Mind The Gap
As I write this, the Euros are behind us, and the Paris Olympics are now in full swing, marking another high point in a fantastic summer of sport. And while I may not be the world’s biggest sports fan, I could hardly have failed to miss the hype and hysteria attached to England’s recent footballing exploits. It seemed that everyone had an opinion, mainly surrounding the performance of manager Gareth Southgate, and, interestingly, he seemed to polarise opinions. Some said that the statistics didn’t lie and pointed to the fact that the England team had achieved more success under his stewardship than under any previous manager since 1966. Others argued that he should have been able to get more out of his team, given the sheer depth and breadth of talent at his disposal.
Whatever your view, the whole depth and breadth thing turned out to be one of the main England talking points, and I suspect it was one of Southgate’s biggest dilemmas. He had some of the best players in Europe in the squad, but some played in similar positions. Then he had other positions where he was relatively short of talent and had to shoehorn players into roles that weren’t a natural fit. Arguably, not enough breadth of talent, but plenty of depth, at least in places. Phil Foden and Jude Bellingham were a particular case in point. Both were at their best playing in the same position, and each could turn a game on its head through their brilliance. So, should Southgate play one or both? And if both played, which one should play out of their preferred position? Of course, it was a tricky bet to win. Unless he delivered an assured, victorious performance, everyone would argue that he’d got it wrong, whichever option he chose. Which is precisely what happened, even when the team won. The manner of the victory was seemingly as important to some people as the victory itself, which, if you enjoy watching the beautiful game being played beautifully, is probably fair enough.
This issue of depth and breadth reminded me of a challenge that crops up a lot in the world of property development, particularly for first-time developers. One of the biggest dangers to prospective property developers is their knowledge gap. Simply put, they don’t know what they don’t know, which can often prove terminal for their development aspirations. The danger comes not from a failure to admit that they don’t know stuff but from a (usually) false premise that their knowledge gap can be plugged by someone else with more experience than they have. The problem that then arises is a case of ‘in the land of the blind, the one-eyed man being king’.
Let me explain. I once met a new developer (we’ll call him Dave) who had fallen into this very trap. Dave wasn’t daft by any measure and had fully recognised that he’d benefit from partnering with someone with more knowledge than he had when doing his first development project. He had sensibly opted to do a simple scheme, turning the upper floors of an empty shop into four one-bed flats. Nothing particularly complicated was involved; it was as vanilla as they came. He had permitted development rights to change the use of the building, which meant that he wouldn’t need to apply for full planning permission. He didn’t need to make any significant structural changes and had already assembled a team of professionals to do all the work. This included an architect, planning consultant, contractor, and project manager who would oversee things for him on site, plus a whole raft of other specialists.
But Dave was still a little worried because it was his first development. Anyone with reasonable intelligence can oversee a development project, and of course, the high-level requirements are relatively logical and self-evident. You work out what sort of project you’re looking for, then you find a property or parcel of land, buy it, then hire a team of professionals to do the work. You’ll also raise all the funding you need from commercial lenders and private investors. Your project manager will then oversee the construction, and once it’s completed, you’ll work with a residential agent to sell your finished units and then bank the proceeds. What’s could be so difficult about that?
The answer is, ‘quite a lot, potentially’. And Dave knew this, which is why he decided to partner up with Steve. Steve was a successful businessman and landlord who had recently completed a mid-sized new-build project in a neighbouring town, creating twenty units. And it wasn’t his first rodeo either – he’d previously done several self-builds, which he and his family had lived in briefly before moving on to do the next one. Dave had met Steve at a networking event a couple of years ago, and they’d become quite good friends. Steve had spoken at length to Dave about his latest development and invited him to come on-site before its completion to see how work was progressing. And Dave had been highly impressed. Steve had effectively created a mini-housing estate on what had previously been the back gardens of two neighbouring detached houses, and he’d shared with Dave how he’d carefully negotiated the deal with the two house owners. He’d then successfully argued his case with the council’s planning department and secured full planning permission in just under a year. It all meant that Steve would be pocketing a significant seven-figure sum once the units were sold, and Dave had been hugely impressed, not just with the profits but also with the quality of the houses and flats that Steve was building.
This led Dave to have what he thought was a great idea. He’d see if Steve would be prepared to become a 50/50 joint venture partner on his shop conversion project. While Dave would be giving away half the profits from the scheme, he felt this would be worth it on his first project to ensure he didn’t fall down any holes. After all, half the profit was better than no profit at all (or, worse still, a loss). Having someone like Steve on board would mean that someone with more experience could double-check Dave’s decisions, and any issues that arose on the project could be run by Steve first so that Dave could determine the best solution. All of which sounded perfectly reasonable and would be a sensible precautionary approach that many a budding developer might take on their first project. But, as I discovered from talking to Dave, things hadn’t gone entirely to plan.
