“The Market Seen from the Street”: What I Have Learned from Real Estate Development Activity

Since 2019, I have had the privilege of participating in Real Estate Development Operations and Activities. From managing and coordinating very specific tasks to overseeing the overall coordination of all phases and tasks that characterize the activity, I can say it has been an incredible learning journey, where mistakes made have been the greatest lessons.

In my understanding and based on the experiences gained, I admit that Real Estate Development is the most complex activity in our entire industry precisely because it requires the incorporation of all the other activities that are part of the real estate ecossystema in its development process.

Image 1 - Summary of the Real Estate Development Activity Ecosystem

 The interpretation of the definition I found for the activity, which I have been continuously improving, is as follows:

"Real Estate Development is the art of planning, coordinating, and developing all activities and processes that allow for the creation of new real estate assets or the rehabilitation of existing ones, aligning regulatory and urban planning with the specific needs of the market, in the most sustainable way possible (Sustainability: Social, Environmental, and Economic).” Today, developers have the duty and responsibility to incorporate the concept of 'Sustainability' into their projects, in a completely different dimension from the past.

The real estate sector is responsible for approximately 30% of global carbon emissions and consumes nearly 40% of the world's energy. The need to reduce these ratios is urgent to ensure the continuity of the world as we know it.

At the same time, we are experiencing times of great political turbulence and social upheaval on a global level, while witnessing an increase in the lack of housing affordability, accompanied by unique immigration dynamics that add further pressure to the problem.

The previous two paragraphs briefly present some of the major challenges that require a resolute and impactful response from Real Estate Development. Time is of the essence, and prompt action is necessary.

Many times, society in general perceives the Real Estate Developer as a figure solely focused on building properties to achieve astronomical profits, seemingly without concern for anyone else. I confess that economic rationale is always essential to bring projects to fruition. Given that it is a highly capital-intensive activity, mitigating risks in the process is crucial. Truth be told, there are no flawless operations, and mistakes happen every day. However, a "miscalculated error" in a Real Estate Development operation can have significant impacts at various levels (Economic, Social, Environmental). We all know of cases with negative impacts (e.g., Subprime Crisis).

The "true" Real Estate Developer's primary goal is to carry out Real Estate projects with positive impacts at all levels. Only this vision will allow them to act consistently and be recognized in the market. If the sole focus is "profit at any cost," I have doubts about establishing oneself in the long term.

The Real Estate Developer can position themselves in three different models, each with its specific characteristics:

1. "Investor Developer" - Assumes full control of the Real Estate Project, owning 100% of its capital. The Developer may have the Bank as a financial partner or other forms of financing. In short, the Developer possesses both the Capital and the Knowledge required to develop Real Estate projects according to their objectives and interests.

The process follows its normal course, from land acquisition, project development, construction, real estate product marketing, etc.  Typically, these are companies of significant size that attempt to handle a large part of Real Estate Development operations, having the ability to take on very significant fixed costs.

The remuneration or "profitability" of the Developer is variable, depending entirely on the project's outcome. However, in theory, their return expectations are quite high.

1. "Management Developer" - The most common model nowadays. In this case, the Developer possesses the Knowledge but may not hold 100% of the Capital for the Development Project. They typically partner with different types of investors (institutional or individual) seeking specific returns on their investments but lacking the expertise or structure to develop Real Estate projects. This model allows for risk diversification for the Developer and the possibility of developing more projects since their capital needs for each project decrease (depending on their strategy and financial capacity).

In addition to the mentioned investors, Banks may also be used as project financiers, assuming a more passive role in decision-making.

The process follows its normal course, from land acquisition, project development, construction, real estate product marketing, etc. The Developer assumes coordination and responsibility for the project's development and delivery. They will always be accountable to their investors if the results do not meet the initially agreed-upon terms. Depending on the partnerships established, decision-making, especially regarding financial matters, may be shared. Operational decisions typically remain entirely under the Developer's control.

Their remuneration should have a fixed base (covering management costs of Real Estate Development) and a variable component dependent on the project's outcome.

