The Biggest Mistakes Real Estate Developers Make

Dale Wills

Last Updated: February  20, 2024

In our journey as developers, we have encountered numerous challenges and learned valuable lessons from both personal experiences and the collective missteps observed within the industry.

One prevalent issue is the tendency for developers to underwrite deals over optimistically, focusing too heavily on what the future could bring. This approach can lead to a dangerous misreading of current realities.

Consciously turning away from this common practice, we take a more grounded approach when evaluating potential deals and our investment approach emphasizes the importance of considering not just the best-case scenarios but also preparing to avoid the worst.

With every investment opportunity we ask ourselves this question: Can we handle it if everything does not go according to plan? If our answer is no, then proceeding with the deal is off the table.

We are all naturally inclined to envision success, sometimes even fixating on that one lucrative project that promises early retirement. However, where many falter is in acknowledging and planning for potential setbacks.

That is why our strategy includes a unique exercise during deal evaluations—we literally divide our team into two factions. One half argues against moving forward with the deal while the other champions its merits.

This debate forces us to articulate compelling arguments on both sides of the coin. If we cannot convincingly justify why we should—and should not—invest in a project, then we recognize a red flag. Such an impasse signals that it is time to pause and reassess.

Through these practices, we have embraced a dual perspective that balances ambition with caution—a philosophy that has become integral to our decision-making process and overall success in development.

In the following article, we identify the 7 biggest mistakes we see developers make and discuss how we actively work to avoid them.

Mistake #1: Only Seeing the Upside

We have learned that the market does not always go up, and our experience has taught us to see the silver lining in downturns. We have had considerable success during such times—take for instance the 2008 collapse. It was a period where we not only made substantial gains for our investors but also managed to make impactful purchases that bettered communities. This underscores a crucial point: while there are opportunities in every cycle, it is important not to fall into the trap of assuming perpetual growth.

Mistake #2: Inadequate Due Diligence

This brings us to another pitfall in real estate—the complexity of it all. Too often, we see people rush into contracts to purchase property without fully grasping what they are getting into. Much like the unseen forces of wind and gravity, invisibility does not equate to non-existence.

Buyers who lack the necessary foresight may boast about closing deals swiftly with cash on hand, but then falter when it is time to truly understand the asset they are acquiring. This approach can be baffling to us—why would anyone commit to such significant investments without completing thorough due diligence?

Take, for example, buying a piece of land. Have you tested the soil to determine if there are any compaction issues? Can a road realistically be constructed on this terrain, or will you find yourself excavating deep just to create a stable foundation? And what about contamination? In one project we undertook, despite exhaustive historical research and due diligence, we were blindsided by old, buried gas tanks from the 1920s—a costly discovery that we had to address.

While in some cases, like ours with the gas tanks, unforeseen challenges arise despite thorough due diligence, most potential issues can be identified through rigorous research. Detailed due diligence might reveal wetlands or protected plant and animal species on the property—all factors that take time to investigate and understand.

The timeline for such due diligence can vary greatly; some projects may only require a couple of months while others could take years before every challenge—or opportunity—is uncovered. Each project presents something unique which does not necessarily spell doom but rather an aspect that needs understanding.

Facing these complexities head-on is key—we have found that some of our greatest projects were those initially daunting due to their intricacy. While complexity can scare off many investors who shy away from what they do not understand, by engaging in detailed and thorough due diligence to mitigate downside risk, we embrace it.

Embracing Complexity: A Real Life Example

Let me show you what we mean by embracing complexity.

We have an ongoing project in a city where there was once a dry cleaner in the 1960s—an indicator of potential environmental concerns but also a marker of an era long gone which carries its own set of unique prospects and challenges.

In our experience, it is not uncommon to find properties previously occupied by dry cleaners that have notoriously contaminated soil. We conducted extensive testing to determine the depth and breadth of contamination and whether it was reaching the aquifer. Through this research, we were able to take the soil and reclaim some of it through a process, rendering it clean and free from contamination.

Many times, people are intimidated by these issues because of the unknown. Fortunately, we have some amazing people on our team who understand the complexity and can resolve these issues. But it is a big challenge—people go in not knowing about potential problems like this. They might acquire an asset only to discover the presence of an old dry cleaner on the site which is a problem that can be very costly to remediate.

Mistake #3: Underestimating Construction Risk

One of the biggest mistakes that investors make is not fully understanding that ground-up development carries with it considerable risk during the actual construction phase.

For example, we know that markets ebb and flow, significantly impacting construction costs. Take, for example, around 2021 when lumber prices skyrocketed. Usually, lumber prices were fairly stable, hovering around $300 per thousand board feet. Then, within a short period of time, it jumped to $1,600 per thousand board feet. This kind of increase is extremely hard to predict.

Imagine a project that forecasted lumber at $300 per board foot and suddenly at the prices rises to $1,600. A project that might have needed $50,000 worth of lumber that, due to the cost increases, could now cost $150,000 to $200,000. Without adequate preparation for these unpredictable risks this could be financially devastating to a development.

