| 1. Introduction | | | | department is involved, either directly or indirectly by |
| Real estate development consists of land assembly, | | | | instructing local lawyers. Regarding construction risk it |
| development, financing, building and the lease or sale | | | | is crucial to use controlled pricing mechanisms when |
| of residential, commercial and industrial property. Real | | | | entering into construction contracts. Therefore, it is |
| estate development is a very dynamic process with | | | | preferred to have a fixed price contract to the |
| a significant average duration. | | | | largest possible extent. Depending on the project, |
| Real Estate Types | | | | flexibility might be needed to achieve the best price |
| Real estate consists of the following types:a) Retail: | | | | possible or to allow for tenant demands, design |
| These are projects suitable for shopping purposes | | | | changes etc. All projects need also to be insured in |
| with modern outfitting, appropriate access and | | | | line with insurance policies. Furthermore, the quality of |
| visibility and sufficient parking space. The occupiers | | | | partner agreements (clauses on the decision process |
| will be tenants. Investors and, more exceptionally | | | | and exit possibilities) need to be highlighted.c) Cost |
| occupiers, will be purchasers.b) Residential: This | | | | calculations: A development appraisal consists of |
| concerns the development of buildings suitable for | | | | assumptions which become more certain in the |
| family living on a long-term basis. The ultimate | | | | course of the project. The risk of surprises and |
| occupier will be a "resident"; however the ultimate | | | | wrong assumptions made during the process need to |
| investor can vary from owner-occupier to institutional | | | | be mitigated by meticulous calculations. These will be |
| investor.c) Offices: Buildings that could be used for | | | | made during the development process as the design |
| market standard office buildings. The buildings should | | | | will evolve toward final specifications and will have to |
| normally be fitted for occupancy by multiple | | | | take into account inflation levels, price increases as a |
| tenants.d) Industrial/logistics: Industrial real estate | | | | result of increasing demand etc. Where necessary, |
| building for multi or single-tenant purpose. The | | | | these should be verified externally.d) Pre-lease/-sales: |
| investors are the ultimate purchasers.e) Mixed-use: | | | | In order to 'test' the market of end-users before |
| This concerns projects being a combination of two or | | | | entering into the commitment to actual starting of |
| more of the above types.f) Area development: This | | | | construction of a project, a certain rate of pre-letting |
| concerns complex long-term mixed-use | | | | or pre-selling is required. It's also the ambition to enter |
| developments, which are often undertaken in joint | | | | other major commitments (a.o land purchase) |
| effort with public bodies. | | | | conditional upon these market-tests. In addition to |
| 2. Risks and risk-mitigating measures at the project | | | | demonstrating the market appetite this will reduce |
| level | | | | the amount at risk as well, since pre-leasing/selling |
| Each type of Real Estate has its own risks. Below is | | | | locks in part of the revenues.e) Timing payments: in |
| a description of the risks that may occur in the Real | | | | the case of costs it is preferred to pay as late as |
| Estate business, along with the mitigating measures. | | | | possible, whereas in the case of revenues it is |
| Project Risks | | | | preferred to receive these as early as possible. |
| The risks can be grouped in the following clusters:a) | | | | Next to the obvious advantage of lower interest |
| Land value risk: land acquisition costs and the risk that | | | | costs, this strategy provides control in case of |
| the value of acquired land changes due to market | | | | possible disputes, relating to for example contracts. |
| circumstances.b) Land exploitation risk: the risks | | | | Furthermore, it is preferable to keep the level of |
| mainly related to environmental issues.c) Planning | | | | spending in the development phase to such a level |
| permit risk: the risk that no usable planning permit is | | | | that a real go/no-go decision before the start of the |
| received or that this process takes longer than | | | | construction phase is still possible. |
| expected. This risk also applies to other municipal | | | | 3. Risk-mitigating measures at the portfolio level |
| approvals/permits, such as commercial licenses. | | | | At the portfolio level there are a number of risk |
| Whether or not grants are obtained is also included in | | | | mitigating measures in place. These are the following: |
| this risk.d) Construction risk: this regards pricing, | | | | Portfolio diversification |
| design, quality and possible delays.e) Revenue risk: | | | | A Real Estate developer is often active in more than |
| there are many factors that influence revenues. | | | | one country; the markets in these countries differ. |
| These include yields, rent levels, sales price levels, | | | | Because the portfolio of the company is spread over |
| inflation and interest rate levels, demand and supplyf) | | | | several countries, segments and project sizes the |
| Duration risk: the duration is a consequence of other | | | | portfolio is rather diversified. However, it is difficult to |
| risks. It can impact interest costs, but can also cause | | | | set up exact target portfolio diversification, since it is |
| other problems, such as claims from tenants if the | | | | not possible to determine which diversification would |
| agreed opening date of a shopping centre is not met. | | | | create an optimal risk/return ratio. |
| A delay could also mean that the project has to face | | | | In order to be able to manage the portfolio and |
| adverse market circumstances.g) Political risk: the risk | | | | diversification over countries and segments, regular |
| that the project encounters problems due to a | | | | reports are essential together with an outlook based |
| change in government, regulations, etc.h) Partner risk: | | | | on the existing pipeline. |
| the risk that a partner in the project cannot meet its | | | | Maximum Investment at Risk at the portfolio level |
| obligations or disagrees on the way forward.i) Legal | | | | Current commitments minus secured revenues should |
| risk: this covers a broad area of topics: possible | | | | never exceed pre-specified limits on amounts at the |
| objections against changes in zoning, liability risks or | | | | portfolio level. |
| contracts which have not been drawn up correctly. It | | | | Restrictions regarding strategic land positions |
| also concerns the risk of not obtaining the required | | | | Strategic land positions concern land /buildings without |
| permits and the risks involved with buying existing | | | | sufficient rental income and not yet zoned for new |
| companies to acquire land positions. Tax risk is also | | | | development functions. At the portfolio level the |
| included in the legal risk. | | | | following limits should be in place: |
| Risk mitigating measures at project level | | | | - the total investment in strategic land positions |
| To mitigate the above mentioned risks the following | | | | should not exceed a pre-specified limit on amounts. |
| mitigations can be highlighted:a) Research is essential | | | | - strategic land will only be purchased for the purpose |
| in assessing virtually all kinds of risks. Important | | | | of residential or retail development. |
| research areas will include: | | | | - the maximum tenure of strategic land positions is |
| 1) Forecast of yield development; | | | | restricted in line with the pre-specified policy: for |
| 2) Allocation strategy; | | | | example, differentiation between mature and growth |
| 3) Investor demand; | | | | countries. |
| 4) Occupiers and consumer demand: The research | | | | To diversify the risk the average tenure of holding |
| into partners (financial position and due diligence | | | | the land for strategic purposes should be roughly |
| check) is also included under 'research' and should be | | | | spread over a pre-defined number of years which |
| satisfactory;a) Phasing: By adequately phasing | | | | should be monitored via periodic reporting. |
| projects, the steps to be taken are smaller, with | | | | Do you want to learn more about Risk management? |
| possible exits following each phase.b) Contracts: Many | | | | Does your organisation require help in setting up your |
| risks can be mitigated by carefully drawn up | | | | Risk management programme or analysing current |
| contracts. It is therefore essential that the legal | | | | and future risks? |