Optimising project funding opportunities in the post recession market.
Chris Whittington and Chris Kirby-Turner, of leading South East law firm Thomson Snell & Passmore’s top ranked Construction & Engineering Team, consider the post recession challenges and opportunities in project funding.
With any recession, the construction industry is always ‘last in, last out’. Projects started before recession hits still provide a degree of work as they are built out, but new orders dry up once it bites. Once it ends, there is the lag while investors test the water to see if it really is over, bring back mothballed projects and arrange finance for new projects, and finally place orders with contractors. So far, so familiar, but what of the long and bruising recession just ended? Is it still casting a long shadow or is it now firmly in the past? And what of the new project funding landscape?
The signs certainly appear encouraging. Construction output, despite the recent blip, has been rising for the last year, but with some sectors performing notably better than others. Articles by Barbour/ABI published in recent issues of ‘Building’ showed that overall their Construction Index as at July shows a 17% increase over the year. Output overall is still behind pre-recession levels (some 10%) but the increase in contract awards suggests continued strong recovery for the year to come.
Residential has been, and continues to be, the “star performer” with the index rising 29% over the last year. Other sectors, such as retail, commercial and infrastructure have not fared as well – for example commercial is, according to Barbour/ABI, 38% below pre-recession levels. Contract awards in retail are currently on a downward trend overall, likely to continue for at least 6 months.
It is not clear why certain sectors are struggling. One answer could be skill shortages – a recent RICS study showed that fears of skills shortages were at their highest level for six years in Q2 of 2014 with 51% of firms reporting a shortage of workers, particularly quantity surveyors and bricklayers.
The availability of finance for construction projects continues to be an issue, although as confidence returns it appears the purse strings are loosening. For contractors, tender prices are beginning to rise but, other than in the house building sector, rising costs mean that margins are very low, particularly on contracts previously won at competitive prices. The situation for SME construction firms regarding trade debt is concerning with average debt standing at £484,000.
In terms of securing finance for projects, there is evidence that there can be a lack of understanding on the part of developers as to what is required of them, both from their own perspective and the lender’s. This seems more prevalent among small to medium size developers, and shows that there can be significant gaps in knowledge as to what will be required under the finance agreement, particularly regarding the requisite construction documentation. Among lenders too, through on-going streamlining, older, more experienced personnel are moving on bringing a risk that the level of relevant expertise is being diminished.
Failure to secure building contracts, professional appointments, collateral warranties and the like which comply with the lender’s requirements for an appropriate level of protection for the investment mean that the lender has to instruct its lawyers to prepare them, which not only adds to the developer’s costs but will almost inevitably delay the project. There can be a lack of appreciation that properly drafted documentation will ultimately benefit the developer as much as the lender – quite apart from providing the developer with sensible protection, it can make the development more marketable to purchasers or tenants.
Where projects require outside finance but the developer decides to commence before this is in place, a lack of appreciation or knowledge as to what construction documentation the lender will require can lead to problems. If contracts have already been executed which do not satisfy the lender’s requirements, this can lead to finance being refused; it may be possible to re-negotiate terms so that the requirements are met, but the danger is that the contractor may refuse, as it would legally be entitled to do, or at the very least will demand extra money for taking on extra risk. Contractors are at risk in such a situation as well – if funding cannot be secured because the documentation does not satisfy the lender, the project may be halted for lack of funds, with the contractor left out of pocket.
To return to the original question - the recession may officially be over, and for the construction industry, although output remains below its pre recession levels, things overall are moving in the right direction and should continue to do so. The ability to secure project funding will, as it always has, play a large part in this, and the benefits to all concerned of ensuring that the project is properly set up from the start with suitable documentation will optimise its availability and moreover benefit all concerned in the project during its implementation.
This article was first published in Construction Manager online 5 September 2014.