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Time for a stand-off or some constructive market disruption?

Fears over spiralling construction costs have been growing for a while among developers and investors.

This is particularly true in the residential sector where the supply chain has perhaps struggled more than other areas to appreciate the rising levels of delivery risk and effort required to undertake such schemes compared with many commercial projects, for instance.

This feeling of extra risk, the impact of legacy contracts still hurting the bottom line of many contractors and the ongoing industry capacity constraints have now created a perfect storm that will start to play out in 2016, but perhaps not be felt in construction for a while yet.

There is now a disconnect between the supply chain feeling busy backed by a well-established order book and the true sentiment in the real estate market, which is increasingly seeing signs of demand-led frailty and macro-economic turbulence.

There is always a lag between property cycles and levels of pricing, but we face the prospect of property and construction being more ‘out of sync’ and the risk of a hiatus in new work being conventionally commissioned.

Across the sector

In the large-scale residential for-sale market, where the impact of fiscal measures is already being felt in reduced off plan demand from private investors, this is likely to be more of an issue. But even in the build-to-rent market where, despite healthy rental demand, the viability model has its own different dynamics, construction costs are now becoming a dominant part of the equation.

High-rise developments where there are no ‘break points’ in phasing construction commitment will be particularly in the firing line.

“There is now a disconnect between the supply chain feeling busy and having a well-established forward order book and the reality of the current sentiment in the real estate market”

The tensions in the market are seen on both sides of the fence, with recent well-publicised examples of contractors walking away from advanced contract and price negotiations as well as clients reviewing their procurement strategy and parting company with contractors.

The response to these conditions by developers, investors and the supply chain alike will vary depending on lots of factors.

One thing’s for sure: it doesn’t make sense at the moment for clients to try to force the issue with the supply chain under the guise of lump-sum contracting, whether it be single-stage, two-stage or negotiated, and end up with a price that is no longer representative of the true net cost of construction.

There is also an unwillingness from the supply chain to forward-fix inflation risk due to recent historic trends, while many clients are now expecting static pricing or in some instances deflation in the future so do not want to buy at the top of the market.

This is a recipe for an increasingly unhealthy stand-off!

Recipe for…

Forget the numerous cost consultant predictions of ‘x per cent inflation for the next y years’; we are in a different space where market sentiment will dictate as never before the pace and direction of movement in construction prices. Skills constraints are now largely priced in and if they are not, they will be unaffordable going forward so are irrelevant.

This a time for us all to embrace some market disruption and to try to build additional capacity that will serve the entire industry better in the future.

“We are in a different space where market sentiment will dictate as never before the pace and direction of movement in construction prices”

Those clients with patient funding, long-term investment plans and a willingness to be innovators have the ability to cultivate and nurture a new sector that relies more on a different supply chain, promotes offsite working and draws on hi-tech manufacturing methodology, not a boom and bust skills constrained one.

Maybe one day we will get to a point where the role of a contractor changes more to one of offsite/onsite construction integration, where traditional construction and advanced manufacturing co-exist, resulting in more stable prices, more certainty of quality and programme and no one losing out in the long run.

It is clear that these issues will run and run, but I for one want to be harnessing the opportunity for the good of the industry not sitting on the sidelines accepting that this is how construction has always worked and always will.

Mark Farmer is the chief executive of Cast Real Estate & Construction Consultancy

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