Managing Risk-Opportunity in Volatile Times

THIS MONTH’S WISE OWL

Justin Sullivan BSc.QS FRiCS ACiArb FeWi – Chair of the Construction industry Council (CiC)

Justin Sullivan is a Chartered Quantity Surveyor with more than 30 years’ experience and standing in the construction industry. He is Chair of the Construction Industry Council (CIC) and a Fellow of the Royal Institution of Chartered Surveyors (RICS) and Chair of the International Construction Measurement Standards Coalition (ICMS). Justin is also the CEO of Adair, the quantity surveying and construction consultancy he founded in 1994.

Managing Risk-Opportunity in Volatile Times

Eighty Percent of the businesses that operate in construction and property can be described as SMEs. From ‘low volume’ SME developers and what can be called emerging corporate development firms, through their professional advisers and aligned specialist business association groups, the industry pivots around the type and scale of businesses, and their representatives, who we at the CIC are dedicated to supporting.

We recognise that in meeting the demands of now and the future, addressing the housing ‘shortage’, the changing face of the high street and the impact of what are no longer ‘new ways of working’ but are simply ‘ways of working’, employer client developers will be the mainspring of overcoming these new challenges.

The prevailing context, widely acknowledged materials and product shortages, price inflation and volatility, labour and, equally importantly, management shortages consequent to Brexit and the pandemic, is increasing complexity and generating new risks, and, as the more entrepreneurial developers recognise, associated novel opportunities. Large numbers of skilled craftsmen and contract and project managers – young professionals who developed inside many of our construction businesses over the past few decades – many of these are now overseas, back in their native locations awaiting resolution of the post Brexit & Pandemic constraints – this makes delivery even more challenging in what has always been an interesting sector.

The rising cost of raw materials is a considerable concern and a problem over the last year since the start of the pandemic when construction was given the green light to continue, although guidelines on manufacturing plants were less clear:
•July alone saw a 4.5% increase of materials across the board
•And a 23% increase in the costs of imported timber

Over the past year there has been volatility in the price of raw materials such as:
•The fluctuations in plasterboard and plaster prices are well known due to supply and demand pressures
•Imported timber and in particular plywood 82%
•Sawn and planned wood 64%
•Steel prices are 65% higher than this time last year
•Brick manufacturers reporting an expected 10% imminent increase
•Generally, materials are 20% higher than a year ago

These ‘emerging corporate developers’ mentioned above are presented with what is in some ways a simple choice – keep doing the same thing, in the same and well-worn way, but try to overcome and micro manage these additional challenges; accept the same old risks and achieve the same reliable but unexciting returns; or, seize the moment to do different things in different ways that challenge the orthodoxy – an anathema to the construction sector and very unsettling for notoriously traditional and conservative investors and funders.

The reason SMEs are so dominant in construction and property, is they are agile, flexible – opportunistic; they turn on a sixpence while the big institutions and Tier One’s change tack like ocean going liners. But how, as an SME, to survive and thrive in times of unpredictability and chaos – crisis even?

Our view is the answer lies not in cheeseparing around cost, but to understand and embrace ‘value’.

For some time, initiatives aimed at addressing the issues in the construction industry have been about introducing ‘partnering’, these have focused on large scale and government capital projects, and how to achieve fair value. This has not considered the vast majority of projects which are delivered by, for and with SME businesses who struggle to catch the attention of government.

However, we are seeing the more adept and agile businesses becoming aware of the value of true collaboration, investing ‘a little more’ more up front in setting up contracts and projects correctly, guided by invested counsel from comparable scale advisers (themselves SMEs in turn), working with trusted partners and building in true ‘pain/gain sharing’ and mutually beneficial shared outcomes.

The most frequent questions faced includes, currently, ‘How do I, as a developer, protect myself from the volatility of the supply market?’ Well, one answer would be to build in ever more complicated and extensive contract amendments, with clauses about price fluctuation and cost certainty, ensuring risk is transferred to the other party – who has to build in contingency and wriggle room – or as we might call it ‘margin’, something that seldom flows ‘upstream’. The smarter investor/developers can see the flaw in that approach – risk is where extraordinary returns are available – owning the risk allows the entrepreneurial developer to control, manage and leverage the associated opportunity.

In our view, the fundamental change is not in the processes or the protocols, those are well established and proven (mostly), but in new thinking – before rushing headlong into getting spades in the ground once planning has been awarded, work with the supply chain, under the direction of like-minded advisers and in open collaboration with those contractors and suppliers who carry the fullest experience and knowledge, I am bound to say, like those members of the CIC I am privileged to represent. Accept that they are as entitled to achieve a reasonable return, as much as are the Risk-Opportunity centric developers who we believe will thrive in this new exciting and challenging market. Work together to set the project up properly – it’s usually faster in the long run, and certainly more likely to be less expensive and the end product far more likely to be what was expected, than is often the result of the compromises that have to be made along the way in the traditional approach.

A smart contractor I know once said ‘If my clients knew what we know, then they’d do it the way we’d do it if we were the client’ – in other words, ‘if this was my money and my project, then [this] is what I would do and how I would do it’ – a completely different mindset to the conservative, ingrained traditional and the adversarial way of things that is the norm.

There’s a reason why only an estimated 60% of projects, are delivered on time, on budget and on quality.

And contrary to what many clients are told, it’s not always the client’s fault…