_Procurement - a two-tier market

Some residential developers paused for breath during 2016, helping to ease constraints on contractors’ delivery capacity – at least in the market for relatively straightforward projects with a construction value of up to £50m. Capacity and capability to deliver these projects is broad and the risks associated with delivery tend to be manageable. Competition in this tranche of the market has intensified and contractors’ price position has softened.

The market for large, complex, residential projects remains busy. Delivery capacity is limited to a small proportion of teams within a handful of organisations. Risks associated with delivering these schemes are numerous and wide-ranging.

With capacity returning more slowly, and exchange rate volatility, raw materials price inflation and shortages of skilled labour driving up the cost of building, contractors’ tender prices for major schemes continue to rise. A two tier market has emerged.

Responses to a recent contractor survey carried out by Core Five demonstrate that, generally, changes in input costs feeding into the construction process are only a small consideration in contractors’ pricing decisions. In addition, pricing decisions take account of risk, relationships and broader market conditions.

Procurement route

Research by Core Five highlighted that two stage design and build tends to be the most common procurement approach on residential projects, particularly for larger and more complex projects. For lower value, more straightforward projects we are seeing a resurgence
of single stage tendering, allowing effective risk transfer. For this to be a success it typically requires a robust set of design information, and careful pre-qualification / warm-up process to ensure that appropriate contractors are selected.

Exchange rates

Up to 35% of the total construction cost of a high end residential development is at risk of being exposed to exchange rate fluctuations. Facades and MEP equipment are typically sourced from Europe, in addition to high end fixtures, fittings and furnishings. Our analysis suggest that a 10% movement in Sterling can often move a scheme’s construction cost by between 2% and 4%. The fit out element of a project will typically be exposed to greater currency risk than the shell of a building.

Exchange rate risk can be managed in many different ways. Domestic sourcing, where viable, is desirable, although it is important to understand the capacity and capability of the domestic supply chain. Building in maximum flexibility, empowering a contractor to select the most appropriate option at the appropriate time, can often prove beneficial but careful drafting of design criteria is vital.

The desire to transfer this risk to the contractor, at the earliest opportunity, can be strong but this can be a false economy. Attempts to unfairly transfer unmanageable risks are often subject to punitive pricing.

Read the London Development Design Study in full for more analysis