What are the risks?

This guide primarily focuses on property that is already built and owned for investment purposes. However, all property owners engage in development of some sort, from refurbishment to full-scale redevelopment. The opportunity to add value to the asset through improvement is a fundamental feature of owning property which is absent from investment in equities, cash or gilts.
 
Property development, whether commercial or residential, has an attractive strategic logic, particularly in the UK, which has a small amount of land available for development, tight planning regulations, and a growing demand for homes and business premises. But the translation of this potential into specific development activity can be fraught with difficulties.

Property development brings with it a specific set of risks and potential rewards, and it requires additional skills. The risks include the project management of costs, liability of suppliers, raising finance and managing cashflow and, above all, the risk of ensuring there is appropriate demand for the finished property. Property developers pay out money during the course of the development (which may last several years), and only get any reward at the end of the project when the building is sold or rented out.

The overall level of risk in development is significant, and the high returns expected by developers reflect this. In particular, developing the property without it being pre-let or pre-sold is seen as a particularly high risk, unless it's timed well within the cyclical property market.   

Whilst almost all property investment - direct or indirect - involves some exposure to property development, investors should be clear about how much development risk is involved, and ensure it fits with their appetite for risk.

Indirect investment vehicles should be explicit about how much development they undertake. REITs, for example, are required by regulation to derive at least 75% of their income from property rental, and offshore Property Investment Companies undertake little or no development. 

Information about how much development is undertaken can usually be found in prospectuses and published accounts. Alternatively, your adviser should be able to find out for you.

A few quoted property companies are specialist developers, as indeed are housebuilders, although investing in these should not be considered as property investment.

Investors considering direct investment in property (commercial or residential) should be clear in their own minds how much of their expected return is dependent on development, and how much is due from rental income, and investors should ensure that they have the skills and time to manage the risks that this will bring.