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Residential market shifts put focus on project failures

Unpredictable prices, project failures and barriers to entry are exposing the structural shortcomings of a sector that must look to new ways of working and collaborating.

Fresh from the surprise election outcome, the residential property and construction sectors have been re-evaluating the outlook for the coming year.

Although there is consensus that a majority government is positive for the industry, some major challenges remain ahead.

One of the most apparent by-products of the buoyant residential sector, especially in London, has been a dysfunctional tendering market.

Main contractors and subcontractors are overrun with work, while construction prices - no longer being driven by material and labour costs but by opportunism and behavioural factors - have rebounded.

Predicting prices has become near-impossible in some parts of the market. This is a dangerous position and exposes the industry’s capacity shortcomings.

An even more worrying issue is the increasingly poor outcome delivered for clients. We are seeing high levels of project failures - poorly co-ordinated design, poor management, programme overruns and materials/workmanship quality issues.

The risk of poor initial planning and design can no longer be transferred down the supply chain - and for good reason. This is not about blame but about recognising the symptoms of a deep, capacity-led structural failure in the industry.

Forced project deferrals

The problems show how difficult residential is to deliver. The reality is that if build costs keep on increasing, new work fails to secure interest and we continue to see delivery failure, many clients will consider deferring projects and wait for the market to cool. Indeed, many are now being forced to do so due to deteriorating viability.

This is no longer just a London problem; regional hotspots, such as Birmingham and Manchester, are starting to exhaust capacity.

Supply chain insolvencies are also rising. Cashflow failures, problem projects and lack of control over the supply chain due to a casualised workforce are becoming more prevalent.

This further reduces certainty of delivery just as the development industry is being asked to pay a premium to build.

Private housing starts volume and quarterly change_DCLG

Source: DCLG

Clients are desperate for added value from those closest to the supply chain. The challenge is to find the real price of something, not just the price that day from a particular contractor or supplier.

What is damaging some longer-term relationships is blatant opportunism and, in some instances, more contrived activity within supply chains.

This should prompt reflection on the route to a decent margin: total openness at day one or cloak and dagger margin expansion downstream.

Cycles and constraints

There is lots of talk among clients of a return to construction management, rather than the negotiated or two-stage lump-sum procurement now being used, to drive better transparency.

But this is tempered by the realisation that there are very few capable residential specialists in this market. The ultimate constraint is appropriate resource with the right mindset and incentivisation to make a difference.

All of the above represents a sad reflection of our industry’s cyclicality: immense pain in a downturn then overcorrection in an upturn, with ever-reducing capacity creating volatility.

“We are seeing high levels of project failures - poorly co-ordinated design, poor management and overruns”

One solution may be new entrants to the market, but this continues to prove elusive. Unlike the real estate and investment sectors, where new overseas players have arrived, construction has more significant barriers to entry that deter many global construction firms.

Although some fit-out specialists from mainland Europe are starting to eye the UK market, this is unlikely to be the longer-term panacea.

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Recruitment initiatives, though crucial, are also likely to continue falling short; they certainly won’t help in the immediate term.

Surely, then, this is the justification - once and for all - for the industry to embrace a different way of delivering that is less dependent on a site-based workforce, and with increased technology and automation driving extra capacity.

We need to reduce reliance on traditional approaches but also boost productivity and efficiency.

Investment and funding

The cyclicality of construction is tied to the real-estate market cycle. The days of large public sector-funded social housing schemes are gone and there is no real demand buffer for the industry to incentivise investment in training and innovation.

There is often a feeling that we need to ‘make hay while the sun shines’, as it’s just a matter of time before another downturn.

With a housing sector dominated by the for-sale market, this model could be difficult to break out of.

Even the registered provider sector, now reliant on cross-subsidy to fund core social housing, is susceptible to a sale-market downturn, the next of which could decimate housebuilding.

What the industry and our housing market needs is a more diverse building programme spread across all tenures and funded by more than just short-term finance models.

This is the challenge for our real-estate industry to embrace, and one that could start to change the industry’s shape and capacity.

Private housing completions volume and quarterly change_DCLG

Source: DCLG

The institutionally backed, professionally managed build-to-rent sector is critical here, as the funding and philosophy behind it is long term and more counter-cyclical than the for-sale sector.

Its additionality of funding creates the biggest opportunity for a step-change in delivery of new homes, rather than just recycling and repackaging existing debt and equity in the market.

Construction needs to get involved in this sector, as it will create routes to 10, 20 and 30-year investment planning, with large-scale new-build portfolios being the aim. In turn, it could help the industry finally unshackle investment and innovation into offsite construction.

Partnership future

Alliances between innovative supply chain partners, institutional funds and professional management firms could well be the future of residential growth.

For an example of the possible future of volume housebuilding, look at the recent announcement regarding Legal & General, Laing O’Rourke and Touchstone building rental homes for councils.

The coming together of institutionally backed build-to-rent and the offsite construction sectors is crucial to the fortunes of residential delivery.

However, there are structural barriers to this happening at the scale required.

Many of these relate to policy-making and implementation at both central and local government level.

“Developers and investors need to know their planning position when acquiring land, not afterwards”

One of the biggest issues is the inability of build-to-rent developers/investors to access land where they compete against conventional developers that can residualise more land value using a different financial model.

Although most agree a new planning use class is not the answer, there is an opportunity for planning policy and guidance to be much more forthright in how it influences planning officers in terms of for-sale and build-to-rent.

Developers and investors need to know their planning position when acquiring land, not afterwards. This is inhibiting build-to-rent and needs urgent government attention to open the floodgates and create long-term construction demand.

Similarly, we need more incentives to promote innovation and investment. Government grant schemes, such as the Advanced Manufacturing Supply Chain Initiative, need additional funding to make them effective and relevant.

The industry needs some carrots - sticks alone won’t work.

Globally geared

The end-user market presents risk and opportunities. The London market is now highly geared to foreign investors, a trend that is moving to lower-value mainstream areas as rental yields and potential value growth compress.

There is a real risk of oversupply in some parts of London amid softening demand for certain locations, especially from some parts of Asia.

This will start to crystallise over the next 12 to 24 months. Contractors need to be aware of some developers’ dependency on the pre-sales model, and the phasing of major projects aims to stop or slow projects in response to changing demand. This could have a huge impact on order books, especially if contracted work has stop-points inserted.

Some of London’s new high-rise residential buildings are at risk of delay by any fall in sentiment, as the lack of phaseability with towers gives a higher risk profile. Many are being developed in preconstruction phase and this could create an illusion of workload that fails to materialise.

Schemes outside central London will increasingly benefit from local owner-occupier demand and investor buy-to-let purchases.

The latter is perhaps the biggest competitor to the institutional large-scale investor model, as it will continue to underpin the prices paid by housebuilders in competition for build-to-rent developers.

The common theme, however, remains housing for rent, not owner-occupation, which is at the heart of the structural shift in the market.

The next 12 to 24 months will present a crossroads for residential investment and development in the UK. We either continue with short-term business-as-usual, or we make the step-change that will benefit all in the long run.

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