commit. You won’t be able to fix them completely, but a common mistake is leaving too many figures as ‘reasonable assumptions’, then getting lazy and assuming that your initial assumptions will be about right. Instead, firm up as many of your numbers as possible before you commit, and you will reduce the risk of expensive surprises later.
On-site
Risk can also crop up while your team is on-site. The most common problem occurs when developers fail to specify precisely what they want. If you have specified ‘a dozen internal doors’ in the tender, imagining (but not stipulating) nice oak ones with brushed aluminium handles, you are likely to be disappointed if your contractor installs cheap-as-chips plywood doors. The doors can be changed but at extra expense.
The lesson? If you don’t indicate what you want exactly, your contractor will likely install the cheapest available, so be very specific.
Exit
It is essential to have more than one exit for your project at the outset. You may want to sell your finished units, but what if the market has tanked when you come to sell?
The logical thing to do could be to refinance the project onto a buy-to-let mortgage and then let the units out until the market rebounds. On the other hand, if you were planning to rent out the units but the rental market bombed, then your plan B could be to sell. Either way, ensure you have worked out a Plan B at the start and that you know the numbers involved.
Summary
With small-scale property development now more popular than ever, many people are eyeing opportunities to convert small commercial buildings and shops into much-needed residential accommodation. But property development has many risks. It is possible to reduce most of them if you make risk reduction your primary focus.
