Commercial Real Estate Development Is An Exercise In Risk Management

At its core, real estate development is a game of risks. Anticipating and navigating around pitfalls that threaten the viability of real estate projects is one of the most fundamental responsibilities for a developer.

While more seasoned developers can see common pitfalls coming from miles away, there’s no guarantee they can outrun the storm using solely traditional processes such as handshake deals and gut instinct. To make matters more difficult, junior project managers with little experience in the field—and even fewer relationships with contractors and vendors—lack the shared institutional knowledge that comes from years of experiencing trial and error to keep a project on budget and on time.

Below are three of the most common setbacks I faced during my time as a developer, as well as ways developers can go about solving similar issues today.

1. Scope Gaps

When working on multimillion-dollar developments that often involve anywhere from dozens to hundreds of vendors, it can be easy for things to slip through the cracks.

Scope gaps typically occur when there is a lack of clarity and understanding between the development team, design consultants, general contractor and project vendors regarding goals, deliverables and costs. These gaps can be detrimental to on-time and on-budget project delivery simply due to a breakdown in communication and planning.

For example, when I was working on a development project in Brooklyn, it was not made clear between our window manufacturer and masonry subcontractor which of them had ultimate responsibility for the thermal barrier and sealant in between the brick facade and window assemblies. In this case, both vendors assumed the other party had this responsibility in their respective contracts. Because contracts had been signed and both parties had already been paid a significant part of their fee, this debate caused a setback both in terms of cost and timeline—all of which could have been avoided with greater awareness and communication of each vendor’s responsibilities earlier in the project.

Better communication and documentation among project teams and vendors is the key to successfully avoiding these scope gaps. This means that project teams should have a clear process for day-to-day collaboration and communication that ensures every team member is properly informed and that no crucial information is slipping through the cracks. Some teams supplement these communication processes with technology that stores and benchmarks all project data, adding another layer of defense against scope gaps and ultimately resulting in a virtuous cycle of improvement with every project.

2. Financial Headaches

There are two critical, overarching themes that highly effective developers focus on as it relates to project financials: 1) accurate reporting to financial partners, which is primarily a meticulous cost-tracking exercise needed to draw down funds from a construction loan and 2) managing a project proactively to forecast outcomes and worst-case scenarios that might warrant preemptive pivots in project strategy.

Because both exercises require tremendous effort and administrative burden, I’ve noticed that project teams who focus solely on the reporting of actuals and the construction loan draw requests are unable to delegate efforts to worst-case-scenario forecasting. Alternatively, more sophisticated teams that do invest substantial time and effort into both tasks (the reporting of actuals as well as the forecasting that quantifies every potential thing that could go wrong) are often unable to focus on creating true value and other project oversight needs.

One of the best ways to avoid financial risk is by leveraging the institutional knowledge of experienced senior team members who have been with the firm for years. Breaking down the communication and collaboration barriers between senior and junior team members allows them to share valuable tips and tricks for navigating financial roadblocks. This helps more junior team members get up to speed quickly and ensures that this knowledge is not lost when senior team members retire.

Regardless of a development team’s size or experience level, technology solutions that provide instant access to both historical project and institutional data are effective tools for avoiding inaccurate financial reporting and forecasting. By compiling all the relevant information needed for reports, these solutions can not only save developers the headaches that accompany an inaccurate report but also give teams back precious time that can be used on overall project strategy.

3. Market Risks

With a recession on the horizon and construction costs continuing to surge with rising rates, current market volatility is at the forefront of developers’ minds. While this is a major challenge for the commercial real estate sector, it has also created several new opportunities.

As an example, the U.S. market’s office building sector significantly contracted when Covid-19 prompted millions to start working remotely. Columbia University and New York University researchers believe tenant demand for office space will fall by 28% this year, reducing property values by $453 billion (download). Developers can hedge their bets against macroeconomic headwinds by pursuing green building renovation projects to take advantage of financial incentives offered by recently enacted legislation or to launch ground-up initiatives in underutilized asset classes.

To fully capitalize on those opportunities, developers need a strong understanding of anticipated costs and the agility to take action when those projections change. This is where data analytics and proactive insights can be especially valuable. AI-driven platforms enable teams to predict how shifts in the market could potentially impact budgets and timelines by combining and collecting historical data and the latest project updates. Access to these insights sets developers up for success by allowing them to make proactive decisions based on hard information instead of guesswork.

No matter the experience level of your development team, in today’s climate, it is crucial for developers to have a real-time line of sight into the budget and performance of their development. This way, they can adapt as needed when challenges arise.

Forbes Business Council is the foremost growth and networking organization for business owners and leaders. Do I qualify?