Major Real Estate Development Risk Management and Insurance from the Developers Position - Research Paper Example

Major Real E Development Risk Management and Insurance from the Developer’s Position Introduction For many decades, man’s existence has been characterized by the existence of different kinds and forms of risks which play a major role in designing how human beings manage and develop various perspectives of the economy and pacts of the organization. Risk can be broadly understood as the possibility of something happening that is likely to impact on the various organizational objectives. Through risk, a person or an organization can either gain or lose in a particular undertaking. In this project, I will look at the aspect of risk and its management to a developer in the real estate industry. I will also look at the insurance factors that affect a real estate developer’s position. Literature review Various literatures offer a different understanding of the concept of real estate development with some looking at it as being similar to property development, while others looking at them differently. Basically, real estate development refers to a process that makes it possible for land use to be intensified for the purpose of coming up with housing structures for occupation. Real estate is also looked at as a concept that makes it possible for construction and necessary access of infrastructure, and at the same time allows legal subdivision of property for the purpose of vertical construction. Real estate itself is looked at as a projection that takes in the aspect of money, space and time. Through real estate, creation and management of time and space is enabled with the aim of generating specific estimated cash flows over a particular period of time. A developer refers to and individual or a corporate organization that develops land and buildings to increase their value to specified amounts over time. Developers in the real estate industry are therefore individuals or organizations who bring together land, labor and capital and plan how to manage and facilitate the market in a way that the requirements of the users are sufficiently met. In addition to this basic definition, the real estate industry is characterized by various types of developers who may be classified on the basis of their strategic capital role, geographic scope and ownership structure or the type of products they deal with (Davis 89). Real estate developers may therefore be classified in three most common categories: trader developer refers to the type of a developer who assumes the entire risk of the project until it’s completed. A trader developer then makes a complete sale of the land and property which results to the main goals as being exploitation of profit margins before and after the completion of the project which results to development gains. An investor developer on the other hand refers to organizations or individuals who carry out various projects and establish their portfolio in a way that they meet their main goals of development profits and capitalization on property appreciation. Service developers finally refer to individuals or organizations that render specific real estate services and therefore act as service providers to third parties in the name and account of the clients while on their part do not assume a majority of the risks. Unlike the other types of developer’s service, developers bear operating risk other than the capital risk (Gaylon & Phillip 67). Real estate development Through real estate development, a company or an individual aims at achievement of several well laid down objectives. The first major purpose of real estate development is to recognize potential opportunities that will build on the value of the developer with time. Real estate development is also carried out with the objective of generating future cash flows for a developer, which are relative to land or buildings and in the process, ensure they are sustainably exploited. Through real estate development, it becomes possible for an increase in the value of a building or the land to be increased through both construction of the structure and on the basis of measures for increasing property usage and productivity such as structural usage of currently unused space and conversion and rebuilding measures. The main aim of a developer is therefore to foster appreciation in value of properties and land through optimal use of capital resources. The role of the developer in the whole process of real estate development is to supply a stream of entrepreneurial services to the market through onetime identification of opportunities and activation of projects that the real estate developer should also be well aware of the target and client groups under his watch, as this will make it possible for focus to be constrained to the satisfaction of their needs. The real estate development industry is therefore enabled by various drivers that make it possible for optimization to be achieved between the clients and the developers. Demand factors are a class of real estate drivers and take into account the factors that facilitate action of developers such as population increases, reduction in sizes of households and commercial and industry development. Supply factors also act as drivers of real estate developments such as increase in prices of land, building materials, reduction in cost of mortgages and increase in labor costs. Factors such as infrastructure changes and differing cultural values and attitudes are also likely to affect real estate development industry either positively and negatively. The real estate developers acquire their return on their investments from various sources and angles such as development fees, sale of properties to potential investors, income from long term equity and sale of development rights. Non financial gains that a real estate developer is likely to obtain also include increased levels of satisfaction and establishment of a good reputation (Robert & Floyd 45). Real estate development risks Like in