Richard Winson, director at Naismiths Analytics, Naismiths, says that data-led approaches based on reliable historical financial data and market insights can provide some level of stability in a challenging market
With developers, contractors and funders becoming more risk-averse in response to tougher construction market conditions, data-led approaches will be crucial to provide assurances.
Over the last few years, the construction industry has taken quite the battering from a number of external factors.
The period from the initial coronavirus lockdowns in early 2020 to last year’s battle with spiralling inflation rates has been a turbulent time for major development projects, and while there is some light at the end of the tunnel, significant challenges lay ahead in 2024.
While the cost inflation that plagued construction projects for the last couple of years has slowed and prices have stabilised, interest rates remain stubbornly high.
This not only adds increased costs to the financing of schemes but also affects their viability – who wants to be building houses, for example, when people can’t afford to get a mortgage?
It is against this backdrop that funders have to make decisions, and data-led approaches will play a key role in helping them on this treacherous path.
Emerging challenges in the construction landscape
Consider a five-year regeneration project that started in late 2019.
The investors and financiers behind the project will have made their decisions for backing it based on prices that will have been reflective of the market at the time.
However, this recent four-year block of external challenges – coupled with the “normal” cost inflation that is expected over longer-term projects – means that those forecasts could now be seriously flawed.
This is a growing problem for consultancies that are acting as the eyes and ears of the investors, who are increasingly looking at ways in which more data-led approaches can be taken to financial forecasting and bring about a long overdue move to the digital age.
The biggest challenge when it comes to financial forecasting for construction schemes – particularly those that have a larger gross development value and are, therefore, more attractive to funders – is that they are, by their very nature, long-term projects.
Ignoring the extreme challenges that have been prevalent over the past couple of years, short-term issues can generally be mitigated by taking a flexible and collaborative approach with the contractor and supply chain.
However, the peaks and troughs of the business and economic climate are much more pronounced on projects that can take multiple years to complete and – in turn – bring return on investment for funders.
There are a multitude of factors at play in this equation, but typically it boils down to having a budget that works for the build programme, and vice versa. The volatility of the current economic climate means that investors are finding themselves in a bit of a bind with the rate of inflation.
Add into that the fact that there will be a general election in the next 12 months – and the various manifesto promises around building more homes and green infrastructure it will inevitably bring – and it presents a real “stick or twist” scenario for investors.
If they do decide to proceed, then the build programme needs to work in lockstep with the budgetary approach. The challenge on this front is that the construction industry has been hit especially hard by the above issues within the economy, all of which have created a knock-on effect that has had a major impact on contractors in particular.
It is often said that there is a lag from when an economic downturn hits and the impact on contractors, and the worrying trend of major contactors going under – something that we saw with the likes of Henry Construction Projects, Buckingham Group and Tolent in 2023 – may continue for some time yet.
A giant obstacle course
Typically, the most successful property developers are those who can replicate a tried and tested formula.
Take a housing developer, for example – they will usually have an optimal size for the plot of land they are buying, upon which they will build a consistent number of homes at a broadly similar cost, which they can subsequently sell at a known unit price.
This cookie-cutter approach tends to serve these developers well, as they will be basing it on the ‘known knowns’ – the format that has worked previously for them.
However, if this developer is looking at broadening their approach and taking on a different kind of project, they will have less of an idea of these parameters, and their data won’t be sufficient to make informed decisions that safeguard the project.
Property development is very much like a giant obstacle course – you need to assess the challenges in front of you and have enough knowledge to work out how to navigate them. Without this data, you can’t accurately assess the risk factors.
It is in this kind of instance that having a unified set of data from an external consultant really comes into its own. Having access to this will not only help you understand your position but also give you much fuller insight into contractor capabilities and the level of risk within their supply chain.
Data needs to be versatile to a changing construction industry
In this kind of climate, data can be your biggest asset, but it needs to be versatile enough to adapt to the changing winds of the industry and detailed enough to help those acting on behalf of investors to make informed, calculated decisions.
Traditionally, the role of the monitoring surveyor would involve the preparation of a written report to consider the viability of a project, and then monthly draw-down reports to sanction the loan.
Consultants have historically made assessments of projects and advised clients on potential risks or deficiencies in the business plan, and help quantify and balance them.
However, attitudes are slowly beginning to change. The construction industry doesn’t have the best record when it comes to innovating its processes, but the benefits of digitisation are increasingly becoming clear.
There is a real gap in the market for the proper use of granular data, and by combining historical data from previously completed projects and live information from the market, there is the opportunity for real-time risk metrics to be assessed across a range of projects.
That real-time element means that not only can this be used at the commencement of the project, but can also be easily adapted for use at various stages throughout the build programme.
This can be particularly useful when investors are looking at their options on specific projects, meaning that they can work with consultancies to independently review their viability when market conditions change, whether that be the cost of materials, the availability of labour or the potential end value on completion.
It can also form a key part of recovery plans should the main contractor on the project run into financial difficulties, allowing the investors to essentially run a “lifeboat drill” and simulate what their level of liability is should such an event happen, and how they can mitigate that risk.
In theory, the journey of property development should be a fairly standard process – a developer buys land and invests resources with the idea that the value of the project will increase and bring them a profit.
However, for the reasons we have laid out here, the process is one of multiple moving parts, and a small change in one variable can have a significant impact on the overall profitability or viability of a project.
Having the ability to take a truly granular look at data can slow down those moving parts, support the longevity of a project and help safeguard investments.
By fully exploring the advantages of digital financial forecasting and working with consultants who can deliver it, investors in construction projects can reap the reward of significantly improved cost predictions and – consequently – more favourable funding outcomes.
