| Down and out in Crunch City
Part-completed projects may still fly if the funder can mitigate losses with a long-term return strategy. John Lombard at Davis Langdon PKS outlines the process
Construction Business Recovery (CBR) is the emerging process of taking distressed projects and moving them forward either to extract a meagre return or at least to limit and manage the loss and damage associated with them.
So far this is a service most likely to be called upon by the banks following the failure of a development company. However it now seems likely that it will expand as a means for developers to avoid the possibility of their otherwise healthy company being dragged under by one or more bad projects.
Typical cases for CBR are those sites which were acquired in the mid ‘00s but were still in early or mid-development by the time the property bubble burst in late 2007. Virtually every town in Ireland has examples of partially completed residential or mixed use developments in this category.
In many cases, the development companies involved have either gone into liquidation or receivership and the funding bank is left holding the keys to multiple overvalued part-built properties.
This trend has led to a virtually total cessation of new development work in Ireland and construction-based consultants such as architects, engineers and surveyors who had geared up to service the demands of the boom (just as had contractors and suppliers) now find themselves rationalising and reducing their capacity to reflect the lack of demand for their services.
One area however where their services and experience will be required is in reviewing the distressed projects which are now emerging from the downturn.
This will require a very specific skill set and will be quite different to the demands of the recent years. One aspect of CBR is that no two projects are the same and there is no single magic formula which can be applied. Each case will require careful and professional assessment in order to create a plan to progress forward.
For consultants, roles are emerging in the areas of assessing and reviewing the condition, completeness, compliance and quality of workmanship on partially completed projects and then drawing up firm action plans to resolve the construction-related issues arising.
Initial assessment
Many commentators in the general media over the past twelve months have suggested that the banks involved in the property development sector were not admitting the extent of their liabilities in this area.
The reality is more likely that there are so many projects in this state of flux that that information simply is not available to hand, regardless of whether the banks wish to make it public or not.
The first task facing the banks is to grasp the nettle and get a true picture of where these projects really are at present.
Regardless of what is happening on the sales and values side, which is an entire other aspect, the exact condition of partially completed schemes needs to be addressed so that the likely costs associated with this can be assessed and accounted for, or an alternative plan adopted.
In order to achieve this, the banks will require an initial overview to be carried out by a construction professional experienced in technical due diligence which would involve a site assessment and high level commentary on the state of the works.
This might identify the need for and lead to a more detailed survey or inspection by an architect or building surveyor or in cases where there is a higher degree of concern, a structural engineer.
The report generated by this initial overview will form the basis on which the relevant bank will decide how to proceed with the development.
Viable or not?
There are a variety of issues which will determine how or whether the parties involved are in a position to progress with the development on a viable basis or not and the initial overview report seeks to address this.
Depending on the extent of likely further works required and if further investigative inspections are required, the overview will provide the funder with an order of magnitude cost for the completion or rectification of the works on which the decision as to how to proceed will be based.
The issues affecting this will include such matters as the quality or completeness of the existing building(s), the existence or otherwise of the relevant certifications or compliances, the extent of rectification or other works and how these are procured etc.
Banks who are holding sites in these situations will look carefully at the ramifications of progressing any further with them. Invariably they will have incurred a loss in the form of funds release which may not be recovered from the project and they now find themselves as reluctant property developers or even landlords if the option to sell is not viable.
They will look at the possibility of selling the development in an “as-built” condition with the overview or inspection reports attached as a declaration of known defects, in order to secure as early as possible release from the project risk.
In other cases where, for example the project is considered to be fundamentally sound despite short term difficulties, the funder may opt to “build it out” perhaps in phases over a period of time and attempt to recover their outgoings over a longer period.
This would be a case-by-case decision however; in the current climate a funder who can also offer private mortgages to potential purchasers may have an advantage here by converting a single “bad” property loan into a series of “good” private mortgages.
Existing team or not?
Another factor affecting the process to recovery is the decision surrounding the professional and construction team involved. Apart from the fact that the construction/development element of the team might no longer exist as a viable entity, there is a large degree of trust required to move forward with them.
After all, if a project has become distressed through poor management there is no guarantee that this will not recur during the recovery phase which would be a consummate disaster.
Where there is a clear lack of trust of the incumbent team or perhaps certification or opinions of compliance are not forthcoming (for whatever reason, and the non payment of outstanding fees is probably the most common) the funder will be obliged to appoint an alternative team to oversee and manage the project through to completion or reach an agreement with the existing members as is appropriate.
Disposal strategy
Fundamental to the recovery of any project is the disposal strategy to be adopted. Until the property has been disposed of closure cannot be gained for the funder and the project remains at the mercy of the open market.
While this is largely beyond the scope of the CBR process, the final disposal strategy will determine the optimum approach to the recovery process and may be tailored to allow an early exit part way through the process.
Therefore it is vital to engage with the funder and their representatives at the outset to establish how these requirements can be best accommodated in the process.
Plan of action
Following the initial overview and assessment process and the discussion of the disposal strategy, a formal plan of action should be agreed and put in place to deliver the recovery solution.
In reality there may be limited options open to the funder and other parties involved and none are going to return the positive outcome that would have been anticipated when these projects originally commenced.
However, the events of the past eighteen months have meant that this is a new era and the expectations of the past are no longer relevant. Only those who accept the reality of the situation and adopt plans tailored to that reality will have any chance of surviving the current turmoil.
Financial considerations
By the time a development is formally acknowledged to be in distress, the financial considerations affect effectively every party involved in varying degrees, and all negatively.
These can be summarised as follows:
Developer Most likely to be insolvent;
Sub-Contractors Likely to have been underpaid and could possibly be insolvent at this stage;
Design Team May not have received all fees to date and unlikely to realise the balance of projected fees for the project;
Bank/Funder Unlikely to recover all of the funds released, particularly those in respect of the site acquisition. Will have to consider reduction in book value of site cost (write-off) and anticipated income for interest and fees.
Purchasers Unless a recovery strategy is implemented, intended purchasers will lose deposits paid to an insolvent developer.
Site value write-downs
The funder is likely to incur a loss on the project unless this can be recovered from the original developer through personal guarantees and which could be a lengthy process, an accounting write-off will be required.
As the build costs and other fees in the overall budget are relatively finite, the only budget categories against which write-offs can be made are the original site costs and the funders potential income from interest and arrangement fees.
Cross-contaminating debts
A given developer who has become insolvent is likely to have had several projects and several accounts with the same and other funders.
These can be considered to be cross-contaminating debts and while it is vital for a funder to allow for these in their consideration of a particular account case, they can serve to confuse the issues relating to a particular site or development.
In order to develop a clear plan of action for a particular distressed project, each should be addressed in isolation and managed as stand alone projects, ideally. |