any industry, the real estate industry is challenged by various risks that take different perspectives on individual and corporate developer. While internal and external risks are present in the whole development phases of projects, developers should also consider of the following basic risks: development risk, that a developer is likely to face if the sale or lease of a particular project generates insufficient returns than had been anticipated and therefore fails to meet the cost that was involved. Management of development risk can be attained by a developer planning and forecasting to ensure actual outcomes are almost similar to estimated returns. Time risk is also a risk that a developer is likely to be exposed to and it’s associated with the likelihood of a project exceeding the established time period, thus resulting to increase in capital cost as a result of increase in rates of interest or negative changes that may occur in market conditions that may force developers to pursue projects that are sometimes marginal. Time risk can be mitigated by a developer putting in pace the best practices of project management such as timely commencement of marketing, timely selection of reliable suppliers and proper documentation, which helps in easing coordination and communication misappropriations. Time risk can also be minimized by a developer having a proper understanding of the existing market forces and dynamics. Cost risk is a type of calamity that is associated with cost factors that are likely to tamper with the viability of a particular project that has been designed by a particular developer. The risk of cost can be mitigated through proper time management and viability. A real estate developer operates within a real estate industry and is therefore prone to either internal or external risks in the process of meeting the laid down objectives. Internal risk refers to types of risk that faces a developer from within their own scope of operation and may include financial management risk, human resource risk, property management risk, housing management risk and legislative and corporate risk. Basically, financial management risk refers to a risk a developer faces as a result of a poor post project planning. Developers are required to undertake an analysis that is detailed for any proposed project, and screen the existing projects for the purpose of ensuring financial viability is achieved. A developer may also be exposed to the risk of financial management as a result of a debt that has been incurred for the purpose of funding particular projects. Project management risk is also likely to affect the viability of a project based on a particular developer. Project management risk is also referred to as construction risk, and it faces a developer in the process of putting up a new structure in the step of planning of the available inventory and keeping stocks into control to ensure optimization of resources. Construction risk for a developer starts as early as when an individual or a real estate firm purchases materials for use, use of the materials in the site and maintaince of the building materials to the right conditions. A real estate developer requires applying various stock management techniques as a way of responding to the risk of property management such as the Japanese Just in Time Technique, where building materials are only ordered when required and used immediately, maintaining minimum stock levels to promote responsibility and putting in place regular stock review techniques (Long 102). The developer can also manage construction risk by deploying contractors who are well skilled and responsible as it will make it possible for supervision to be maintained at the right levels. The contractors can also help in management of property development risk since they are useful in coordination of materials with the suppliers and their positive contribution is likely to mitigate the risk through budget control and proper time management. Construction risk can also take a perspective of building site risk that occurs when the building site becomes unsuitable for immediate commencement of the project work. Building site risk may also add to the cost of a particular project by requiring a site to be modified prior to the commencement of the project. The risk of building site can be minimized through seeking an insight of professionals who offer the much needed advice. Legislation exposure is a type of risk that a developer is likely to face especially because he is required to disclose most of his information to a third party such as a client to facilitate a particular project. A developer can manage the risk of legislation by calling for the compliance of the privacy act by all parties, which will help in ensuring personal and financial information that may be relied is safe and secure. The developer should also ensure that all parties that may be engaged in negotiations for a project are well versed with the corporation act as this will ensure conflicts and issues that may arise in the construction and maintaince of a project are followed and grounds established in time (Davis 98). The developer may also be exposed to a risk of occupational health and safety especially where he fails to correctly understand the mechanisms involved in the process of meeting a projects expectations. As an internal risk, the extent to which it can be minimized or eliminated at a whole depends on the developer laying down well established guidelines for his or her operation. Operation and health risk can be managed by a real estate developer inviting officers in the department to monitor and examine the site before and during the work. The risk can also be managed by ensuring the position of construction workers is well secured through putting in place heath and safety measures. A developer should also ensure that advance planning is made that may be needed to offer extra assistance to any external clients who may be present. A developer should also ensure that the concept of corporate governance is