For some time, headlines in the construction industry have been dominated by the record number of insolvencies.
The constant news has become the norm which has compounded into a negative sentiment of the industry.
At times, this has led to misinformation and market rumours. Just look at the recent false claims against organisations such as Richard Crookes and their perceived cash-flow challenges, only to be shut down immediately by the owners.
As a result of this common narrative, property owners and developers may have formed a view that projects are less viable with no solutions for challenges such as latent defects which can cause costly disputes.
While it may seem all doom and gloom, what has been missing from the conversation are the high-performing developers who are leading the way through these challenging times and taking decisive action to improve project profitability.
For developers, it’s important to understand what these actions are to help ensure more profitability and maximise the return on investment.
In response to industry feedback, whilst solutions and considerations are commonly explored and discussed at length, the intention of this article is for Lockton to share examples of some of the more unknown solutions which developers are leaning on to survive and thrive amidst these market pressures.
Four actions to position developers for profitability
Protecting your assets with Latent Defect Insurance
Inherent Defects Insurance (IDI), also known as Latent Defects Insurance (LDI) or Decennial Liability Insurance, covers the full reinstatement value of the building for a period of 10-12 years following practical completion to address any associated costs arising out of defects that cause damage and pose an imminent collapse threat.
Given the nature of the cover, insurers will settle a claim before understanding who is responsible for causing the defect. This means the rights of recovery are done at their own expense (not by the building owner or tenant), avoiding lengthy and expensive court battles which may come to no resolution.
It is also worth bearing in mind that the actual cost of IDI/LDI is a cheaper alternative to the Strata Building Bond.
A developer recently had a residential block reach practical completion. After a year and half it came to light that there was severe cracking within the foundation slab and there was inadequate structural support. This put the building at risk of collapse.
Given the significant cost associated with remediating a defect of this nature, the 2% strata bond would not be enough to respond.
Whilst costs can be passed back to the contractor, this is on the assumption they have the balance sheet or appropriate insurance cover to support this. If not, this is a cost which the developer will have to bare.
If an IDI/LDI policy had been arranged, this would have been one less headache the developer would have to worry about.
Exploring alternative ways to finance projects
Credit Wrap Insurance offers developers a financing alternative that enhances their borrowing capacity and allows them to secure larger loans by leveraging this insurance solution.
As lenders are more inclined to lend to borrowers with proven trustworthiness and reliability, this allows the opportunity for projects to be more ambitious.
This offering also allows developers to minimise their upfront capital requirements, freeing up resources for allocation elsewhere and enhancing the overall profit margin of the development.
A client had concerns about putting a lot of upfront capital into one of their developments. The bank was loaning 60% and advised that was the maximum they could do. The client ideally wanted 70% in order for them to maximise their return on capital.
By utilising a Credit Wrap arrangement, an extra 10% of funding was secured, allowing the developer to deploy less capital but also secure a higher return of investment.
Protecting against uninsurable risks
Parametric insurances offer a modern and innovative twist on traditional insurance policies. Rather than the usual scope of assessing the loss or damage incurred from an event, parametric cover pays out a set limit as long as it meets the predefined triggers agreed upon prior to coverage commencing.
A client had disruption to their project due to rain. With no option for insurance coverage, the heavy rainfall caused delays beyond what they had anticipated in the contract.
The client purchased a parametric policy for their next project to cover for weather delays that exceeded the amount in the contract.
With the policy in place, if the excess precipitation event is repeated, they will now receive the full daily insurance limit for those delayed days.
Managing the costs of environmental issues
With greenfield sites becoming increasingly scarce for development, there is a growing shift towards brownfield sites due to their abundance and the value they offer based on their existing condition and characteristics.
These characteristics tend to consist of an unused plot of land which bears the remnants of the previous development and will tend to remain heavily polluted as a result.
Consequently, any rejuvenation projects that go ahead require a commitment which is lengthy in time and significant in costs.
Given the nature of these projects, developers are using Environmental Impairment Liability insurance to provide protection from the potential financial risks associated with pollution or environmental incidents where contamination or environmental damage occurs.
A large contractor in Australia was undertaking a redevelopment of a site. They employed a small landscaper to spread mulch across parts of the land. It was then found a few months later that the mulch had asbestos in it.
As a result, the cost of clean up was $3.2m. Fortunately, as environmental liability insurance had been procured, this cost was covered.
Leading through challenging times
By incorporating these insurance considerations into project development, a developer can minimise risks, enhance financial viability, and maximise return on investment.
To read all of the actions which developers are taking, read our Securing Project Prosperity Guide which is available for download now (located on the right for desktop users and at the bottom for mobile users).