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Appreciating the risk profile of property investment

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Whether you are investing in commercial property or housing stock, you need to appreciate the risk profile of property investment. In simple terms, the earlier you become involved in a property investment/development the greater the risk therefore the greater the potential reward. This is assuming that the financials add up and there is an exit route. There are also many ways in which you can use funding to gear up your initial investment in a development although this does obviously attract greater risk.

Acquiring land

The most basic strategy associated with property investment is acquiring land with no planning permission. This offers the greatest degree of risk because there is no guarantee that planning consent will be agreed with the local authorities and therefore no guarantee that your development can go ahead. As we move forward each stage from the initial acquisition of land to the completion of a development so the perceived value increases. In effect as you near the final stage of a property development you are paying for the risk taken by those further down the development chain.

There is potentially the greatest reward to those brave enough, who have done their research, who acquire land with no planning permission. Receiving planning consent for a development immediately increases the value of the land and we move onto the next stage.

Property development

Those who acquire land with planning consent will then take on the risks of property development which are many. These risks include unexpected increases in the budget, delays, problems with contractors and a potential downturn in the market. These elements are all factored into the value of unfinished property developments, although it will depend where and what they relate to, when other investors look to join the party at a later stage.

Many people use bridging loans/short-term finance to fund the actual property development in the knowledge that the value will increase significantly, above and beyond funds invested, when the development is complete. In reality there will be a steady increase in the value of the property development the more of the development that is completed. This is simply a risk/reward ratio factor because the nearer you get to the endgame, the actual completion of the property development; the easier it is to clarify the actual cost with no additional investment required.

Acquiring a completed property development

In theory there is still potential profit margin when you invest in a completed property development which is basically the cost of the development compared to rental income or a resale value. The earlier an initial investor becomes involved in a new development the greater the opportunity for them to reduce their sale price while still making a profit. On the other hand, the later in the day you join a property development the less potential margin and “headroom”.

The main driver for those acquiring developed properties is to negotiate the best deal possible, maximise their rental income, increase the overall value and perhaps the biggest kicker, benefiting from a buoyant market going forward. These elements attract their own specific risks!

Conclusion

When looking at property development, whether commercial or domestic, the simple fact is that the earlier you join the development chain the greater the perceived risk therefore the greater the perceived reward. Unfortunately delays and cost increases can have a material impact in the early days. They increase funding expenses, the breakeven level and this is why in some circumstances, especially where commercial funding is released stage by stage, some property developments are not completed.

Where developments remain unfinished there is the potential to “grab a bargain” but you will need to take into account the level of funding required to finish the project, its perceived value at the moment and the potential sale price. Do the potential rewards outweigh the risks?


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