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What do we mean by property development?
Property development can mean anything from buying a home near to where you live in a bad state of repair and fixing it up for sale at a profit to building a 1,000-unit resort development on the other side of the world.
This guide focuses on larger developments – typically developments of 100 units or more – as this is where the greatest scope for a successful rescue occurs.
What goes wrong with property developments?
There are almost as many causes for the failure of property developments as there are failed projects but some are far more common than others:
The world moves against you
Property development is a cyclical activity. Sometimes it is all the rage and very profitable but, from time to time – typically every 7-10 years – the market turns against you. Prices fall, the profit disappears, banks stop lending money and hoards of developers go bust.
This phenomenon has been very prevalent in the last few years. The worldwide economic crash of 2006-2012 paralysed and nearly destroyed the property development industry in many countries around the world.
Take just one of the world’s property development hot-spots: the Costa del Sol in Spain. In 2004, 45,000 building licences were issued. In 2010, there were just 2,362. With this level of collapse, if you get your timing wrong nothing is going to recover your full investment.
Spain is far from unique. Similar patterns could be seen in countries as far apart as Bulgaria and Brazil.
It was not just property developments that collapsed. The prices of individual homes also fell dramatically. During this period, in many places, property prices fell by 50, 60 or even 70% – creating, perversely, a massive buying opportunity for those who had the cash and the nerve to get into a falling market and the sense of timing to pick (more or less) the right moment.
The collapse in the value of development land was often even more dramatic. In many places, development land – even in good locations – became unsalable at any price.
Lack of finance
In boom times, developers can build their projects with little of their own money. Bank financing is plentiful and there is a steady stream of buyers who will buy houses ‘off-plan’ or in the course of construction; paying a part of the price ‘up front’ and the rest as building work progresses. Together, this funding pays for the construction of the project.
However, if the market changes or if the developer hits unexpected problems, there may not be a reserve sufficient to allow the project to be completed.
The high levels of profit projected for development projects attracted many new developers into the field. Many lacked the experience needed to deal with the complexities of property development, especially international property development and especially when – as often happens – things start to go wrong.
In fairness, many of these developers recognised their inexperience and tried to compensate for it by bringing in highly experienced architects, project managers and the like but (with hindsight) this often turned out not to be enough.
When developers – large and small – saw the potential profits arising out of their projects many reached an obvious conclusion: if I can make US$5million by building 100 units, I can make US$50million by building 1,000 units. Many discovered that a huge project is much more complicated than a small one, that the costs snowballed and consumed all of the profit and – particularly if they were inexperienced – that the whole exercise was simply beyond them.
Getting the basics wrong
I’m sure everybody has by now heard the property adage: everything related to property is dependent upon “location, location, location”. All too often this was ignored in the belief that apparently endless demand would allow them to sell their project, wherever it was located.
Similarly, many failed developments ignored the equally important requirement to price for profit.
Sadly, in a relatively small percentage of cases, fraudsters became involved in the property development process. They had no intention of ever building or delivering anything but every intention of separating you from your deposit. 1,000 deposits of $10,000 each is $10million of easy pickings.
Although truly fraudulent developments are few and far between, they are often the most difficult to rescue because, usually, nothing in connection with the development will have been done right.
There is a sub-category of crooked developments. This is where developers, who had every intention of delivering your homes and making a profit, find that things go badly wrong. They usually hit problems and run out of money. At that point, they start cutting corners and engaging in activity that is illegal.
In some countries there are well-developed and working safety mechanisms that help guard against disaster when a project fails.
For example, there could be laws preventing a developer taking more than 5 or 10% of the price of the property before giving you legal title to the land upon which your home is to be built. In other countries, there is a deposit guarantee scheme which ensures that, if a development fails, any deposits paid should be returned to the buyers. In others, developers have to carry insurance against the risk of failure. See our country-specific guides to buying property.
Unfortunately, in many countries – particularly in many of the developing countries which seem to offer such great potential for property developments – these safeguards simply do not exist. If they do exist, they sometimes just don’t work.
In some cases, and recognising the limitations on the safety mechanisms available in a particular country, developers try to create their own safety mechanism. The most common of these is to create some form of trust under which the land upon which the project is to be built is either owned for and on behalf of the people who are buying the properties on it or where a legal charge (mortgage) in favour of the buyers is created over the land.
What to do if your development has failed
If you have bought a property – whether it’s a home or a commercial property – in a development that looks like it’s going nowhere, there are steps that you can take to make your position better.
Before you do anything there are three really important things to bear in mind:
1. In all likelihood, your ship has sunk
What you’re about to engage in is a rescue or ‘salvage’ operation. In any salvage operation you know that you are not going to get back the whole ship or its entire cargo. Generally, in a classic marine salvage, you would be overjoyed if you recovered 50% of the value. You would not be dismayed if you only recovered 10%. The same is true if you are rescuing a failed property development.
In other words. if you are going into this in the expectation that you will recover all of your initial investment plus compensation, you will, almost certainly, be grievously disappointed.
2. You should never throw good money after bad
If your investment has turned into a disaster, do not fall into the temptation of putting more and more money into it in the hope that it will come right. This does not mean that you should spend no more money – if you spend nothing you’re likely to recover nothing – but you need to be clear in your own mind that what you’re being asked to spend is justified in that it gives you a real chance of recovery. Ideally, you should not be spending more than 10% of the amount you already have invested, and you should almost never be spending more than 30% of the amount you presently have invested.
3. It’s your hole. Nobody else is likely to help you dig yourself out of it.
At the present time (2018) you’re highly unlikely to be able to obtain bank finance in order to rescue a failed development – though there are some signs that the position is easing for good quality and profitable projects in good locations.
You can sometimes still obtain some funding from a ‘vulture fund’. These funds specialise in picking the last bits of meat off the carcasses of failed projects. They are, generally, ruthless and they will want to give as little value as possible back to those who originally invested in the project. They will give nothing back unless they are forced to do so – for example, because you have a claim to the ownership of the land.