Project managing development risk in volatile times

Today’s market is – undeniably – a volatile one, if not entirely contradictory. On one hand, demand for housing is at an all-time high and, on the other hand, developers across north America are struggling to contend with a constantly changing environment. With no shortage of challenges, from the entitlement approval phase, to rising interest rates, ongoing supply chain challenges, labor shortages, construction costs, sustainability concerns, and more, development projects currently face high levels of risk.

Altus experts Faris Rehman and Jack McGowan joined Marlon Bray, Director, Development Advisory at Altus Group, to discuss the key risks now facing developers and, more importantly, how to mitigate them and find success in an uncertain (or in some cases, unfamiliar) market. According to Jack McGowan, Senior Director at Altus Group, there are five stages of risk to consider within any development project:

• Risk identification and assessment

• Contingency planning

• Risk transfer

• Risk avoidance

• Risk monitoring and control

“First, you have risk identification and assessment – you have to look at what you’re doing, where you’re doing it and, from there, identify the associated risk,” explains Jack. “Then you try to mitigate that risk with contingency planning, and then most clients will look to transfer that risk from themselves to the people who deserve the risk at that time, which leads into risk avoidance. Finally, there is risk monitoring and control, which involves monitoring the risk during the project, and then attempt(s) to control outcomes and mitigate any emerging risks.”

Of course, risks vary from project to project, as well as market to market. In today’s climate, change is a constant issue in every segment, and risk factors such as high construction costs and the ongoing liquidity crunch must be considered. “The other side of the coin is the operational or project risk,” notes Faris, Development Advisory at Altus Group. “Delays and lack of funding – things of that nature – are happening too. When we look to the larger economic picture, we see rising inflation in addition to talk of a potential, impending recession – it may be a muted discussion, but it’s happening. On the legal and contract side, risk mitigation must be considered. In this market, it’s more important than ever to include specific clauses that safeguard the interests of developers, contractors and sub-contractors.” In the realm of predictive estimating and the use of robust artificial intelligence (AI), Jack notes that the quality of input factors is the biggest piece to the risk mitigation puzzle.

When it comes to project development in a new area, there are a number of important variables to consider – from the regulatory framework you are stepping into, environmental considerations, project financing, and more. “You have to make sure you understand what you're stepping into and how those variables may impact the product you plan to deliver in that market,” Jack explains. “You’re going to have to take into account building codes and standards, as they change from province to province and state to state. Project financing and procurement is also very different in some areas – for example, Montreal and Calgary offer very different landscapes for funding, in addition to cultural and social differences. More than anything, you must have an in-depth understanding of the market you’re entering and the product you’re offering. Moreover, you need to utilize marketing data to establish a plan for how you will position your product in that new market.”

Think locally, act globally

When a developer enters a new market, land acquisition is, of course, the first step – but they must also prioritize building relationships with the local people. “You have to think locally, but act globally, particularly when you are a developer working in the US, Canada, or overseas,” says Faris. “Teaming up with a national firm with a strong local presence is key. Start with data to learn the market and fine-tune your niche product, accordingly, acquire land and get boots on the ground, and then partner with someone in that marketplace who has local knowledge and connections.”

Every project development team has two major components: the development team at the beginning and the construction team which implements the plans set by the development team. Once these teams are aligned and you have teamed up with local players, you can align your project goals with the overall profitability and risk profiles, etc. for the job. “Again, we can’t stress this enough – knowing the local market is very important, especially as it relates to costs and timelines. For example, utility costs may vary drastically across markets, or, from an environmental and geo-technical perspective, soil conditions can represent a huge cost as well,” explains Faris. “You need to have that information upfront, and this discovery will be largely informed by the local teams and local players aligned with your project, who have been working in those markets for a long time. Their input is critical to mitigate those risks and determine if a project is truly feasible.”

The impact of data on change management

How important is it to deal with change and change management if you're looking at going into new markets in a different province, a different state, or even a different country? According to Faris, it comes down to the commitment of the company to that change, the allocation of appropriate resources, and making sure that the product that you're bringing into that new market actually fits.

“Change management is complicated, but as a starting point, data is the key. At Altus Group, we take pride in our data, and we have a large amount of it that we can adapt for the benefit of the client, to present them with a comprehensive view of the best and worst-case scenarios,” he shares. “Going forward, data will only become more central to everything we do in this industry as AI disrupts key areas of CRE business, such as project management and the feasibility and pre-construction phase. We must adapt.”

Regional differences in risk tolerance

Different marketplaces exhibit different appetites for risk – so how does project management in North America compare to another market, such as the Middle East?

“In the Middle East, they have a 30-year plan where they’re developing an entire area, so you do find that they’re more accepting of risk and building change,” explains Jack. “You could compare this to Calgary from 2017 to 2019 – it was quite a period for development and people, but the development wasn’t robust, even though it could have been. So, I do think the model for risk – and the tolerance for financial outcomes – in the Middle East is more aggressive than the model we have here.”

Canadian markets are, perhaps, the most risk adverse, and our zoning policies – as well as our approach to building – reflects that, adds Marlon. “I would say the US is somewhere in between the Middle East and Canada, and different states have varying levels of risk acceptance, and a more entrepreneurial approach.” This begs the question – with a housing crisis currently unfolding across Canada, is our risk aversion a flaw? Do we have a lack of willingness to mitigate that risk and just get it done?

“I think that we need to be a little bit braver in building larger projects that really do change the landscape of where we're working,” shares Jack. “We’ve got a huge housing problem across the country, and yet we still don't seem to be able to make the big decisions that that should change that.”

Speculative trends in the construction industry

"Notably, the US housing market is home to more speculative building. Faris notes that this works well, although it may not align with our way of mitigating risk in Canada. Is this embrace of speculative building a more entrepreneurial approach? Could Canada learn a little bit from the US about risk tolerance? Or should the US learn a little bit about risk avoidance after the meltdown in 2009?

“I think the issue in US is mainly the funding,” notes Faris. “The laxer the markets are, the more speculative trends we see in the construction industry. Since the 2018 Dodd-Frank reform, which abdicated thousands of small and medium-sized mostly regional banks from strict rules that had been enacted as part of the initial 2010 Dodd-Frank law, we saw a lot of building activity funded by the same in CRE. In the current, more volatile post-pandemic market, this is impacting the overall banking sector and it's impacting the lending, which is again, slowing down construction progress – particularly on the multifamily side.”

Faris adds that, ultimately, it should be a combination – a thoughtful balance between risk tolerance and risk mitigation. “I think banks learned their lessons in 2008, and the market has been more reasonable and manageable ever since. However, COVID upturned a lot of that.” The office sector is under a lot of stress right now and it is impacting the lending industry in general, as well as the lending for new projects in particular, which are developer-finance projects. But overall, the issues you're seeing in Canada are reflected the US market as well.

Although the risk approach in the Middle East might not be perfect, Marlon notes the value in a governments’ willingness to take risks. “That willingness to take risks generates growth that, in the long run, works out for the good of everybody, even despite the risks. Canada, as we mentioned, is ultra-conservative in the risk department, and in the US some states tend to be a little restricted. That’s why we see these massive challenges materialize in places like California with respect to housing – that different approach to governance can, unfortunately, become a major roadblock.”