Overview of Real Estate Development

Overview of Real Estate Development


What is Real Estate Development?

  • Real estate development or property development can be described as a change to existing use of land by providing a real estate solution for society by designing, financing and constructing a facility that satisfies demand. 
  • It is a process requiring meticulous and thorough research together with a firm understanding of current and future market conditions in the property industry.  
  • Some may consider property development as a skill, but in reality, property development is an analytical process of how a specific development matches the current and projected market in line with associated risks and financial rewards. 

Why do we need Real Estate Developers? 

With the ever-increasing global population, there is an ongoing demand for food and shelter — our very survival impacts directly on how we use and manage our resources and land. Since the evolution of man, humans have made significant steps in the utilisation of land as described below. 

  • Land is not only used for shelter but also recreation, shopping, education, transport, business activities and entertainment. The homes we live in provide accommodation where we eat and sleep. Commercial buildings provide space for social and business interaction and retail centres for selling of goods and services. 
  • As our communities increase, the demand for these facilities increase and this is where more property developers will be needed. In Australia, the population at the time of writing is 24.64 million and projected to be 40 million by 2060, meaning more housing and related facilities will have to be provided to accommodate this growth. 

Types of Real Estate Developers

There are many different types of developments, and by the same token, many types of property developers. Listed below are definitions of some typical developers: 

  • Part-time developers – This group consists of novice developers or investors who hold a full-time job or run a small syndicate of friends or business associates. They often develop with the aim of holding onto the development as a long-term investment. They tend to focus on smaller projects such as a new residential or acquire an existing building and add value through renovation. 
  • Full-time developers – Full timers consist mainly of individuals or partners who have decided to make development a career. They can be professionals like accountants, quantity surveyors, construction managers, project managers, builders, architects, engineers, real estate agents or ordinary people whose initial developments turned out to be financially rewarding. These groups tend to be highly geared, aware of the latest financial instruments, and seek to maximise tax benefits and capital gains from their developments. 
  • Corporations – This group includes property development companies and major financial institutions. They could be privately owned corporations, public companies listed on the stock exchange, large insurance groups, superannuation funds or trade unions. They develop larger commercial properties such as regional shopping centres with a view to of generating profits for their shareholders aiming for long-term capital gain and good cash flow through positive rental income.  
  • Government/Institutional – This category consists mainly of state governments assisted at times by the Federal Government. Type of developments would be government offices, hospitals, police stations, industrial land sub-division and other public institutions.  
  • Service fee developers – These developers have experience and qualifications to contract with a landowner to develop their property for a fee. They are experienced in all phases of commercial or residential development and are familiar with all aspects of developments including finance, feasibility studies and so on. They understand the risk involved and how to either avoid or mitigate them. These developers can also be part of an investment syndicate, and while they maintain a shareholding, they are also paid a fee in managing the development process.  Fees charged for their professional service can range from 3 to 5 %, depending on the complexity of the project. First-time developers and investors who do not have time or experience should consider employing such professionals. 

Types of Residential Developments 

Residential developments can be categorised into the following areas: 

  • Renovations – Renovating older homes can reward a developer handsomely in a short period. These homes may require some alterations, additional rooms or just a coat of paint to bring the building to present market standards.  
  • Speculative homes – These new homes are usually built on a single lot in a new land sub-division or on an older block in existing suburbs that have been sub-divided into smaller lots.   
  • Small units – Smaller unit developments range from two to six single or double storey units. They are commonly found in suburban areas of both new and old sub-divisions and can be defined as villas or townhouses.  
  • Group housing – Under this category, which can include Townhouses, Villas, and Retirement Villages, one would find a group of eight or more units. Each development would have an architectural theme defined by a similar use of materials, scale and building style. 
  • Apartments – These buildings can be found mainly in the inner-city areas of most capital cities. Also referred to as multiple dwellings, this building form is defined as dwellings in a group of one or more where any part of a dwelling is built vertically above the other or part of any other.  
  • Government housing – Also known as Public or Social Housing provided by the Government for members of the population that cannot afford to purchase their own home or afford higher rents in the marketplace.  
  • Residential land – These developments can vary in scale from small backyard sub-divisions to larger scale suburban community land developments. The latter requires intensive town planning in conjunction with local Councils and various other Government authorities.  
  • Niche residential developments – In addition to the above residential developments, there are many developments, which we can consider as niche markets, and these include: 
    • Holiday homes,  
    • Timeshare apartments,  
    • Cooperative housing,  
    • Student accommodation,  
    • Lifestyle villages; and  
    • Caravan parks.  

