Welcome to the supplement as we head towards one of the most important Bank of England Monetary Policy Committee rate-setting meetings of recent times. This isn’t being talked about just yet – and it might be nothing – but my numbers are 30% that the rate goes up 0.5% this week to 1.5%, and 68% that it goes up 0.25%. I have “no rate rise” at 1/50, 2% chance. I’m not laying bets, to be clear – just sharing my probabilities.
Why so important? Well, 0.5% is a clear admission of failure and also a precursor to bigger and longer rises. The bond yields will go through the roof in comparison. At my glance, the markets see 0.5% as much less likely than I do – and I still see 0.25% as more than twice as likely, as the numbers show. So what? Well, I will say one thing I’ve said for months now but with an even more short time window to it – FIX YOUR FLOATING DEBT, WHERE POSSIBLE, BEFORE THURSDAY 16TH JUNE. This is a no-brainer, a free bet, an arbitrage, a world-class play. Get your brokers to get those applications in before that date and secure the rates for you. Thank me later, or berate me at your leisure.
So next week will be the time to take a closer look at that, and also next week’s stock market performance, after the week we’ve just had ended in a very cold shower for the S&P 500 and the Nasdaq. The FTSE was 7600 early in the week, pretending like all was fine, and has taken a near-300 point haircut by the end of trading yesterday. The FTSE’s c.15% gain last year was nothing compared to c. 45% for the S&P, but there’s still points to be lost rather than gained this year. Most will be out the woodwork now, calling this a bear market. The old “sell in May and go away” looks to have offered a bit, once again, and as we get into slow news/silly season, news is rarely positive for stocks.
That’s where the rest of the investing world has been focusing this week, and my idea of where they SHOULD be focusing. Debt is back, as a driver of transactions, whether we recognise it or not just yet. This will drive some motivated stock back somewhere towards old levels, over some time. How long? Can’t tell you, sorry – but it’s back and it’s bigger and nastier than before.
This week however I wanted to put the spotlight on pressure, once again, but in a project-specific context. I presented this week as the warm-up to an amazing presentation from Paul Bridge, CEO of Social Housing at Civitas Investment Management, and spoke about a self-build project that I’d carried out, which ran into the pandemic and all of those challenges. That sparked some really good conversations afterwards, as always, and I wanted to collect some of those thoughts so that readers and listeners could hopefully benefit from them. There was also an excellent presentation by Mike Bristow, CEO of CrowdProperty, who gave some fantastic insights into some of the commodity pressures driving price increases in the sector, which gave me more food for thought, so I’m grateful!
Firstly, let me address the macroeconomic situation overall. Not in the highest level terms as I have at the beginning of this article, or in the continual barrage of information around inflation that I’ve been offering up for the past 18 months or so; but in direct relevance to the construction sector.
Commodities are difficult beasts to predict in terms of their pricing. This is exactly why the derivatives markets exist. For example, no-one really knew (aside from the metals traders) that Russia produces 42% of the world’s Palladium, and you might have heard about the lawsuit from the American hedge fund that is trying to sue the London Metals Exchange for closing trading in Nickel pricing when the incursion into Ukraine was in full swing. (Nickel and Palladium are heavily interrelated and share many of the same qualities, Nickel is far cheaper in the usual world, but there was a substitution effect that the traders were gambling on).
For those outside of their comfort zone here – just let me say that derivatives are called derivatives because their pricing derives from the price of an underlying asset, and remind you that derivatives are by far the largest market in the world – $1 quadrillion in notional value, although that’s not entirely accurate at all (gross positions are a better proxy, because often derivatives are being used as insurance – you could have a £1m share portfolio and notional value of derivatives of £1m to protect you from downside risk, and the gross value of the derivative position would be zero) – they are best understood as hedges, although they allow for huge amounts of speculation.
When the derivatives markets (specifically futures and options) get it wrong in the event of a critical event – e.g. a pandemic – and, more importantly, the underlying suppliers and producers get it wrong – shutting down timber mills left right and centre in a period where demand for timber actually ended up going upwards, rather than crashing to a halt as predicted – it can take years for the effects to work through. Often, mills, mines, and the like are closed for a “season” or a year – and then in a situation like post-2020, you are playing catchup in a way you can’t just flick a switch and make up for the excess demand. Also, from a commercial perspective, you might not want to – better to sell 100 million tonnes at 60% margin than 500 million tonnes at an 8% margin, for example – and that’s business.
What’s the upshot of this been? Huge inflation specific to certain types of building materials specifically – wood and steel are two that will be widely known about to readers and listeners here. How do you control it, more importantly? Well, the point is that you can’t directly control it, but what you do need to to is review all procurement processes, shop around, look at entrepreneurial solutions such as reclaiming, and be willing to call 10 suppliers rather than the one builders’ merchants you might be a regular customer of. Negotiate, and deal-make.
Some have also resorted to stockpiling as the “just-in-time” model (not just in construction) has fallen over. Different outcomes from this – security risks, cashflow issues, lender comfort on these sorts of ideas – perhaps increasing cash required up front, and thus suppressing leveraged returns.
Substitution and the skills and ability to manage this is another option. Not everything that is usually wood needs to be wood. That is often forgotten. There are alternatives that used to be faster but more expensive that are now faster and cheaper, potentially. This comes down to working with the right people who are upskilling themselves on modern methods of construction, rather than doing it the same way they’ve done it for the past 30 years.