This model usually requires the Developer to have two to three projects at different stages (ideally, one project in licensing, one in the early construction phase, and another in an advanced construction stage) to achieve better cash flow balance.

Expectations of profitability are not as high as in model 1). The focus is on increasing the quantity of Real Estate Development operations and diversifying operational risk. Dependency on external capital is higher.

1. "Consultant Developer" - This is a model that is more challenging to operationalize since it depends heavily on the "wishes and/or needs" of potential clients. In this case, the Developer assumes the role of "holder of knowledge" that enables the development of Real Estate projects. This model mainly applies to small-scale operations with the following characteristics:

• Investor or an investors group who decided to diversify their portfolio by investing in Real Estate Development operations but lack the know-how to do so. These are often test operations, and there is uncertainty about their continuity, so they prefer to hire services.

• Land or building owners with a need for value enhancement (common in inheritance cases), who have the capital to enhance their asset(s) but lack the knowledge to do so and have had less positive experiences in the past. They often prefer to sell the assets, losing value (more common when liquidity is needed).

• Investors or Investors Group or Land/Building Owners who decided to proceed with Development operations but encountered many obstacles and challenges, endangering their viability. They typically seek support and advice to make the operation viable or minimize potential losses.

The Developer's remuneration may include a fixed base plus a variable component. It is usually the business model with the lowest potential for profitability when compared to models 1) and 2). Given the "independent" nature to be assumed by the Developer in these cases, this model has a higher potential for implementation when the real estate market lacks dynamism or fervor.

For those (like me) who aspire to become a Real Estate Developer, what is the best way to start?

1. You have the Capital and Knowledge that allow you to start on your own and take risks; - Investor Developer

1. You have specific Expertise that enables you to be valuable and generate value and investment opportunities for those seeking them; - Management Developer (Ex: https://andrecasaca.pt/case-studies/o-independente)

1. You are "invited" because you have the Knowledge that will create value or solve challenges; - Consultant Developer

Examples of Cases:

● https://andrecasaca.pt/case-studies/principe-real

● https://andrecasaca.pt/case-studies/campuslide

● https://andrecasaca.pt/case-studies/afonso-pala

Knowledge is the common factor. I especially highlight practical experience and understanding of the process and its systematization, which is essential to mitigate potential risks. In my case, I had the opportunity to enter the field as a Consultant Developer.

It might be a good option for those who want to take risks and start independently.

 Personally, reaching the level of a Management Developer in a consolidated and consistent manner has been challenging. Today, it seems clearer to me that having a structured team, tailored to the scale of operations you intend to develop, is necessary. The multidisciplinarity of profiles and complementary knowledge is increasingly important.

Image 2 - DEPARTMENTS" OF KNOWLEDGE REQUIRED IN REAL ESTATE DEVELOPMENT ACTIVITY

Image 3 - Processes to be developed in each "DEPARTMENT"

Creating a completely different team for each project is not the best option. It is practically impossible to align the interests and values of all participants when there are no perspectives of continuity and loyalty.

And then, above all, it will be necessary to have a good dose of madness and courage to take on "unknown" risks. This is the main ingredient to try to start as a "small fish in the shark tank."

In my understanding, it is also pertinent to distinguish "Property Trading" from "Real Estate Development."  There may be some overlapping tasks and phases, but the level of complexity is much higher in Real Estate Development. To date, it seems obvious to me that to reach the level of the 3rd option - Investor Developer, it is necessary to combine "Property Trading and Real Estate Development" to counter the long cycles of Development that can create cash flow challenges and even motivational ones. "Small victories" are essential to keep motivation levels high. A demotivated team/structure does not function at all.

What are the main challenges and tips to consider?

It is not easy to define exactly the greatest challenges of the activity because it also depends on the specificities of each project. However, I share with you some tips that may help.

