From 2008 until early last year, the UK construction market was either in a deflationary or static pricing market.
Margins had been squeezed and in some instances, contractors were taking on work as a ‘loss leader’ to maintain cash flow. The industry also lost a large proportion of its workforce as turnover and volumes declined. During that time, developers were purchasing contractors in a buyers’ market, but it is worth remembering that those few clients who were developing between 2008 and 2012 were doing so in a much more difficult market where they were usually taking a higher risk on exiting their development profitably.
The benefit of the market mechanism forcing construction prices down during this tough period was therefore not always a licence for developers to profit beyond the normal risk and reward equation. What has happened, though, in the past 12-24 months, especially in London, is a very localised residential-led construction boom that has taken some contractors from ‘famine to feast’. The level of work coming forward is now significant and developers are not able to pick and choose their contractors and in many instances are not able to force any real competition on price.
The key challenge for developers now is to select the right supply chain that will deliver what is required across quality, programme and commercial considerations. The opportunism that is sweeping the contracting market brings with it grave dangers for unwary clients. There will be a temptation to seek alternative contractors when the preferred choices do not have capacity or their price does not work for clients. This risks the use of inappropriate contractors who will potentially put a successful project outcome in jeopardy.
By the same token — and even more worryingly — there is an increasing possibility that the first choice supply chain, which on paper is corporately credible and is often charging a higher price for that benefit, is in reality also a delivery risk as it does not have the right individuals in the teams it is proposing. The level of recruitment and turnover in the industry, even at the most senior level, is creating some latent risks where the corporate track record is not backed up by the proposed team’s proven collective capability or the safety net of long-term senior relationships.
Developers are therefore in an increasingly difficult position of having to secure capacity in what is now a sellers’ market. The problem now is that the seller might not always be offering what the buyer thinks they’re getting. It will not take many failed projects to seriously impact the market and the unfortunate reality is that as the price of delivery goes up, so will developer expectations, just at a time when the supply chain appetite for risk is reducing — ie. clients could be getting less for more!
In summary, I think the projects being delivered and completed over the next two or three years will be crucial in determining where reputations are either made or damaged. You now have contractors shying away from risk while looking to maximise their margins with finite resources.
While developers are needing to control their cost exposure against a backdrop of increased land acquisition costs and in some instances softening development values, they also desperately need to ensure they get the team that will deliver real results, not just a brand promise. How this combination of competing drivers comes together remains to be seen but I fear the London development and construction market is inherently fragile at the moment as these tensions play out.
Mark Farmer is head of residential at EC Harris. Last week saw the publication of the annual EC Harris London prime residential development pipeline report, the main theme of which this year was lack of industry capacity.