well mastered as it plays a major role in internal risk management in the real estate industry. Corporate governance refers to an organization role in the external environment within which it operates. To mitigate the internal corporate governance risk, developers should and can properly align the ideas and objectives of both internal and external groups that affect the operation and viability of the projects in place. Corporate governance risk is likely to face a developer for example in cases where they fail to appoint the right and qualified personnel as this is likely to result to a conflict of interest. Whether an individual or a corporate group, a real estate developer should ensure their operations and scope of activities are well analyzed in a way that terms of the real estate market at large are well understood, as this makes it possible for performance to be measured and dynamics to be understood. A developer should also minimize this risk by ensuring the policies and the procedures within which they operate are well functional and re updating with circumstances. A developer is also faced by an internal risk of housing management. Housing management risk refers to a risk that is associated with the overall investment in the real estate industry and may take the perspective of being in par with financial arrangements involved and maintaince of the project units. The management of housing risk is commonly mitigated through a developer appointing a property manager who is assigned the role of ensuring maintaince requests are responded to, collection of rents and leases and routine inspection and monitoring of the properties. Through management of the risk associated with housing, a developer easily meets client demands and in the process, builds on his image and reputation in the market. In addition to the internal risk, a real estate developer is also faced by external risks which basically refer to the risks that occur outside the scope of operation of a particular developer. External risks to a developer may take different perspectives which include: financial funding always associated with the need for a developer to obtain external funding to make it possible for a project to commence or be completed. The availability of funding to a real estate developer is dependent on various factors such as them economic situation of the market, level of market performance and credit availability on the basis of the future cash flows. Economic factors that are likely to affect a developers project may include changes in the political environment, rise in the price of building materials or disruption in production of building materials. To mitigate the external risk of funding, it’s important for a developer to consider the rates of interest within their operation and the financial and political laws that have been put in place to govern business activities within the scope of operation. Funding risk can also be minimized by a developer having the right mechanisms which project correct anticipation of future cash flows, as this makes sure credit risk is completely avoided (Warren 145). Regulatory environment that exists outside the scope of a business operation is also an important factor that poses an external risk to a real estate developer. An investor developer should be well ware of the existing local, state and national regalities that are likely to disrupt the completion of a real estate sale. Risk of regulation can be eliminated by understanding the scope within which they operate, depending on the economic environment, credit and market risk. Developers should be well aware of the actual effects of failing to accordingly comply with the regulations, as it may result to a complete scrapping of a particular project or lead to delay in attainment of their objectives. The reputation of a developer is also an external risk that affects the environment within which projects are founded upon. A developer can minimize the risk of a bad reputation by taking time to study the behavior of clients in a particular locality as this will help in ensuring the right projects are laid down. Through understanding clientele, it also becomes possible for a developer to arte the viability of particular project, as this will help increasing his capitalisation and at the same time develop a positive reputation. The level of competition is also a major risk that faces a developer in the real estate industry. A developer should be well familiar with the degree of concentration of investors in the market and develop the right techniques with which to attain a sustainable competitive advantage. While maintaining healthy competition, developers should also ensure they meet the expectations of various groups who are dependent upon their projects as this is likely to result to manageable levels of competition (Gaylon & Phillip 109). After the identification and management of various risks, a real estate developer takes in various important steps that further help in the management of the risk faced. Through risk control, the identified risks are actively managed for the purpose of reducing loss exposures. A developer should also be able to practice risk avoidance through putting in place the right measures that make it possible for the likelihood of other risks coming up being completely eliminated. A developer can also practice risk reduction which will make it possible for prevention and limitation of likelihood of an ongoing project. Risk retention can also be practiced where a developer voluntarily or involuntarily assumes the implications of particular risks. Risk monitoring can also be practiced, which makes it possible for a project to have its processes in line with the planned standards through reporting and control measures. A developer can also practice risk transfer by spreading the implications of risks that may occur to third parties such as insurance companies. Insurance companies risk management takes in various perspectives of the developer as a way of determining the degree of concentration of