December-03-2021 in Banking & Financial Services, Property, Construction
From our recent activity in the residential and commercial construction finance space it has become clear that one of the key challenges facing borrowers and funders is the issue of escalating costs on construction projects and the delays being experienced as a result.
It has been well documented that there has been an unprecedented period of disruption in relation to the construction sector, the two obvious contributing factors being the ongoing Covid-19 pandemic and the fallout out from Brexit. Coupled with these factors are supply chain constraints, exceptional increases in materials and labour shortages.
The Society of Chartered Surveyors Ireland (SCSI) Tender Price Index figures highlight that national construction tender prices increased by 7% in the first six months of 2021. Such rate increases have not been seen since the Celtic Tiger era. SCSI reports that national annual inflation which is now at 8.3%, is almost double pre-Covid levels.
The rise in prices was somewhat inevitable after construction sites reopened on 12th April this year, following a considerable lockdown period. However, the scale of the increase has been greater than anticipated and this is attributable to international competition for building materials. A further impact of Covid-19 and extended periods of site closure has meant that skilled workers left the market to take up alternative employment and many have opted not to return to the sector.
The impact of Brexit may not be seen immediately but there are also other contributing factors facing the construction industry. The Suez Canal blockage caused billions of euros worth of international commerce to sit paralysed at either end of the Suez Canal due to a single container ship that was lodged across the waterway. Another constraint is the building boom in the United States which is severely impacting supplies. Ireland is not alone in experiencing these difficulties, with warnings being issued by the Construction Leadership Council in the UK of shortages of many items, with timber, steel and plastics being the worst hit.
Politically, construction costs have become intertwined in the housing supply issue, which has been a major talking point since the full re-opening of construction earlier this year. In a recent interview, Housing Minister, Darragh O'Brien, discussed the myriad of obstacles faced by a government seeking to achieve 33,000 housing units per annum. Unsurprisingly, labour and materials featured heavily.
In their Real Estate Planning & Development Statistics Q1 Industry Review[1], published in May this year, Deloitte analysed construction costs and predicted an increase in construction cost inflation towards the end of the year and beyond, as rising costs become fully realised and new projects become available.
Conclusion
Cost certainty and availability of materials are key considerations for developers and funders alike - both at the pre contract/ funding stage and also during the course of any development. The simplistic approach is to build in additional headroom within the main build contract, however doing so may have knock-on implications for loan to cost determinations. The standard position was that the contractor would take liability for any cost increases as part of the determination of the overall contract sum. Certain other construction contracts also provide for additional costs to be vetted and signed off by the Architect. In more recent times we have seen alternative approaches by funders and employers in respect of treatment of escalating costs. One example is an agreement between the employer under the build contract and the contractor that if there are additional cost overruns to a specified level, the employer will discharge same however any payment in respect of this obligation would rank in priority and be subordinated to the funders entitlement to repayment.
Ultimately, cost escalation is with us for the time being and those within this sector need to be live to the implications and adaptable in terms of approach in order to mitigate and minimise delays to projects and financings.
In our experience, the key consideration is to avoid delay on these projects. As soon as rising costs become a consideration on a project, it should be discussed and a suitable arrangement agreed and documented to facilitate continued progress on the project.
If you wish to discuss any of the issues raised or if you require guidance, please contact Michael Hanley mhanley@hayes-solicitors.ie or Danny Heffernan dheffernan@hayes-solicitors.ie from the Banking and Financial Services team.
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