Real estate development is a high-reward business that carries equally high risk. You’re committing significant capital in the hopes of achieving oversized returns. When things go well, the returns are massive. When things go wrong, the exposure is enormous. That’s just sort of the way it goes
The developers who build sustainable careers in this business are the ones who identify risk clearly and put structures in place to manage it before a problem materializes. Let’s explore some of the ways they do that.
Carry the Right Insurance Coverage
Insurance is the most important layer of protection for a real estate developer. It’s also the one that too many developers approach with a “good enough” mentality. A basic general liability policy isn’t sufficient for the range of risks a development project creates.
Real estate developer insurance needs to be structured around the specific risks of your projects. There are several different kinds to be aware of.
- General liability covers third-party bodily injury and property damage claims.
- Builder’s risk covers damage to the structure during construction from events like fire, storms, and vandalism.
- Professional liability covers claims arising from design errors or project management mistakes.
- Environmental liability covers contamination issues on the property.
- Umbrella policies provide additional coverage above the limits of your underlying policies.
The right coverage mix depends on the type and scale of your projects. For instance, a ground-up residential development carries different risks than a commercial renovation. Work with an insurance broker who specializes in real estate development and construction rather than a generalist who handles your auto and homeowner’s policies.
Structure Your Entities Correctly
How you hold your development projects from a legal entity standpoint matters. It directly affects your personal exposure if something goes wrong. Holding properties and conducting development activity in your personal name or in a single entity that also holds your other assets creates unnecessary risk. This is not advised.
The standard approach is to hold each development project in a separate limited liability company (LLC) or similar entity. This structure isolates the liabilities of each project from your personal assets and from your other projects. If a lawsuit arises from Project A, the claimant’s recovery is limited to the assets within Project A’s LLC. Your personal accounts, your home, and your other projects are shielded.
Use Thorough Contracts
A development project involves contracts with dozens of parties. You might have general contractors, subcontractors, architects, engineers, lenders, investors, property managers, vendors, and eventually buyers or tenants. Every one of those relationships needs a contract that clearly defines the obligations and provides remedies when performance falls short.
Indemnification clauses are very important in construction contracts. Your general contractor’s agreement should include indemnification provisions that shift liability for construction defects, worker injuries, and third-party claims back to the party whose work or negligence caused the problem. Without these provisions, claims flow uphill to the developer, regardless of who was actually at fault.
Insurance requirements should be specified in every contractor and subcontractor agreement. Define the types and minimum amounts of coverage each party must carry, require certificates of insurance before work begins, and include provisions that make you an additional insured on their policies. If a subcontractor causes a claim and doesn’t have adequate insurance, the shortfall falls on you.
Build Relationships With the Right Professional Team
Developing a piece of real estate is a team sport. The developers who protect themselves the best are typically the ones who surround themselves with the right professionals. This includes:
- A real estate attorney who handles transactions and disputes. They will structure your entities, review your contracts, manage your closings, and advise you on regulatory compliance.
- An experienced CPA or tax advisor who understands real estate taxation. They will help you structure transactions to maximize tax benefits, including depreciation strategies, 1031 exchanges, opportunity zone investments, and cost segregation studies.
- A reliable insurance broker who specializes in construction and development. As mentioned above, they will ensure your coverage keeps pace with your projects and your risk.
Lender relationships matter as well. Having established relationships with lenders who understand your track record will make it easier (and faster) to get the money you need for your projects. Those relationships are built over time, so don’t neglect the importance of nurturing relationships as you go.
Minimizing Your Risk as a Developer
Real estate development will always carry risk. And while you can’t always totally insulate yourself from risk, there are plenty of ways to strengthen your position by taking the right proactive steps. If you consistently pay attention to what your biggest risk factors are and know how to offset them with tangible investments, you’ll set yourself apart from the average developer and enjoy much greater success.
