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What are we doing about rising costs?

Andy Gray - Avamore Capital
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26th April 2022
Andy Gray Avamore new
"We can expect to see more developers facing cost overruns with their original contingency funds not being enough to cover rising prices."

By the end of 2021 costs had reached a 40 year high based on the annual growth of the BCIS Materials Cost Index and since then they have continued to escalate.

This staggering change is being driven by three core factors. Over the past few years, material costs have been increasing through on-going supply issues; on top of that we have seen interest rate hikes across the board which is inflating the cost of goods; and further to this, the steep increase in energy prices due to supply and demand on the wholesale market is pushing up costs for developers further.

Right now, developers are weathering a high-cost storm which shows no sign of slowing. Increasing build costs mean that a project in today’s markets is more expensive to undertake than it was this time last year; we will see higher market build costs reported in Monitoring Surveyors’ reports which funders base their lending decisions on. As a consequence, profits in the overall capital stack are being reduced, LTCs are reaching their peak quicker and clients are having to put more cash in Day 1. For some, this combination of factors may mean that schemes are no longer viable.

There are different challenges when it comes to projects which are in the process of being built. We can expect to see more developers facing cost overruns with their original contingency funds not being enough to cover rising prices. There are also an increasing number of issues with main contractors who have taken on sites against a fixed price contract and are finding that the cost of materials have increased dramatically against their initial quotes. Not all of these can be renegotiated and so we could see a number of businesses folding mid-way through a scheme rather than operating at a loss. For the developer, that means spending time finding a new main contractor and undoubtedly reaching a new agreement at a higher price.

If developers stop developing the whole market will suffer and so, we have a shared responsibility to think creatively to move through this. At Avamore, we are the pioneers of Part-Complete Development funding; that means we are well placed to step into a project part-way through the build. We have a ‘golden brick policy’ so if it there is just one brick down, we can still fund 100% of the remaining works; it’s customer centric thinking like this that means the broker will be able to deliver relevant solution driven funding to their customers.

Depending on how the situation progresses, we may find that across the board, lenders have to consider how they are assessing deals and whether their historic expectations still seem reasonable. Due to rising costs, the once acceptable 5% contingency is now considered foolish, with many pushing for a new minimum of 10% or 15% built in on top of the construction costs and professional fees. This is a sensible approach to take but we may find that the once expected 20% profit on cost is no longer feasible and so needs to come down.

Another option could be to consider the monies clients have likely already spent to date when a deal comes in. Site preparation, planning and enhanced planning costs in addition to upfront professional fees are all items that could be used to offset the Loan to Cost calculation at the outset which would alleviate some of the challenges we are seeing emerging. These considerations must be approached with caution however, lenders cannot simply disregard former policy and are beholden to funding line requirements so it’s not necessarily an easy adjustment to make.

Regardless, Joe Martin, a BCIS Lead Consultant commented that “pressure on material prices and availability [is] expected to continue at least until the end of 2022”. Inevitably this will mean greater reliance on lenders that can think creatively, be flexible in their approach and remain prudent in assessing the viability of schemes.

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