Price-chipping and inflation risk: the development issues slowing projects for RPs

Price-chipping

Another recent phenomenon is price-chipping – where developers are demanding more money for a site before exchange of contracts or, on the contrary, RPs are having to re-evaluate their offers before exchange.

The reason for this on the developer side is largely driven by the rising costs of materials, while RPs are facing their own financial pressures.

Not only has the cost of borrowing risen exponentially in recent months but, where there are a high proportion of shared ownership units, RPs need to effectively manage that sales risk and make more conservative projections in a turbulent market.

It generally takes three to four months from agreeing heads of terms to exchanging contracts.

In the current climate, we are seeing the market change rapidly during this short period. Increasingly, developers feel they are left with no choice but to ask RPs to increase their bids for sites or face losing them.

Often RPs are walking away from deals, allowing the site to be sold to another provider for a higher price.

What can RPs do to mitigate the risk? The importance of stress-testing the performance of assets cannot be overstated. Will the asset still perform under tougher market conditions? Numerous factors come into play, but RPs need to consider the impact of economics: inflation, interest rates and access to funding; a change in government policy and specific business risks such as voids, declining sales and the cost of remedial works.

Due to these pressures, we are seeing a slowdown of developments across the board and an increase in large-scale stock rationalisation. Approximately one in four deals are suffering some form of price-chipping, price negotiation or are being aborted altogether. RPs still have housing targets to meet and we predict more and more will turn to strategic land opportunities to fulfil those targets.

Contractor insolvency

When a recession is on the horizon, a further concern high on the agenda of all RP development teams will be contractor insolvency. There was an increase of 25 per cent in construction industry insolvencies in the past year and this high level shows no sign of abating due to the current financial constraints.

To mitigate against this risk, RPs need to carry out financial checks on contractors prior to entering into contracts, but these can only provide limited information. Remember that financial figures available on Companies House are outdated as companies are generally obliged to file accounts one year after the end of its financial year.

Another option to consider is what security an RP can obtain from the outset: this can be by way of parent company guarantee if a contractor is part of a larger group of companies, or by way of a performance bond which is an insurance-backed guarantee which compensates the RP in case of contractor insolvency.

Unsurprisingly, the cost of bonds is currently high and this will need to be factored into overall project costs.

As always, RPs ought to ensure they have warranties in place with key designers and sub-contractors and consider including step-in rights in those warranties. Step-in rights allow a developer or RP to step in and take over the sub-contract if a contractor goes insolvent.

The turbulent economic picture has undoubtedly meant a downturn in traditional developments and resulted in much soul-searching by RPs over whether once viable opportunities are still worth pursuing. With there being no sign of inflation settling anytime soon, RPs will have to continue assessing each development on a case-by-case basis to ensure it is worth the financial risk.

Triya Maicha, partner, Devonshires