the established risks. A developer should be able to recognize the importance and weight that lies behind administration and risk management for the purpose of ensuring feasible and viable projects. A developer should be able to recognize and practice proper record keeping as this will make it possible for an insurance company to attain needed information and at the end result to proper management of the existing risks. Additionally, proper documentation makes it possible for an insurance company to derive detailed information which in the end translates to desirable results. Insurance in real estate management takes various forms in which a developer can transfer the risk to a third party. General liability coverage is a policy that responds to claims that involve bodily damage and injury while on the building site. The general liability may also consider property damage to third parties who may affected by a developers project. An insurance policy takes into consideration wrongful acts that a developer may be engaged in the development phase and construction of the entire project. The insurance of real estate risks requires insurance companies to be written on a policy form. A policy form clearly lays down the extent to which a risk is insured against and the time within which the policy will be complete. Whether and individual or a corporate, a developer should be able to bring together several forms of information: an insurance company requires the marketing and financial function of a developer to put up a proper record of expenditures and incomes, tax records and invoices. Tenant management should also be maintained for the purpose of recording details of rent payment, client requests and rules of payment and violations. An insurance company should also be presented with maintaince of facilities and guidelines to repairs (Robert & Floyd 56). Real estate developers operate in a volatile and dynamic industry which is characterized by natural hazards that coexist with serious accidents, environmental liabilities, partnerships and contractual obligations, thus broadening the scope of operation of insurance companies in the real estate industry. The insurance companies take into consideration a number of factors before making a decision on whether to represent a particular developer. One of the factors that an insurance company puts into account in regard to a particular project is whether the locality in which the structure ought to be put up is prone to natural disasters such as hurricanes, mudslides or wild fires. Depending on the type and likelihood of occurrence of a particular disaster, an insurance company draws up a suitable policy within which a developer is insured against the risk. An insurance company may also consider the type of building materials that have been used in determining the cost of a particular policy in regard to a developer. Building materials vary in their level of resistance to natural and secondary disasters. Where masonry has been used for example, it’s less likely for a calamity to occur and therefore this result to a less costly policy which may sometimes may eligible for a discount. The electrical system that a particular developer is also an important factor that determines the insurance policy that will be offered by a particular company. The electrical system needs to satisfy a good insurance rating which qualifies it for a particular policy which makes sure it meets the current codes (Robert & Floyd 59). A real estate developer may also be exposed to a financial loss as a result of putting up a building on lease which creates a major financial loss to them. Although most leases require tenants to assume responsibility for liability that occurs within the property of a developer, sometimes the responsibility may be placed on the developer. Through insurance, the risk is transferred and shared, thus reducing its negative impact on a developer. The process of risk transfer from a developer to an insurance company takes various perspectives which helps in increasing their viability. A developer should ensure the staffs that are involved in the project are trained on the risk programs as a way of ensuring they recognize the type of risks that they may face in development programmes. Where the risk identification is too complex for the developers staff to recognize, the insight of a professional may be put in as this results to more accurate opinions (Robert & Floyd 60). The developer in question should also ensure that all aspects of an insurance package that the insurance company has introduced are understood. This can be achieved through a review of the policy in a way that several aspects such as loan under writing and the manuals that have been written are at par with the activities of the developer. A developer should therefore review the characteristics of different policies and ensure the policy that has been chosen is in line with the activities in which they are involved. As a developer, an individual or an organization should give a chance for home warranty policy to be put in place before a project is commenced, which is limited to the circumstance that the developer is required to undertake all the development work. The developer should also be able to seek professional advice as a way of minimizing the loss and developing mechanisms that eliminate the risk of death for builders. Works Cited Davis, Tanya. The Real Estate Developers Handbook: How to Set Up, Operate, and Manage a Financially Successful Real Estate Development. London: Atlantic Publishing Company, 2007. Print. Gaylon, Greer, & Phillip Kolbe. Investment Analysis for Real Estate Decisions. Chicago: Dearborn Real Estate, 2003. Print. Long, Charles. Finance for Real Estate Development. New York: Urban Land Institute, 2011. Print. Robert, Kyle, & Floyd Baird. Property Management and Managing Risk. Chicago: Dearborn Trade Publishing, 1998. Print. Warren, Elizabeth. Commercial Real Estate Losses and the Risk to Financial Stability. New York: Diane Publishing, 2010. Print. Read More