Real Estate Development - Case Study Example

Risk assessment and probable measures to mitigate risks concerning the real e sector in London Introduction: Real e development projects are subject to several risks. Starting from the conceptual framework of real estate projects, feasibility analysis and design as well as planning of the project, bidding and tendering for the same, constructing and handover of the project; all involves significant volume of risks that are multifaceted. Real estate risk management involves weaving of three stages namely; identification and assessment of risk, responding and moderating that risk and at the end analysis for further risk that might pop up at any moment. Risks in real estate development might be classified under five broad heads namely; social, technological, economic, environmental and political; cumulatively referred as STEEP. Risks arising out of these factors if neglected can cause severe loss to a real estate project (Khumpaisal and Chen, 2007). The present paper considers the risks arising out of the STEEP factors associated with the office development in London and explain strategies that might be used to mitigate them by the developers. Theory: The aforementioned STEEP model involves five major criteria and 33 sub-criteria to risks assessment. Social risks might involve availability of work force for the concerned real estate project, acceptability of the project by the community, cultural compatibility and public hygiene (Wiegelmann, 2012). The developer might consider how much he is satisfied with the availability of local work force and that at a reasonable rate, benefits received from the local community would be benefitted from the project, if the project and its final manifestation would be in tune with the lifestyle of the local community and the impact of the project on the health and hygiene of the local people (Khumpaisal and Chen, 2007). The technological risks might arise from conditions of the project site, designers and constructors associated with the project, multiple functionality of the project, constructability, time taken by the project, amendments, facilities management accessibility and evacuation as well as durability. The developer might take into consideration while assessing risks arising out of all these factors as associated problems and difficulties in site preparation that might arise out of difficult terrain, topography, surrounding and presence of pre-constructed buildings around or on the proposed site for the project. Is the developer is satisfied with the performance of the designers and the constructors. The building is capable of serving multiple purposes? What might be the level of technological difficulties of the construction? What time would be taken to finish the design and construction of the project? Is the design is flexible to incorporate any change is deemed necessary? What would be the level of complexity in managing facilities in the concerned project? Can the building be accessed quickly and evacuated promptly in time of emergency? Whether the building would be subject to regular renovation during its lifecycle? (O’Connor, 1986; Khumpaisal and Chen, 2007) The environmental risks might arise from any adverse impact of the building on the environment and any climatic change that might be associated with the building during or after the construction of the same. The developer might take into consideration the nature of environment of the concerned cite and its susceptibility to the proposed building to get an idea regarding the possible adverse impact of the building on the local environment and climate. (Khumpaisal and Chen, 2007; Newell and Steglick, 2006). The economic risks might arise from changing market rate of interest, type of property, market liquidity, exchange rate, demand and supply of the real estate, purchaseability, brand reputation, capital exposure, depreciation of the property, infrastructure around the area, buyers and tenants available in the area and return on investment. The developer might consider the impact on the project from the changing interest rate (loan rate). A change in loan rate would affect project financing as well as availability of loan to the purchaser. Whether similar building does exist in the area should also be considered along with the potential buyer as well as tenants and suppliers and affordability of the consumers of similar building in the area as this would point to the expected level of competition and opportunity. The developers might consider the selling rate of similar properties in the area as that would help to assess the prospect of their project. Possible impact on financing and selling of the property arising out of exchange rate fluctuation should be considered to have a clear idea regarding risk arising out of market liquidity and exchange rate fluctuation. The developer should have a clear idea regarding his reputation in the particular type of construction; a fresher would definitely face higher risk than a reputed builder. Depreciation rate of the property and the volume of fund the developer is engaging should be valued against the expected capitalization rate to assess the return to investment. Finally the developer should take note of the available infrastructure of the area to assess the risk arising out of accessibility of the area under consideration. (Khumpaisal and Chen, 2007; Newell and Steglick, 2006). The political risk might arise from the political groups or activists, changes in tax policies by the government and council as well as license approval. The developer should take into consideration the presence and level of protest by the political groups and activists and any possible impact of the same on the project, possible impact of the tax policies by the government on the project, and impact of time taken for any type of approval by the government on the project. (Khumpaisal and Chen, 2007). Analysis and synthesis of information: Though London is one of the prime cities of the world but getting skilled labourers for office building would not be easy as most of the construction workers are unskilled and without any formal training. Moreover, the wage rate in the concerned sector is far higher than the national average of the same sector (The Stationary Office, 2008, pp.260-261). The community acceptability and cultural compatibility level regarding real estate sector specifically office building is not very bright in London (WCGG, 2014). Office buildings at times affect the public health negatively in London. Owing to their tall structure they often block sunlight and wind; most importantly congestion on an already overburdened city and poor waste management by the office buildings are often been reported. To manage these risks a developer might opt for personal training for labourers opted to work in the project. This would help in creating a skilled labour pool and might ask to provide a compensatory salary to his workers working on that particular project till the project is over. This would create a win-win situation for both the developer and the labourers. The grudge of the community against real estate should be taken care of and project should be developed with consultation of community representatives to encourage higher acceptability. Project should be framed in tune with the local lifestyle and culture and tangible benefits should be offered against each project to the local people. London is a hub for excellent designers and hence finding an appropriate designer would not be tough in London for the developer (Montgomery, 2008, p.68). Since the city is on plain, hence terrain would not be a problem for the construction. However, owing to high