Developers face a perfect storm of challenges

COMMENT As a regeneration developer working in the regions, primarily the North West and the Midlands, we have seen attitudes start to change towards development of our secondary cities and larger towns, with a realisation that there is potential for greater growth and that occupier demand does exist. The government’s levelling-up agenda and the changes in working patterns that have developed in the post-Covid era have both helped reignite interest in the regeneration of provincial towns and cities. But just as government initiatives and confidence in these markets have started to kick in, we are faced with a combination of factors that are having a very real impact on both public and private development. The consequences for the viability of developing high-quality buildings in many towns and cities in the Midlands and the North is dramatic. There has been real growth in values in recent years in many parts of these regions, and that has encouraged developers to bring forward schemes and proposals that are not reliant on public sector support. Interest from build-to-rent investors has burgeoned, including from institutionally backed investors and registered providers acting as private landlords. Clearly, the events in government and the financial markets of last summer have had a negative effect on this positive trend, but a bigger threat to regional growth relates to the delivery side of the development process. Perfect storm We are now seeing funded private development schemes grind to a halt owing to the inability to secure a construction contract at a viable price. We are also seeing public sector projects with central or regional government funding (and delivery deadlines) face issues because they are receiving tender returns significantly above their quantity surveyor’s pre-tender estimates and budgets. The Office for National Statistics national construction output price indices for all new work, published in February, showed an 11.9% increase for the year to December 2022. This is a cripplingly high rate for marginal schemes, but it does not reflect the whole story. Tales abound of tenders that are 20%, 30% or even 100% above detailed cost plan estimates. Just as common are stories regarding the lack of contractor appetite for projects, particularly where these involve houses or flats. There is clearly more to this than pure inflation, so what is going on? I would suggest that we are in the midst of a perfect storm of challenges, including overall capacity and nervousness within the construction industry, supply chain issues of labour and material availability and cost and, at least for residential development, changes to building regulations. The common theme across all of these areas is uncertainty, which is leading to an abundance of caution when it comes to pricing by contractors. Last year saw the highest level of contractor insolvencies for more than a decade, and there have been several high-profile failures so far this year, including companies such as Tolent, which operated throughout the North. Often these problems have been caused by cost increases on subcontract packages on design-and-build contracts, where the main contractor has agreed a fixed price so has no ability to recover losses from the client. This has led to fewer contractors in the market and to prudent contractors adding extra margin to tenders to cover the risk of cost increases. The root of the problem starts further down the supply chain, with subcontractors that are struggling to find skilled labour and often suffer the brunt of unexpected major increases in the cost of materials. The feedback from several major contractors is that they are pricing inflation risk at well above the projected indices, such as BCIS, which is projecting a 2.5% rise in building costs for 2023, owing to the uncertainty regarding subcontractors and materials. Interestingly, they are also saying that they will not be “buying” jobs at lower rates, even if that means a reduction in turnover. Need for resilience In residential development, the building regulation changes that came into effect last summer in Part L (relating to energy efficiency) and Part O (dealing with building overheating) have caused further potential cost increases for future schemes. This has been estimated at around 10% on total costs, on top of inflation. So where does that leave the regional development industry? I would suggest that most are sanguine about the situation. Those operating in this sector need to be resilient, taking a medium-term view. There has certainly been a slowing down in the progress of many schemes not yet on site, and we have witnessed a marked reduction in developer interest in bidding to the public sector on development procurement exercises in locations with marginal viability. However, many continue to plan to move forward, securing the best sites and even exploring solutions such as off-site construction as the cost gap narrows. Many local authorities are realising the benefits of working with private developers to deliver their budget-challenged projects using expedited procurement approaches. Yes, this situation does affect the whole of the UK, and in many markets it will result in a reduction in land values or profitability, or a need by a local authority to call on reserves. But in those places that really do need development, it is becoming a major problem that is preventing the economic growth that is required for levelling up. Steve Parry is managing director at Ion Property Developments Photo © Ion Property Developments