The way we manage this kind of construction risk is by ensuring we have solid contracts with our suppliers and trade partners that offer some protection against these fluctuations. Lumber was a pronounced case, but we have seen similar volatility with, for example, commodities like oil. One moment oil might be at $30 or $40 dollars a barrel; the next thing you know it has climbed to $150 a barrel and it is surprising how many construction materials contain oil and so are tied to fluctuations in the price of the commodity.

The plumbing systems, electrical components, shingles for roofing, siding materials, carpets—even many types of flooring and vinyl windows involve oil in their production.

If oil prices suddenly increase, the cost for all these materials rises too. Managing these commodities by keeping an eye on market trends is crucial so we do not overcommit on future projects based on current prices.

Another example is taken from the lessons from the recent pandemic. Initially there was a drop in commodity prices as people were laid off and spending slowed down. Then government subsidies kicked in and people started investing in new houses or home improvements once they realized their jobs were secure. This demand drove up lumber prices dramatically.

Similarly, unexpectedly, in 2022 through 2023 we saw inflation spike – causing costs across the board to rise with that economic shift. We were insulated from these unpredictable events because we do not extend our commitments too far into the future. Predicting commodity or labor costs even a year and a half from now is nearly impossible; no-one can predict what might happen but we can and do prepare through our conservative underwriting and due diligence that focuses on surviving downturns while hoping for the best case scenarios.

The Importance of Having Good Project Managers

Effective and detail-oriented project management that operates within a well-formulated internal communications process has been a bedrock of our success.

Our project managers are on-site daily. They understand what needs to happen and monitor conditions and progress regularly to ensure our projects remain on time and on budget.

This helps us avoid costly overruns. For example, if a project ends up with mold developing in it because onsite management were not conducting inspections regularly enough, that can lead to serious cost implications that can also slow a project down.

Our experienced project managers operate as the linchpins of project success, ensuring that such risks are mitigated before they become real issues. They have an eye for detail and a commitment to quality that goes beyond ticking boxes; they understand that their role directly impacts the well-being of future occupants. They enforce protocols, inspire their teams to adhere to high standards, and swiftly address any deviations from plan.

Moreover, our project managers bring foresight into planning stages, identifying potential problems before they arise. Their expertise allows them to communicate effectively with architects, contractors, and other stakeholders to ensure everyone is aligned with the project's goals.

These managers also embody adaptability—when unforeseen challenges emerge (as they often do in construction), our approach here at Centra, is to respect their expertise and to empower them to devise solutions that keep projects on track without compromising on safety or quality and without being overburdened by a bureaucratic corporate management structure that would slow them down.

In essence, a top-tier project manager possesses a rare blend of technical knowledge, interpersonal skills, and strategic thinking that transforms complex projects into safe and successful structures. The value they add cannot be overstated; their presence can mean the difference between a hazardous dwelling and a secure home.

In today's competitive landscape where safety cannot be compromised for speed or cost savings, investing in such talent is not just wise—it is indispensable for any construction endeavor aspiring excellence.

Mistake #4: Not Thinking Long Term

Real estate development is not a quick-buck investment approach and requires careful planning and long-term thinking to protect investor capital while maximizing returns.

We have seen mistakes other developers make when they buy land. Sometimes people will build developments based on speculation of what the market might do. Then the unexpected happens, such as during the 2022-2023 period when interest rates jumped from around 3% to over 8%. If a developer underwrote a project assuming a 3% interest rate at sale, their exit numbers will be badly off; the value of the homes might drop because what someone can afford with an 8% mortgage, is very different from what they can afford with a 3% mortgage.

When it comes to long-term development projects we, by definition, look far out to mitigate long-term risks that stem from the inevitability of market volatility. We try not to make commitments too far out into the future because it is difficult to predict things like economic downturns or 'black swan' events, and we underwrite our assumptions accordingly when planning a project.

While we aim for solid contracts with suppliers and trade partners that provide some protection against market fluctuations and while we carefully monitor market trends, we do not overcommit based on current prices. For Centra, our approach is in balancing long-term planning with flexibility and foresight into potential market shifts.

Mistake #5: Underestimating Market Risk

Real estate is not like buying and selling stock which can be done in the time it takes to click a button on a page. To be successful in real estate requires a long-term perspective and an approach that is engineered to weather any kind of market volatility.

Because predicted market risk is inherently difficult (as discussed above), here at Centra we have found that being pragmatic optimists, where we hope for the best yet plan for the worst, helps us weather any market risks, no matter how unexpected. This approach is driven by our focus on protecting investor capital as a priority, while still delivering outsize risk-adjusted returns.

Our conservative approach means that while we like to look at what the upside future might be, that if the future is better than our underwriting assumes, that will be wonderful; all our investors can reap the reward of that increased investment, but we do not plan for that to happen.

We analyze, run forecasts, and look at different scenarios. For instance, when building a home subdivision, we forecast what we think we are going to sell for and consider the best case and worst-case scenarios.