This sector inflation isn’t just materials though, of course. As usual, Murphy’s law has kicked in, and whilst there’s a generational rise in materials, there’s also an extreme spike in labour prices. We could get into a “Brexit vs Covid” debate here, which I’m keen to avoid, but suffice to say that you can look around the world and see the challenges that global labour markets are facing as the extra long-term sickness thanks to Covid, the early retirement thanks to life reframing during Covid, and the upskilling/remaining in training thanks to Covid have kicked in pretty much globally. Construction has been no different and we are near 50,000 vacancies (27k was the number Dec 2019 – Feb 2020). The highest ever before the pandemic was 32k. I’d say Brexit hasn’t helped, it isn’t clear looking at the international figures as comparables just how far it has hindered.
Labour inflation is harder to contain and manage. If you’ve been in this game some time, you may well be leaning quite hard on relationships. If you are new to it, you might want to understand exactly who is a lifer/their length of service on a crew, versus how many subbies there are, before you start taking a job on. This really is one of the toughest parts of the equation – but it is safe to say at the moment that those who are cheap and available are likely there for a reason, and that reason won’t make a great or positive impact on your project. Fix prices, close to the start date of the job, protect yourselves with your payment milestones, and go from there – or contract with larger firms if your jobs justify that level of contract.
If we drill down one further level – from issues that are affecting every project appraisal at the moment, to issues that may or may not be affecting a project – then we might be looking at problems such as party wall issues, where either ignorance, or occasionally gamesmanship, can backfire quite easily, blow up and in the worst case scenarios end in injunctions. This is a classic example of needing to educate yourself on exactly what’s required on excavations, and being respectful and building a working relationship with neighbours.
Specification changes can also be an issue – sometimes at the moment they are driven by the external environment, simply because certain materials are not available; sometimes, they are driven by not spending enough time in the design phase of a refurb. The words that ring true in my head are that changes in practice can cost 10 times what they cost in design, and fixing those changes after the job has finished or retrofitting can cost up to 10 times as much again. This might be an oversimplification but is not much of an exaggeration, and proves the need, and the rewards that can be reaped, by getting the design right in the first place.
This generally splits down into two major areas – one, how the property will operate in reality when it is delivered – the “flow”, as built. The other is the technical specification side – will you achieve that EPC with what you are intending to do, for example? Is that internal box gutter really the only way to achieve the rainwater management on that side extension, and how will you monitor the performance/blockages on such a system?
This leaves out those who cannot make their mind up, which is a dangerous thing when it comes to property development and improvement! We’ve seen projects that we’ve managed for others where the client has been read the absolute riot act on this fact up front, and still changes things throughout – overspends and time delays become absolutely guaranteed.
The above can also affect the relationship with the main contractor – and this is critical. There’s a very symbiotic relationship that has to develop throughout a project – often, as above, margins are slim and the contractor is relying on timely payment to cascade that money down through the team and any subcontractors that are being used. Likewise, once the MC is on the job, it is one thing to have the contract, but in the ideal world you will not be relying on enforcing it – if you get to enforcement, then that’s the surest sign that things have gone wrong. All the skills on both sides should be being used to ensure that doesn’t happen, and, as so often, the features that are helpful in enjoying that stage include significant and suitable detail on the schedule of works, in all documentation in fact, including the contract – and, of course, like in any relationship – communication. That should be two-way and transparent. This isn’t just for the main contractor of course, but for any key trades within the project.
We can then drill down one more level to the one thing that you can control (that doesn’t make it easy, of course) within a project – you. There will be pressures, and managing them well is absolutely key. For example – there are often pressures brought about by poor organisation, or lack of organisation. Messy sites often lead to messy minds. That is a key factor. If you aren’t extremely well organised by personality, or can’t become extremely well organised – no particular issue, but you need to delegate to someone who is.
There are then data quality, or systems issues – how does the reporting work? Who is doing valuations to work out what percentage of work has been done, on larger jobs, where some of the milestones can be broken down, and often are asked to be broken down, for payment? How does the whole site operate? When you’ve handed over, it doesn’t just become a case of becoming the QS and making sure invoices are paid in a timely fashion (unfortunately) – you need to ensure you are also protecting your interests.
Then, of course, there are often financial issues that crawl out of the woodwork, or – more likely on bigger jobs – the groundwork. The one factor I’ve seen lead to crippling contingencies and delays over the years is groundwork related – and this is hard, because investigations simply won’t uncover everything up front. We can often be dealing with drainage, ground quality/piling, particular pockets of soil quality and lack thereof – and much more complex issues than this depending on what part of the UK you might be operating in. Contextualising – and having someone to go to, for decent quality advice or consultancy, can get you through these, although you are inevitably accessing contingency funds as well. Quality relationships with your lenders – rather than going through box-ticking exercises to ensure you get what looks like the lowest rate – are the way forward here, that’s where the commodity of money becomes branded, in a way – a great lender at 0.1% a month more than the cheapest in the market is worth 10 times that in the event of a problem; it is similar to an insurance policy.
Then, there’s the last one – that was addressed several weeks ago in the supplement – personal pressure. Sometimes you can be driving yourself too hard, or making unreasonable demands. Ensuring that you are not overly hard on yourself is important. Likewise – starting with yourself is also key. As above, it is the only thing you can truly control – yourself, and your reactions. How do you improve? How could you have set things up in a better way in the first place? After all of that – how do you get to the goal in this one particular project, because once that symbiotic relationship with the contractor has been started, changing lanes really is a last ditch/worst case scenario – one reason why, like many other things in life, you need to be very careful before embarking into such an important relationship!
You could call these the musings of a madman – or simply a braindump of several hundred refurb projects – but this is the summary of my nuggets on my least favourite part of the entire value chain; one that it is absolutely critical to try and get “right”. Fear not, I definitely do NOT get it right every time! Like so often, it is how you react when something goes wrong/badly.
Until next week – keep calm and get those projects started, keep them ticking over, and get them over the line!