Active Asset Management – Navigating the Challenging Construction Backdrop
How Lenders Respond When a Project Goes Wrong is Critical.22 August 2023
By George Craven, Senior Construction and Development Adviser at Hilltop Credit Partners
When a project goes wrong, no matter the size, sector or economic conditions, it’s worth remembering that it did start out right, and what went wrong is never usually driven by one single factor. It is generally a combination of factors.
Those factors will be nuanced by the project, but it is what do we do about it as lenders, and as sponsors, to restrict lost time and increased cost, that matters. The difficult macroeconomic backdrop of the past couple of years has meant that projects across the real estate sector have faced challenges. Last year in Spain for example, 40% of construction companies cancelled or delayed work due to the rise in cost of raw materials.
Often there is a wait-and-see approach, which can mean that no one wants to know the answer as that would mean accepting responsibility. In many cases there is a “let’s blame everyone” approach. Whilst that may feel fine for a while, it doesn’t help in fixing anything.
A better approach might be summarised as "active asset management”. When a project goes wrong and it is in construction, wherever possible our advice has been to keep a main contractor in place (if there is one), and to work in partnership with them to get through the issues.
Losing a main contractor has cost and time implications which are more than likely going to wipe out profit, and the unintended consequences of losing a contractor can be far-reaching.
Where a main contractor has gone into liquidation and there is no option but to step in, rather than immediately seeking a replacement main contractor, you should consider an interim construction management approach. This can provide security for the subcontractors and save time in the longer term. While the CM approach is functioning, that will provide breathing space to procure a main contractor who can pick up the reins if appropriate. If the project is close to completion, then a CM approach can see it out to Practical Completion.
Having worked and delivered thousands of residential units across multiple European jurisdictions, the challenges across those jurisdictions have been similar over the past few years, and going forward the challenges remain similar: lack of experienced labour force and globalisation of supply chain.
A recent European Commission survey revealed that a quarter of the EU contractors cite availability of sufficient labour as problematic. In the UK, the number of vacancies in the construction sector was 65% higher in the three months to January 2023 compared with immediately before the pandemic.
With these issues having been compounded by COVID, we have seen a marked increase in construction companies going into liquidation. In the UK alone 42 construction-sector companies entered administration in May, a record, while in France, construction business failures have risen by 40% year-on-year.
You must change your approach to align with the realities of today and the intricacies of the market. On supply chains, encouraging local teams to procure as locally as possible will not only help meet CSR targets and provide environmental benefits; it will also reduce development risk. It is also important to promote an overarching belief that all parties to a project must be given the opportunity to make money, this way longer term partnerships can be built, and pipeline projects can be delivered quicker and more efficiently.
A 2022 report by risk mitigation and dispute resolution consultancy HKAA found that building projects were the most susceptible to over-run versus other sectors. Where cost over-runs are the issue and that has led to a lack of debt and equity to complete the project, then often the first ask is for more cash to complete. Active asset management can run financial due diligence by looking at all options to complete without the need to throw more money at it.
There are numerous ways to achieve this, and successful outcomes can be achieved through reassessment of the planned exit. Recent solutions both in the UK and mainland Europe have included involving the main contractor, providing contractor funding against completed units or stopping and selling as is, or in phases, essentially recycling the income.
The unprecedented macro volatility has required businesses of all shapes and sizes to adapt. Challenging all assumptions can pay dividends, but it needs to be done with a positive mindset and not one which is solely concerned with recovery. There is no reward in seeking to snatch defeat from the jaws of defeat.