We ask ourselves: What is the worst-case scenario? What would we have to sell this product for to get it to move no matter what? General market volatility as well as ‘black swan’ events can dramatically impact that, but typically we will look at it and say, "Okay, in a worst-case scenario, how do we ensure all of our investors get their money back?"

Sometimes developers will find that they do not have the flexibility to change course when market conditions shift. For example, when interest rates jumped during the 2022-2023 period, we retooled some of our product offerings because the ultimate amenity in a new home is price. To do this, we reduced costs by eliminating some of the amenities we offered with new homes, discovering that buyers’ first priority was to be able to buy at an affordable price – even if a home did not have, for example, a fireplace.

During the 2022/2023 period when interest rates climbed to combat inflation, we focused on ensuring that we were giving the very best value for homeowners. We thought of the process as being like a funnel where there are many people who can afford something at $300,000; fewer at $400,000; even fewer at $500,000; and so on. There are fewer people in the funnel as prices go up. So having a product with the greatest demand means hitting that funnel as high up as possible.

The same goes for positive changes – we are always evaluating if there is potential for greater value or additional options that could make us more profitable and thus provide better returns on investment for our investors.

We have seen the inner workings of all the mistakes that developers made, which led to banks foreclosing on their properties. Often, it boiled down to planning too far ahead and building too much too fast. They operated under the assumption that the market would always rise and there would never be any struggles. We don’t do that; we play it safe. If we make a lot more money, that is wonderful, of course, because we want to give better returns to our investors. But what are we going to do to mitigate those risks? We look at interest rates as they could continue to rise.

In sum, to combat market risk when underwriting a project that might have a three year lifecycle from inception to exit we look at, one, conservative underwriting by ensuring investor capital is protected by making sure we can survive a worst-case scenario; two, constantly assessing what is happening in the market; are sales where they should be? Is the product what consumers want? And three, being willing and able to adapt product type or offering based on real-time market conditions.

Mistake #6: Taking on Too Much Debt

Now let us talk about debt in our industry as it is so critical to protecting investor capital while staying focused on creating the maximum returns. Real estate development is a cash-intensive business. 

During prosperous times like 2019-2021, banks were offering 100% financing to developers which we thought was absurd and never engaged in. In fact, we were curious about who would take such offers because if the market slowed down slightly, those assets would be something we would want to acquire from those over-leveraged developers.

Overleveraging is a common mistake; it leaves no room for error correction when conditions inevitably change.

To mitigate excessive debt risk while maintaining cash reserves to combat market shifts, at Centra we utilize lines of credit from banks while remaining conservative with our approach to taking on debt. These credit lines act as an insurance policy—if the market slows or expected income gets delayed for any reason, we have access to capital that allows us to weather these situations.

Growing and developing properties typically involves some level of bank debt; however, it is essential not to borrow what the bank will lend you but rather to borrow what makes sense for a project’s successful outcome. Having some 'dry powder' on the sidelines through holding credit lines in reserve ensures that we can mitigate challenges should anything go wrong.

Mistake #7: Not Underwriting to Best, Worst, and Most Likely Scenarios

We have talked about worst case scenarios as being the hurdle we aim to clear on all projects; something that not all developers plan for. 

One way we achieve this objective is through our research on the concept of converting what we might have planned as for-sale homes into rentals.

It is an area we look at during initial due diligence stages prior to acquiring properties. When there was a rapid increase in interest rates starting in early 2022, we saw the market cool down and people temporarily stopped buying homes. We had numerous houses that were not selling at the velocity we had anticipated. To counter this cyclical shift, we switched them over to rentals. These properties covered our debt and bought us time for the market to improve.

There is a clear demand for housing, whether people are looking to rent or buy, and our goal is to meet that need either way. Each deal requires its own analysis and is driven by how we underwrite them, and by looking at what approach will yield the best value and return for our investors while also serving the community effectively as we build.

In this short video, watch as Dale Wills, Owner & Founder, discusses the mistakes developers make and the lessons learned from them.

Learning From Mistakes

The world of development is fraught with risks and uncertainties that require a careful, conservative approach to navigate successfully. From the dangers of over-optimism in deal underwriting to the complexities of unforeseen economic challenges, developers must stay vigilant and adaptable. The industry's landscape has taught us that while ambition is necessary for growth, caution is essential for sustainability.

In our view, developers should not only prepare for the best-case outcome but also brace themselves for potential downturns so they can maximize returns while protecting investor capital. Our practice of internal debate to critically evaluate deals from both positive and negative standpoints serves us and our investors well as an effective risk assessment tool.

Ultimately, success in development hinges on a blend of foresight, adaptability, and grounded decision-making. By learning from past mistakes and maintaining a disciplined approach toward growth and investment strategies, we have built a sustainable business capable of weathering economic storms while safely maximizing our investor returns.

Whether it is tackling economic issues or navigating financial complexities, our perspective is one that balances calculated risks with prudent management practices. It is an investment philosophy that resonates throughout all we do here at Centra Capital Partners, and one we believe is key to our enduring success in the industry.

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