The cracks started to appear not long after work had begun on site. Dave had picked a contractor with a solid local reputation who had also been able to recommend a good project manager he’d previously worked with. The quote looked good, and Dave was confident he’d achieve a solid 20% plus margin on the scheme once he sold the finished units. That was until he got a phone call from the project manager asking him to meet the contractor on-site. In stripping out the building, the contractor discovered some structural issues that would require an additional £75k to fix. This had not only wiped out Dave’s contingency fund, but it had also eaten into his profits. But he’d had little choice but to stump up the extra cash.
A few weeks later, the contractor started making claims for ‘overs and extras’ – additional work that he said had not been priced into his contract. The project manager agreed that Dave had little choice but to pay these, and having re-read the ‘standard contract’ that his contractor had asked him to sign, Dave had to agree. Dave had asked Steve for his advice, but there wasn’t much he could add. Steve hadn’t worked with Dave’s contractor before and couldn’t see any loopholes in the contract. And so Dave’s profit margin took a further battering.
The final straw came when Dave started questioning some of the additional costs that his contractor was billing him for, as they seemed expensive, to say the least. Steve had also taken a look and agreed they appeared over the top. Dave called his project manager and asked what could be done, but his response was simply that the contractor could charge those prices under their agreement. If Dave didn’t like it, he could kick the contractor off the project. However, he would have to pay a premium to get a new contractor in to finish the work. Plus, the current contractor could potentially claim damages, given that they weren’t breaching their contract in any way.
Dave had also become frustrated with Steve. After all, wasn’t this the sort of issue that Steve’s experience should have prevented? But Steve hadn’t encountered a problem like this before. His own contractor had never behaved that way, so he hadn’t been alive to the potential problem. This strained their partnership, with Dave feeling that Steve wasn’t adding the value he’d reasonably expected. As for Steve, he could see that Dave’s project was now breaking even at best, and so, much to Dave’s frustration, he started to make decisions unilaterally to protect his position. This deal should’ve been a no-brainer for Steve, but he could now potentially lose money on it.
Dave didn’t like Steve taking over, but there was only a limited amount he could do since Steve was a 50% shareholder in the project. Eventually, Steve appointed his own contractor to finish the job, which at least stopped the current contractor from bleeding the scheme dry. But as Dave later discovered, Steve’s contractor had effectively charged a premium to take on Dave’s site but had then given Steve a discounted rate for Steve’s own project, effectively robbing Peter (Dave) to pay Paul (Steve). He’d also discovered that the original contractor and project manager were old classmates and had known each other for years. Perhaps it wasn’t so surprising that the project manager hadn’t been keen on challenging the contractor.
Dave felt he’d been done up like a kipper, and I explained to him where he’d gone wrong. None of it was rocket science, and all of it was preventable. The problem was that Dave didn’t know what he didn’t know, and Steve was in the same boat. Just because Steve had more experience than Dave, it didn’t mean that he automatically had all the answers. He was arguably only one or two steps ahead of Dave in terms of his experience, so his view of the world was still very limited. Between them, they had some depth but lacked the breadth to know where there were gaps in their knowledge.
So, what’s the solution, bearing in mind that any new developer will have gaps in their knowledge for obvious reasons? The answer is twofold. First, get yourself properly trained as a property developer before you embark on your first project, and make sure you get the best training you can afford. The best training doesn’t come cheap, but it should pay for itself several times over on your first project alone, and of course, you may well go on to do multiple projects over many years, in which case it’s the gift that keeps on giving. Training allows you to become aware of the gaps in your knowledge and the things you need to look out for. And once you know what you don’t know, you can put arrangements in place to protect yourself. I would urge you to do your due diligence on each training company you speak to, to ensure you pick a good one and be sure to get some first-hand experience of their training. You want to make sure you like their training style and that they go into sufficient detail. Also, find out how much experience they have in development? Have they done a handful of projects over the last few years, or do they have a development track record that stretches back decades? You should also speak to other people who have done their training to get some first-hand feedback. Finally, good training will also show you where the best opportunities are – and not just how to avoid the pitfalls.
The second part of the solution is to work with someone who has more experience than Steve had. You want someone who’s been there and got the tee-shirt several times over, ideally with 25+ years’ experience in property development, either as a developer or as a professional consultant such as an architect or project manager. Someone who’s just a few rungs further up the ladder than you won’t have enough experience to give you the protection you need. Dave’s other mistake was giving up 50% of his profit along with his majority stakeholding in the project. It allowed Steve to effectively take over and make decisions that benefited Steve but at Dave’s expense. Dave would have been far better off giving Steve a profit share for a lesser amount. That way, he would have retained control and gained more profit.
With the myriad challenges facing the buy-to-let sector, we’re seeing more and more landlords and new property investors turn to small-scale property development projects as a highly attractive way of creating wealth through property. But you need to be aware of your knowledge gap. Just because it’s possible to develop property without being trained or having a knowledgeable advisor on your team doesn’t mean it’s a good idea. It’s far better to invest in your education and reap the rewards down the line than jump in without and repent at leisure.