Types of Commercial Developments 

Commercial properties can be categorised into the following areas: 

  • Office Buildings – These structures are designed as low-rise, mid-rise or high-rise buildings and can consist of one to multiple stories depending on zoning and density regulations. The users of the office space sell and administrate a service to the public. Depending on their quality and finishes they can be classified a Class A, B or C offices. The following are the various types of offices.  
    • Renovated house  
    • Strata title offices  
    • Office parks 
    • Multi-storey office blocks 
  • Retail centres – Retail facilities come in all shapes and sizes ranging from a corner shop to large retail shopping malls. Larger developments require intensive analysis, planning, financing, leasing and management. Below is a list of some types of retail outlets. 
    • Corner shop convenience store  
    • Strip shopping or showrooms 
    • Neighbourhood shopping centre (10,00m2 – 5000m2) 
    • District shopping centre (5000m² – 20,000m²)  
    • Regional shopping centre (20,000m² plus)  
    • Hyper-Centre (20,000m² plus)   
    • Theme Centres (size varies) – These are retail centres designed around a common theme:  
    • Discount Centre  
    • Factory Outlet Centre  
    • Fashion Centre  
  • Industrial Buildings – Industrial buildings fall under to two categories, light and heavy. Light industrial mainly consists of warehouses or small manufacturing units. Heavy industrial are larger buildings providing space for heavy industrial work or manufacturing. Some examples of Industrial properties are noted below: 
    • Office-Warehouse.  
    • Service industrial units 
    • Distribution centres. 
    • Bulk-Distribution  
    • Manufacturing facilities 
    • Storage facilities 
  • Tourist facilities – Tourist buildings can include many varied facilities that are common to all types of short stay or holiday destinations that provide accommodation, restaurants, cafes, entertainment, leisure and relaxation. Popular types of tourist facilities include: 
    • Hotels  
    • Service apartments  
    • Motels  
    • Casinos  
    • Entertainment centres  
    • Resort golf course estates  
    • Marina developments  
    • Waterfront developments   
    • Theme parks   
    • Conference centres   
  • Mixed Use Developments – Mixed-Use development can vary with different asset classes with a mix of residential and commercial buildings. These types of development are found closer to the Central Business District or transport nodes. 
  • Niche Markets – These are specific developments that are generally not available to the average investor or developer and can include: 
    • Petrol Outlets 
    • Parking lots and garages 

Types of Social & Community Developments 

Also known as social infrastructure, community needs rather than commercial incentives drive most of these developments. Various levels of government normally develop community and social projects. However, some of the buildings can be lucrative to developers especially if a long-term government lease underwrites them. 

  • Educational Centres – Facilities in education can vary from private primary schools to tertiary centres such as colleges and universities with adjacent science technology parks. 
    • Child Care Centres 
    • Primary to High Schools 
    • Colleges 
    • Universities 
    • Science technology Parks 
  • Medical Buildings – Development and investment in medical facilities can be lucrative if well-located sites are found. Depending on its size, facilities can vary from small doctors’ practice to fully operational hospital. These buildings can be categorised into the following: 
    • Clinics 
    • Suburban medical centres 
    • Neighbourhood medical centres 
    • Private hospitals 
    • Regional hospitals 
  • Sport and recreation facilities – These facilities are difficult to fund and generally developed by the government with taxpayer funds or via corporate sponsorship — the income stream of such developments can be volatile and varied. Some typical examples include: 
    • Sports Stadiums – Indoor and outdoor  
    • Sport Club buildings 
    • Public swimming pools 

Residential versus Commercial Developments 

In deciding which area of real estate development, one should focus on, it is worthwhile to understand the difference between residential and commercial property development.  Residential is generally easier to understand when starting while commercial which is associated with greater returns and higher risks requires more experience. The critical difference between residential and commercial developments is in the assessment of their asset value in dollar terms, as explained below:  

  • With residential, the value is based mainly on supply and demand in a specific location;  
  • With commercial, the value is based on an inverse proportion to the level of inherent risk to the long-term stability of the income stream known as the “yield” from the property. (This means that no matter how attractive a commercial building is architecturally or how much it has cost to build, the bottom line in assessing its value will depend on the leases and the net income stream that the building produces.)  

Other differences between these assets are described below.  

Market research – In analysing the market for a potential development, Commercial property requires more intensive market research on a macro level whereas with residential the supply and demand is localised.   

Long-term values – The long-term value of any property is based on variable factors, such as the neighbourhood, demographics, communal facilities, schools, transport and the local economy. Residential property in the right location allows for the most effective management and control of these variables, whereas commercial property can depreciate for example from the closure of a road. Commercial properties could however have a monopoly if no further development would create competition. 

