Mitigating Risk During Economic Recovery

Stephen Baldock
As the market moves towards recovery, how can clients mitigate risk?

The UK is poised for recovery, but the construction industry remains on a rocky path. It’s not all bad – there are some encouraging signs of recovery – but the return to pre-recession industry-wide trading will be a slow journey.

The impacts of recession have been deep and the rapid growth that followed the 1970s and 1990s recessions is unlikely to occur this time.

The impacts of recession have been deep and the rapid growth that followed the 1970s and 1990s recessions is unlikely to occur this time. Instead, we can hope for steadier and more sustainable year-on-year growth, without shortcuts or quick fixes. During the three months December 2013 to February 2014 the estimated construction output shows an increase of 0.3% compared with the previous three months (September 2013 to November 2013). This trend is promising for UK PLCs, but challenging for many segments of the industry. Publicly-funded initiatives such as infrastructure and housing are providing a catalyst for investment. The residential market is certainly experiencing stronger activity.

Commercial and mixed-use developments are also showing encouraging signs of recovery with London also being the main focus. Regeneration-led schemes are becoming more prominent, with many mixed-use schemes scheduling the residential element during the earlier phases of construction. Following the changes in planning law, offices to be converted for residential use are now coming to market.

Regeneration-led schemes are becoming more prominent, with many mixed-use schemes scheduling the residential element during the earlier phases of construction.

In the regulated infrastructure industries, five-year budgets require savings to be made. The watchword is efficiency. At Faithful+Gould, we are seeing many clients in this sector becoming more open to alternative procurement routes. Outsourcing and joint ventures are under consideration for some, and others are looking to whole-life and lifecycle costing approaches to make the difference. A changed emphasis on innovation is clearly visible – new technologies, new materials, new approaches to preventative maintenance. A shift in mindset is beginning to happen, hinging on creative interrogation of delivery models.

In the private sector, however, it's still front-end costs that count, with capital expenditure prioritised over whole life in most schemes. The limiting of front-end enabling and infrastructure costs, to avoid burdening the development appraisal, is key to progressing private developments. Securing private funding remains a challenge, as equity providers continue to be cautious in releasing funds. Private residential and pre-let commercial schemes are favoured as they are seen as lower risk investments.

UK GDP growth is estimated at 0.7% between Q3 and Q4 2013 and at 1.7% in 2013 when compared with 2012.

The construction market is already reduced in capacity and we are now seeing contractors exercise more caution, being more selective over the bids they pursue to counter negative margins and/or increased risk transfer. UK GDP growth is estimated at 0.7% between Q3 and Q4 2013 and at 1.7% in 2013 when compared with 2012. While the challenge of securing appropriate skills has forced the supply chain to increase off-site prefabrication techniques, there has been a reaction to the greater number of opportunities being presented in relation to their capacity levels. This is resulting in inflationary pressures, which can no longer be absorbed and are now being recovered through increased construction costs. Tender Price Inflation (TPI) is now exceeding building cost inflation.

...more than ever, the precise planning of any development to suit market conditions is crucial to maximise the return on investment.

Risk mitigation is key. We expect to see clients considering more creative ways of engaging with the supply chain and considering the timing of project roll-out with even greater care. UK construction is even more closely affected by the global economy than before. Issues such as domestic or foreign policy, market confidence, natural resource supply and demand now mean that, more than ever, the precise planning of any development to suit market conditions is crucial to maximise the return on investment.

An example of clients embracing modern procurement methods is the growing popularity of engaging contractors in early involvement (ECI). This promotes collaboration throughout the build process, necessitating project or programme-specific procurement contracts. ECI promotes a reduction in pre-construction lead-in time and provides the opportunity for early collaboration between the client, designer and the entire supply chain, thereby facilitating greater control in the management of risk.

Faithful+Gould's Construction Intelligence and International Construction Intelligence publications offer regular forecasting insights, based on the latest construction industry data.