The 3 Red Flags That Show When To Run From a Developer

How To Do Due Diligence on a Developer

LM b W

Laine Moger

Journalist and Property Educator for 6 Years
Introduction

Developers aren’t regulated.

Sure, they have legal obligations. They’ve got to follow the Building Act and RMA regulations, but there are no special rules when it comes to selling off-the-plan properties.

That means a developer with no experience, and with no finance in place, could set up shop and start selling properties for a 200-unit project.

So the onus is on you to weed out the good from the not-so-good developers.

This is why it’s important to conduct your own due diligence for any would-be development.

So, in this article you’ll learn the 3 red flags that suggest a developer might have a bit more risk. You’ll also learn the 3 green flags, which suggest a little less risk. Ultimately, this will allow you to weigh up the risks before making your investment decision.

As with everything, rather than attempting to avoid risk altogether, it's about being aware of what the risks are, so you can make an informed decision.

Bad History

Red Flag #1 – Bad History

Let’s start with an obvious one.

If your developer has ever been personally bankrupt, or if a Google search reveals any fraudulent ties (or something that just doesn’t “feel” good) – it could be a good idea to look elsewhere.

So, when running due diligence on a developer always start with a good search on:

  • Google
  • The Companies register
  • Consumer NZ
  • Business websites like the National Business Review (NBR)

The two main questions you want answering:

a) How long has the company been developing for?

b) What’s the general reputation?

For example, if your developer’s company has been registered for less than six months, it could be considered higher-risk than a company registered for 2 years or more.

Also, keep an eye out for registered issues or complaints. To double-check public record, Consumer NZ is a great resource for finding historical stories or cases.

To a certain extent the risk level for this may be determined by your personal tolerance.

For example, if your developer has an overall good-standing reputation in the industry, you might be happy to let slide the few bad reviews you found on Google.

However, there are a few tricks to watch out for.

Let’s use a real-world example of Oaks Living. This company was started in 2020 and is a developer many of our investors here at Opes Partners have purchased a property from.

Even though they are buying from Oaks, they may not sign a contract with Oaks Living Limited. Instead, you might sign a contract with Oaks Living Coronation Limited. This is a company they’ve set up just for one particular development.

Obviously the company that’s been formed solely for the purpose of this development won’t have been around for as long.

That’s OK. The key thing you need to look for is how long the parent company has been around.

The next thing to be aware of is that one of its subsidiary companies – OD 2019 – went into liquidation. However, all the investors in that development on Russell Road had their properties completed on time and budget.

The owner of this company was not made personally bankrupt. So this is an example where a flashy news story may not actually be a red flag.

No Team

Red Flag # 2 No Team

As a rule of thumb, developers are good at building properties – they’re not good at admin (sorry developers).

To successfully deliver an on-time project, all your administrative ducks need to be in a row. It’s a lot of work.

That’s why developers need a professional admin team to ensure the project runs smoothly. Things like building codes, when not handled correctly, can cause delays to your project.

Put simply, if your developer doesn’t have a team working with them it is more likely some things will go amiss.

So, if a developer is a one-man band and is trying to build 300 properties, you could consider them to be in the higher-risk basket.

If they’re a one-man band and building 4 properties, it could be OK.

So an important question to ask your developer is who the members of their team are. If they can rattle off the names of a couple of people in their team you know they’ve got some support behind them.

Size Changes

Red Flag #3 Developers Biting Off More Than They Can Chew

There is a big skill set (and risk) difference, between building a row of 6 townhouses and building 206.

The more properties being built increases the chances of things falling over … metaphorically speaking (we hope).

For instance, if a developer has previously only delivered small-scale projects but now they’re pitching one that’s neighbourhood-size – you might like to probe a little deeper.

Doesn’t mean they can’t handle it, but there are more unknowns on their part.

So, when you’re going about researching your developer, make sure you compare past and present properties.

Questions to ask:

  • How do you have the confidence that you can deliver this dramatic increase in development size?
  • What additional resources do you now have that you didn’t have for previous projects?

The key things to look out for are being able to finance the larger development and having the labour and building materials locked in.

However, just remember, everyone has to start somewhere, so one red flag shouldn’t always be a deal breaker.

If this is the case, size still matters.

It might be a better idea to buy from a developer pitching a 6-unit development for their first project than one attempting to tackle 100 straight out the gates.

Proven Experience

Green Flag #1 Proven Experience

One of the first things to check (aside from potential fraudsters or bankruptcy) is previous experience.

Because if the developer you are looking into has several successful projects under their belt, this is a great green light.

This has a knock-on effect too. More projects mean a clearer reputation within the industry and how well known they are. It also means they know how to handle the inevitable things that go wrong.

It’s also very handy for the investor, because there is opportunity to nosey around any previous projects to see how they look visually. There will also be lots of feedback floating about, good or bad.

Here at Opes we rank developers from high to low risk, determined by how many projects they have completed.

For example, a low-risk developer would have 8+ previous projects completed.

But at the other end of the scale, a developer who has completed 3 or less would be considered high risk.

If you’re working with a new developer it’s worth asking about their previous work experience. If the developer has just stopped working for a major building company and is striking out on their own, that’s at the lower risk end.

If they’ve just stopped working retail and now want to be Sir Bob Jones, you might want to be more careful.

Good Financials

Green Flag #2 Good Financials

Being “not bankrupt” is just not enough to give your potential developer a financial green light.

You need to know they have the money to complete the development. If they don’t you might sign a contract, pay your deposit, and then the property never gets built.

Sure, you’ll get your deposit back, but you’ve missed the opportunity to buy a property that actually gets built.

One of the things to look for is knowing that the developer could cope if there was a 20% increase in the overall cost of the build.

To give you some peace of mind, the main question to ask is whether the developer has already approved finance, and if so who the lender is. If your developer has good funding from a reputable lender like a bank, it’s a good green light for you.

As a potential buyer you are allowed to ask them questions about their numbers and calculations.

Such questions may sound like:

  • Do you have a cash management policy in place?
  • How tight is their funding line?
  • Who is your lender and is it locked in?

Of course, they can refuse to reveal all the details, but then what would that refusal say to you, and would it colour your decision to purchase?

Labour and Materials Supply

Green Light #3 Labour and Materials Supply

Without sounding too obvious, properties need materials to be built. But they also need people.

Even the most prepared, well-researched developer will fall apart without a team behind them.

So, it’s worth your while asking who their third party providers are. Things like who their builders are, whether they’re using a labour hire company and whether their materials have already been ordered.

This way you’ll get a good gauge on certainty of materials and labour.

For example, a high-risk developer would hire labour on a week-to-week basis, whereas a lower-risk developer would have a locked-in contract and will have pre-ordered materials (ideally with the materials already on-shore).

Conclusion

So … What Makes A Good Developer, A Good Developer? Which Developer Should I Use?

Remember low risk, doesn’t mean no risk. Any investment decision you will make, even with a great, well-experienced developer, will mean accepting some risk.

In a nutshell, the qualities you are looking for in a developer are:

  • Previous experience
  • Good industry reputation
  • A team of support staff and industry contracts
  • And they have the finances to back them up

But at the end of the day, any variations in how much, or too little, of anything on this list may come down to a judgment call from you.

If you want a recommendation, here is our list of top 5 developers.

LM b W

Laine Moger

Laine Moger has been a journalist and reporter for the last 6 years. She previously worked for Stuff, The North Shore Times and Radio NZ. She has a Bachelor of Communications (Honours) from Massey University and a Diploma of Journalism from the London School of Journalism.