Counting the cladding costs

The legislation requires among a range of changes that building owners and landlords cover the costs of rectifying defects, something that collectively is likely to run into many billions of pounds. Assessing the costs involved, which party is liable to cover them and how to represent them in a company’s financial accounts poses a significant challenge for the firms affected. However, directors have a legal duty to represent the financial risks of the remediation accurately in their accounts.

To help shed some light on this complex question, Property Week spoke to Phil Westerman, partner and head of real estate and construction at top-20 accountancy firm Buzzacott, about the steps companies can take.

Watch the interview on the player below, or click here:

The Building Safety Act received Royal Assent more than a year ago, but there is still plenty of uncertainty about what it actually entails. What are the key grey areas from your perspective?

Westerman: The main developers are aware that they now have both a moral and a legal obligation for the buildings they are responsible for, going back over a period of 30 years. But one of the biggest grey areas is going to be around which buildings are the obligations of which developers. There is uncertainty there because many of these projects have been undertaken through joint ventures: how much of any remediation obligations will rest with the primary developer and how much will be the responsibility of other parties? Which elements can be recovered through the Building Safety Fund, which was established to remediate certain buildings more urgently?

The other key grey area is around the recent change to expand the scope of the legislation to cover buildings over 11m high, rather than the original over 18m-high requirement.

It can take a long time to fix buildings once safety failings have been identified and establish who should ultimately foot the bill. Does that mean multiple firms will have to make potentially overlapping financial provisions on their books?

Westerman: There is a chance that different companies will book provisions for the same obligations, although the legislation has been written in such a way that it should be possible, if not easy, to identify who the obligation rests with. Primary developers will be required to recognise a provision for their obligations. They will, most likely, settle the costs of remediating a building and then if there is recourse from other parties they will pursue that, whether that is subcontractors, insurers, joint venture partners or the Building Safety Fund.

Do firms actually need to put the money aside, or can they simply record it as a financial risk?

Westerman: I don’t believe there is any requirement to ringfence a bank account to settle the amounts that will need to be paid. But it is sensible for companies to start ringfencing monies against those future costs. Some will be doing it already in terms of how they are modelling their cashflow forecasts, and what they will need to spend their money on. In reality, this will be driven by the financial resources available to them in relation to other commitments, and how much they can put aside to meet these costs.

The big cost is not necessarily replacing the cladding; it is everything else that may need to be done

Phil Westerman

How has the cladding scandal affected the stance of insurers? Given the sums involved, how keen are they to avoid liability and to exclude it explicitly in future?

Westerman: This is very much an evolving position, and one where the insurance industry will quite possibly be keen not to be liable under policies in place. We will have to wait and see, but there is inevitably going to be an impact on how policies are written and what is covered, and potentially on premiums going forward.

Do you think banks and other financial institutions will be understanding of remediation risks, or might they be concerned that the costs may snowball?

Westerman: Again, this comes down to uncertainty, not so much in terms of the fact that remediation work will be needed but how much it will cost, how much impact it will have on an individual business’s finances and how long it will take. I suspect these things will all be taken into consideration when lenders are asked to provide financing for property development businesses.

There may be requests for more information and more detail behind the company’s forecasts and projections before the lending decisions are made. Lenders may also be looking at any cross guarantees from other corporates in the group, securitisation of assets and so on.

How do firms arrive at the right value for these potential building repairs?

Westerman: There is obviously a huge amount of estimation. There is the whole process of identifying the buildings that need remediating and then trying to cost up the remediation work. You really don’t know what you are going to find when you start to take cladding off a building that was, for example, built 30 years ago. The requirements for fire-safety systems and other aspects of building standards were very different back then.

The big cost is not necessarily replacing the cladding; it is everything else that may need to be done – there is a genuine risk of scope creep. There will be some more grey areas here in terms of what is technically within scope and needs to be factored into the cost, and what are nice-to-have improvements that aren’t really what the legislation has been introduced to cover.

Has housing secretary Michael Gove’s approach of making firms commit publicly to fixing cladding been helpful?

Westerman: I suspect he would argue that he didn’t have a choice. There was a degree of consultation with developers to try to make it as clear as possible exactly what they were signing up to. But the alternative would have been to make firms commit in private. That certainly wouldn’t have worked with larger listed companies, for example, where the shareholders would have expected to know what was going on.

One of the major changes to the act was the extension of liability for existing buildings to 30 years. What impact do you think this is going to have?

Westerman: The biggest initial impact will be the time that needs to be spent trying to identify those older buildings, and in some cases to confirm that they actually are your buildings and that you were the developer. Some records will be hard to find. In addition, a number of those buildings may have had a lot of work done to them since the original build. It will add significant time in the identification process and it will be harder to cost up the remediation of those older projects, and to identify exactly what needs to be done.

What is your message for developers on the best approach to take to this legislation?

Westerman: The biggest thing here is the degree of estimation and judgement that is going to be required for businesses in recognising these financial liabilities on their balance sheet. There is also a huge amount of commercial exposure in terms of cash out of the business and managing the conflicting demands of running their businesses and complying with their historical obligations under the Building Safety Act. It will have an impact on businesses for years to come so there needs to be a lot of thought, time and effort put into this.