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With interest rates still way in excess of the pre 2021 rates and highly unlikely to return to those record lows, the costs of funding construction projects continue to increase. So, it’s perhaps unsurprising that developers are adopting a more cautious approach when reviewing the viability of their projects.
Ben Cussons, Business Advisory Partner, shares his thoughts on some of the approaches and the impact and risks of low balling to win work.
Back when interest rates were at record lows, the costs to have many projects running at once were low enough that it wouldn’t be uncommon to be highly geared to finance working capital.
So now, one of the strategies being commonly adopted is to rationalise the number of projects on the go at any one time, limiting the amount of finance required to fund the developments.
With development finance commonly being quoted with a rate of 10% or higher there is a considerable saving to be had by not borrowing as much and being more methodical with the approach.
This desire to not have huge sums of money tied up in developments – which in some areas are seeing a reduction in demand as residential properties are deemed unaffordable because of mortgage affordability issues – is no doubt increasing.
More and more developers are waiting for a commitment from a purchaser for a new build before they complete the internal fit out. Which in turn means that work available for those sub-contractors who depend on this flow of work to earn a living is increasingly volatile.
Additionally, commercial developments are being considered for viability to a much higher level, not unsurprising given the new hybrid working world and the subsequent reduction in demand for office space, further reducing the work put out to tender.
So, is Low Balling a good approach?
With work out to tender being on the decline, it’s not a surprise that we’re seeing more contractors and sub-contractors low balling on tenders to win work and fill the order book.
But with so little room for manoeuvre within the scope of works and profit margin, it’s very feasible that unexpected delays and costs can quickly eat into profit. And without realising it the lucrative project, albeit on tight margins, can suddenly turn loss making and a significant drain on cash.
When this occurs it’s quite often the case that the contractor awarded the work will then begin to “borrow” from the next or another project to get this over the line to completion. This in turn compromises future projects and, if not addressed, can very quickly see what was once a successful and profitable company get into financial troubles on the back of one bad project.
Not only does this all come with significant risk to the sub-contractor who has secured the work, there is also a greater risk that the contract defaults and the body awarding the contract will need to reissue making them also vulnerable to increased costs.
What to consider when bidding on new contracts
It’s first and foremost important that when bidding on contracts, businesses do not tender and aim to win projects with so little margin. Or if margin is tight, as a minimum, businesses must make sure that variations clauses are sufficiently ironed out against unknown delays or cost increases.
It is then of even greater importance that the businesses awarding and awarded the contract has robust financial reporting procedures in place, and that they undertake regular reviews of project performance to identify any issues as soon as possible so they can have the opportunity to react accordingly.
Because without having regular oversight of the financials, quite often when the issue comes to light it’s already too late.
For further discussions regarding your financial reporting procedures please get in touch with Ben or one of our Property & Construction team specialists by calling 0330 058 6559 or emailing hello@scruttonbland.co.uk
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