1. The phase of selection and acquisition of the real estate asset is the most important in the entire process. It is not just about "buying low to transform and sell high." It is about understanding the main project risks with assertiveness, so that the business evaluation is valid and thorough. A client who has taught me a lot over the years never tires of repeating: "what seems very cheap can turn out to be very expensive."

2. Technical and legal Due Diligence (thorough analysis of the asset) is essential for the Business Plan to have some solidity. When we acquire properties without any type of licensing, these risks increase substantially, especially regarding the definition of the Development Cycle, essential for the viability and success of any real estate project. There's no point in saving "a few thousand euros on Due Diligence" and "risking millions of euros" later in the Project Development. I am exaggerating a bit, but it all depends on the scale of the business. In Real Estate Development, mistakes can be very costly.

3. "Impredictable events" are one of the biggest certainties in a real estate project. It is crucial to identify the main sources of these events. The Licensing and Construction phases are fantastic providers of unforeseen events. "Small miscalculations" can jeopardize the viability of the project. Anticipating different scenarios and action plans for each possibility is never too much.

4. Hiring external teams and partners that will participate in the development of the Real Estate Project cannot be based solely on "budgets and good references." During the procurement and hiring phase, I firmly believe that the Developer should be totally transparent regarding their strategy and vision for the Project (including presenting the business plan and numbers). I believe transparency is the soul of this business. Giving priority to those who work in the same way can be an excellent decision. Competence and talent are not enough (seriousness, honesty, and responsibility are already intrinsic to competence). Compatibility between the work teams is essential. The cost of replacing people is very high when the Project is already underway.

5. Trust, delegation, support, and coordination are keywords. The main function of the Developer is to be the "glue or connector" of all Project Stakeholders so that the Business Plan is fulfilled, and objectives are achieved. It is essential not to "create silos" in decision-making. All participants should be aware of all relevant decisions and developments that occur throughout the project, whether positive or negative.

6. The Developer must always be present and available to their suppliers, customers, and all other possible participants in the process. One of the biggest mistakes that can be made is to "show up only when everything is going well" and avoid or postpone delivering bad news. A project has ups and downs, like everything in life; we have to count on that. We cannot celebrate victories and disappear in defeat. Excuses like "I'm very busy," "my schedule is full," among others, do not work. We all have better and worse days. Simple things like phone calls, messages, or emails should always be answered or returned in a timely manner, whether the matter is more or less serious. It's a matter of respect and responsibility. If we run away from our responsibilities, we cannot demand them from anyone else. Small details can make all the difference.

7. Many solutions arise from unexpected places. Encouraging and motivating all stakeholders to put forward their views whenever they have different ideas from what is conceptualized and often projected, should be part of the DNA and culture of the activity. We all have much to learn and improve every day. Always in a coordinated manner, without "collisions," promoting critical thinking to improve productivity and efficiency is essential. Treating everyone as we want to be treated is also an important principle.

8. The Project does not end when the Developer "hands it over" to its clients after the completion of the works and respective certifications. The after-sales service phase is one of the strongest generators of trust and factors for customer loyalty. In this phase, there is no short-term economic viability. However, in my opinion, it is one of the most important investments for the long-term success of the operation.

In summary, real estate development is not a seven-headed monster. However, we are going through a period of "Disruptive Transition" (expression copied from the European ULI Conference, 2023 - https://europeconference.uli.org/). It is precisely this need for "Disruption" that made me fall in love with the activity. The potential for evolution of Real Estate Development in Portugal is tremendous. The process has many inefficiencies by its very nature. For a long time, our sector invested practically nothing in Research and Development. In the coming years, we will have the unique opportunity to participate in the transformation and evolution of the activity. The needs for productivity and efficiency improvements are glaring, while we must be able to develop real estate products that can respond to the new needs of society. Is there any more exciting activity?

I'll end with an expression I've been using a lot lately: "the more we share the knowledge we acquire, the more knowledge we gain that we don't have."

The responsibility is always ours. We cannot expect changes in mindset and evolution if we don't set the example. We cannot demand that other professionals share their knowledge with us if we are not willing to share ours.

See you soon,

 André Casaca.