Value adding – Developers in residential property have the potential to add value to their properties by constructing additional rooms or by renovating parts of the property like the kitchen or bathrooms. With commercial property, these opportunities are relatively limited, as local government regulations can prohibit large-scale renovation works. However, on the positive side, the value can improve by undertaking cosmetic changes to the facade or favourable negotiation of lease terms.    

Rental growth – Commercial property offers greater opportunities for rental growth compared with residential. The rental yields are generally lower in residential properties. With commercial leases, the annual rental is higher and rental increases are usually in line with the Consumer Price Index (CPI) or by 4%, whereas this is not always achievable with residential property. Commercial property leases tend to be longer than residential properties, ranging from 3 to 20 years and are often secured by bank guarantees, which make them a reliable investment.  

Market size – Residential property can cater to a broader market when compared to the sale of a commercial property. It easier to market and sell a residential development as it can be broken down into smaller units such as an apartment block which can be divided into strata sections and sold to several purchasers. On the other hand, commercial buildings with comparatively similar floor area, such as small office block or shopping centre, would need a single purchaser in most cases.      

Initial investment – Most residential projects require a smaller amount of capital to get started compared with commercial. Also, lending institutions have the infrastructure and systems to make home loans more accessible for the consumer to apply for a loan. As commercial developments require substantial capital, the application for funding is more complex and takes longer to obtain approval. 

Liquidity – With residential finance more readily available for end purchasers, housing developments are a lot easier to sell than commercial developments. This allows the residential developer to exit his or her development earlier. Commercial projects will generally cost more and take longer to construct incurring higher interest on building cost. With commercial developments, finding an end-buyer can be complicated as buyers are more sophisticated and impose stringent conditions for purchase.   

Leasing – Commercial properties can be harder to lease due to the specific requirements of commercial tenants. In some instances, owners who are pressed to find a commercial tenant, will offer generous lease terms to make sure that the property is not vacant. This can take the form of rent-free periods or expenditure to meet the tenant’s specific needs. With residential developments, the developer has the flexibility to sell part of the development to individual purchasers and rent out the balance. This avoids the need to reduce their rent but will be subject to the residential development being in a location where there is good infrastructure and demand. 

Purchasers – Purchasers of residential property are not as sophisticated compared to a seasoned investor interested in commercial properties. Commercial property investors will generally negotiate actively which could delay the settlement. An offer on a residential property is usually completed on a standard offer and acceptance executed by a real estate agent, whereas with larger commercial properties a solicitor would be required to formalise the purchase. 

Capital growth – During the boom period of a property cycle, residential properties have a far higher capital growth than commercial. A shortage of residential properties on the market will drive prices up. Whereas with commercial properties, their value is tied up to the term of a lease with only CPI related increase in value. However, most commercial properties generally have a rent review over an agreed period to make up the loss of capital growth during the boom period. 

Residential Commercial
Market research localized  Market research based on a macro or regional level 
Valuation based on supply and demand  Valuation based on the net income of the property 
Improving value, a lot easier  Limitations to adding value 
Less sensitive to competition for rental growth  Sensitive to competition from similar building type 
More opportunities for building improvements  Less opportunities for building improvements 
Larger purchaser base  Smaller purchaser base 
Ease of finance  Complex financing 
More flexibility in exiting   Limited exit strategies 
Less sophisticated purchaser – shorter negotiations  Sophisticated purchasers – longer negotiations 
Greater capital growth in boom times  Less capital growth in boom times 
Shorter vacancy periods  Longer vacancy periods 

From the above analysis, it may seem that there are more risks involved in commercial properties. This is true as a generalisation, but if one is knowledgeable and experienced in the commercial sector, there are better profits to be made for the same amount of time and capital investment compared to residential developments.  


Conclusion 

With the world’s constant increase in population, the demand for housing to live in and commercial buildings to work in, will create many opportunities for real estate developers. As a developer, you are the initiator and leader who will not only be building new structures but create jobs for professional consultants, suppliers and tradespeople. It is a risky and complex business but with risk comes rewards not only in monetary terms but also in receiving a sense of satisfaction and achievement when your development is completed.    

If you are considering making real estate development as a career, may I advise you that success does not come automatically. Anyone can call themselves a developer as you don’t need a degree or certificate to claim the name. However, not many can claim to be a “smart” developer! To stake claim as a smart developer, it may take anything up to 10 years working in this industry, or at least experiencing and surviving one “boom and bust” economic cycle. 

To kick start a career as a property developer, you need to be educated. Knowledge is the key to a successful business. Being in a complex business without education, a developer can and will make many mistakes along the way. So, read many articles, blogs, books and keep yourself updated with news on real estate. Also, listen to podcasts, watch videos, share experiences and educate yourself to gain the necessary knowledge to become a smart developer.   

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