Investment is not an exact science, and each project is unique. That’s why at Urbanitae, we never tire of explaining both the advantages and the risks of each investment opportunity we present. This time, we are going to talk about perhaps the most variable factor in real estate investment: the timeline. If you’ve ever wondered why an Urbanitae project can be delayed, you’re in the right place.
Risk in equity projects
Our equity projects involve partnering with the developer, either to undertake the purchase of the land or to support the start of the project until bank financing arrives. Urbanitae investors are shareholders and, consequently, owners of the special purpose vehicle created specifically for the project. In these types of projects, we enter in the initial phases, and therefore, the risk we assume is greater.
For each project, we have a business plan with a determined duration. The success of the project depends on meeting the milestones of this plan. Delays occur when there are hold-ups in meeting one or more of these milestones. For example, taking longer than expected to achieve the pre-sales required by the bank, or the city council extending the deadline for granting the license, etc.
When delays occur, it is difficult to compensate for them later, as construction activities have specific timelines. In any case, it is important to remember that encountering a difficulty does not necessarily mean the project will fail. A delay in equity projects does not deteriorate the asset’s value, but it can impact the IRR – the way of measuring profitability that takes the timeline into account.
Why Urbanitae projects get delayed
As we said, the main risk in the projects we finance is the timeline. It is not unreasonable. Consider that even something as simple in comparison as a home renovation often doesn’t strictly adhere to the timeline. It is reasonable to think that a development of 50 homes might face some deviations in its development.
Here are some of the factors that most influence the timeline.
Administrative procedures and permits
One of the main factors that can cause delays in real estate projects is administrative procedures and obtaining permits. The bureaucracy associated with the approval of construction plans, licenses, and other permits can be extensive and often unpredictable.
In the case of Urbanitae, the key is obtaining the building permit. We usually estimate a broad margin for this milestone, but the fact that it depends on third parties introduces uncertainty into the timeline estimation. It is important to note that the license cannot be denied; the administration cannot refuse it but can require modifications to the project for its granting.
Construction problems
Problems during the construction phase are another common cause of delays. These can include technical challenges, issues with contractors, lack of materials, adverse weather conditions, among others. For example, a structural problem discovered during construction may require a revision of the original design, which can delay the business plan.
Delays in sales
Many of our projects start with a certain level of commercial progress, that is, with a certain level of reservations or pre-sales. In others, the marketing has not yet started. In either case, it could happen that the sale of the units takes longer than expected. For example, because the price is too high and needs to be reduced to attract more customers.
Bank financing
Although real estate crowdfunding facilitates project financing, in most cases it complements the role of banks. The entry of the developer loan is usually conditional on a certain level of pre-sales, obtaining the license, and owning the land. If any of these milestones is delayed, so will the bank financing. Additionally, the bank’s risk committee may delay its decision for reasons unrelated to the project.
Exceptional circumstances
That said, at Urbanitae we have experienced delays in projects funded before COVID or affected by the war in Ukraine. These two black swans affected not only timelines but also the project’s financial results. Yet, these are operations that will be completed, delivered, and will yield good returns.
Business plans, in general, estimate reasonable timelines for things to happen. But it is almost inevitable that if unforeseen problems arise (with the license, the pace of pre-sales, the closing of bank financing, etc.), all this translates into delays. Our model prioritizes capital protection and is subject to those delays that do not deteriorate the total returns but obviously do impact the IRR.
It is also important to note that, with a prudence criterion, we tend to announce delays and deviations when we suspect them, but we resist announcing the improvements we anticipate. We do not rule out that there are ongoing projects that may improve the return or the timeline, but we rarely announce it until it is confirmed.
We do not want to overlook our share of responsibility in presuming timelines, which have proven to be too optimistic in our first projects, and we are tending to announce predictions with more leeway. Therefore, if a macroeconomic environment without the upheavals of the 2021-2022 period is maintained, we are convinced that in new projects, our timeline estimates will be much more accurate.