level of congestion and meagre open land; finding a suitable ion site would be a tough problem. Pre-existing building on the other hand would deliver topography related challenges. Again London often faces transport congestion (BBC News, 2014) and that is a big problem regarding accessibility of a proposed site in London. The developer might look for a site near to the London station that connects even the distant parts of the country in quick time with the city. This might also help in avoiding the road while travelling to office and thereby avoid congestion. Eventually this decision would reflect in market price for the property. However, the developer needs to ensure that the proposed site is comparatively free of pre-existing buildings, though that would almost impossible to find. Since constructing a building for only one purpose and that with too rigid a plan would eventually turn the property towards a smaller market of customers hence, flexibility on both the ends would strengthen the developer’s position in terms of risks. Again constructing the building with better material and providing adequate features to be used in emergency would lessen the risk of renovations time and again. The LIBOR rate determines the ultimate rate of interest for many types of loan such as project financing loans as well as housing loans. Higher rate of interest makes loan costlier. The present one year LIBOR rate is 0.55% which was 0.68% a year ago (Bankrate, 2014). Such changes against huge volume of loan result in quite a substantial amount of loss or gain. It is apparent that the LIBOR and hence the other forms of interest rates are variable over the years in London. This become clearer if an account of the change in UK bank lending to UK real estates and UK bank interests to real estate sector are taken into consideration. Both are subject to wild fluctuation starting from 1970 to 2002 (IMF, 2005). The developers need to take historical account of interest rates and have to be well informed regarding any expected changes in interest rates to avoid risks associated with interest rate changes. In the same way they have to be well acquainted with various tax rates that might affect their activities as well as any expected changes in the exchange rate. In last one year the pound against dollar was as low as lower than 1.5 USD/pound, and higher than 1.7 USD per pound (Allen, 2014); such fluctuation might initiate added uncertainty through direct and indirect effects. The developers might opt for money market or currency market hedging or even use a combination of both to create a buffer against any changes regarding interest rate and exchange rate. For sudden change in tax rates; investing in tax saving bonds might prove valuable for them. London as one of the prime cities of the world is full of world class developers, hence competition is strip. The developer should opt for innovative techniques a competitive price for their project and should be sincere in reputation building to reduce risks that might pop up from these aspects. Again consideration of historical price of the properties in the concerned area would eventually help him to have a clear perception regarding the property price in the area. Long construction and delivery period of a property would not only result in less liquidity on behalf of the builder but would also impose significant opportunity cost to capital and hence a quick delivery would be optimum for the developer acting in London to reduce associated risks with the same. The project as mentioned earlier should use better material for construction so that depreciation remains low. Finally the office demand in London and supply of the same have never remained stable over the time frame 1970 to 2002 (IMF, 2005). Again the rental value and capital value of the office market in London have experienced similar fluctuation (IMF, 2005). Unless the developer takes into account the historical trend of the same he would never manage to overcome the associated risks with it. A rational, down to earth expectation and forecasting would help the developer to mitigate the risks arising out of these economic factors. The developers need to construct their office building with environment friendly material and in an energy efficient way to leave minimum possible anthropological impact on the local environment and climate. An environmental accounting prior to the project might help to grasp the possible environmental impact of the building and thereby might help the developer to initiate certain program that would eventually lessen such impact and save him from any future legal hazard. The London community is not too friendly towards the real estate developers and they have blamed them for making their life congested, awful and unhealthy (WCGG, 2014). At this circumstance there is every possible reason that they might again become a hindrance to the real estate developers and express their agitation through collective movement. Courting this situation a developer must go through with his operation with least disturbance to the community and go for a holistic public campaign explaining to the community, different political and activist group that how their concerned project would outweigh the negatives of the project with the positives. Experienced and skilled public relation campaign might prove helpful regarding the same. Conclusion: After a careful consideration of STEEP theory regarding assessing risk; the same has been applied to the development of office building in London and some measures have been suggested that might be followed to mitigate risks arising from the STEEP factors. However, risks are erratic and considering the risk exposure of real estate business; at any time assessment might go absolutely wrong. Throughout the last decade UK has been subject to a couple of financial depression and that pose grave threat to real estate market. Similar financial crisis might again throw the UK real estate sector into deep abyss. Considering the openness of the UK economy in coming times real estate sector might face added risks from international competition and abrupt exchange rate fluctuation. Courting this situation learning from own mistake and addressing the same in the next project seems to be necessary for the successful existence of the UK real estate sector. References Allen, K. (2014), Pound hits five-year high against euro and dollar, The Guardian, available at: http://www.theguardian.com/business/2014/jun/16/pound-high-five-year-dollar-euro (accessed on July 25, 2014) IMF (2005), Real Estate Indicators and Financial Stability, IMF Khumpaisal, S and Z Chen, (2007), Risks Assessment in Real Estate Development, Liverpool John Moores University, available at: https://www.ljmu.ac.uk/BLT/BUE_Docs/Pat_S_Khumpaisal_1.pdf (accessed on July 24, 2014) Montgomery, J. (2008), The New Wealth of Cities, London: Ashgate Newell, G. and M. Steglick, (2006), Assessing the Importance of Property Development Risk Factors, Pacific Rim Property Research Journal, Vol 12,No.1, 22-37 O’Connor, J. (1986), Real Estate Development, Real Estate Issues, Spring/Summer The Stationary Office (2008), Construction Matters, The Stationary Office Traffic jams in London getting worse, (2014) BBC News, available at: http://www.bbc.com/news/uk-england-london-25622364 (accessed on July 24, 2014) WCDG (2013), Protest at Boris selling off London at MIPIM - the "international real estate show for professionals", Available at: http://www.wcdg.net/content/protest-boris-selling-london-mipim-international-real-estate-show-professionals (accessed on July 24, 2014) Weigelmann, T.W. (2012), Risk Management in Real Estate Development Industry, Bond University Read More