Real-world Development with propertyCEO – Part 9
Small-scale property development projects that use permitted development rights can be done in your spare time, boast six-figure returns, and have a lower cost of entry than buy-to-lets. It all sounds great on paper, but what’s it REALLY like to convert a property?
Join Ritchie Clapson CEng MIStructE, veteran developer, author, commentator, and co-founder of development training company propertyCEO, as he guides us through a real-life commercial conversion project from start to finish. Witness the highs and the lows, and learn the critical takeaways in this eye-opening, warts-and-all look at what REALLY happens where property development theory stops and the practice begins
You can watch a video of Ritchie walking around the project. Click HERE for exclusive video content.
The story so far…
Ritchie’s five-flat commercial conversion project was now only one step away from starting on-site. The finance was in place, and all the third-party consultants had been appointed. The final hurdle was to agree on pricing with the contractor, and then work could begin.
I’d already chosen my contractor for this project, one I’d worked closely with on other projects, which meant I’d be negotiating with a single supplier. Usually, I’d go out to tender and get several contractors to quote – and on a first project, you would definitely be doing this. Tendering is a tricky process and one that your project manager will handle on your behalf. You want at least three quotes to be sure of getting a good price, so you’ll need to approach at least six contractors, as only half are likely to respond. Tender pricing costs contractors money. If they don’t need the work, don’t fancy the job, or are aware that many other contractors are pricing for it (word will get around), they may think it’s not worth the effort to quote. It’s even been known for contractors to collude, with one purposefully submitting a price that’s 10% higher than a competitor, just so that they a) don’t win the business and b) don’t get omitted from future tenders for not responding.
The art of a good tender process is detail. You want to have an ‘apples vs apples’ comparison, which is only possible if your PM gives the contractor a highly prescriptive list of requirements. Without this, you’ll find it difficult to identify the reason for any pricing differences. Did the contractor miss something, or was there a lack of clarity regarding your requirements? Did one contractor include all appliances but another just the built-in units? If you’ve got the detail, you’ll be able to see where the differences are and then clarify things with the contractor in question.
* Top Tip: Getting clarity from contractors on their pricing can involve a fair amount of toing and froing – make sure you allow sufficient time for this in your schedule.
Time is money in development, and you can’t judge a contractor’s quote based on price alone. If one quotes 20 weeks to do the job and another 16, then that’s an additional month of financing costs you’ll incur, so you and your PM should bear this in mind.
* Top Tip: Always hold and personally attend formal interviews with potential contractors and be sure to meet the head honcho. Do you get on with them? You’ll have to deal with them if something goes pear-shaped, so you want it to be someone you feel you could have a good relationship with.
Your PM should only invite contractors to quote who they’ve ‘approved’. Apart from the usual due diligence, part of this approval process involves determining each contractor’s current workload as a percentage of their annual turnover. If their turnover is £5m and they already have £5m of work lined up, they may be too stretched to take on your job. Similarly, your PM will review their cashflow risks as well as their most recent work.
* Top Tip: Be sure to meet the site manager and ensure they have your PM’s approval since the two of them will be working closely together.
Once all your tender responses are in, your PM can recommend a preferred contractor, and you both can then work with them to agree on the contract value and a start date. On our project, I already had a target contract value in mind and had done some value engineering with the team, including the contractor, to ensure we could hit our numbers. I called the contractor and PM to arrange a final pricing meeting where we put a few loose ends to bed and then shook hands on the deal.
* Top Tip: Never over-negotiate with contractors. If you screw them down too hard on price, then they’ll simply claw it back through extras and overs.
This left the PM and contractor to put together and agree on the contract, which we both signed in due course. Another handshake and we were good to get things moving on site. Finally, the rubber would be hitting the road.
* Top Tip: Always use a recognised industry contract format when hiring your contractor. JCT (Joint Contracts Tribunal) is the most common and my preferred format. You shouldn’t need to rely on contracts (most issues can be resolved over a cup of coffee), but there must be one in place.
Two things often surprise people about development. Firstly, the actual construction phase starts way down the line; many things need to happen before anyone picks up a spade. Secondly, they think the construction phase would be the busiest time for the developer, whereas you actually get to take a step back because your PM will be running the show on your behalf.
One of the most important aspects of the construction phase is cashflow. This is how the funding works; my lender would release the money needed to pay the contractor’s invoices in tranches (called drawdowns) during the works, as opposed to handing over a lump sum upfront. My contractor has payment terms with his materials suppliers, meaning he didn’t need to invest his own cash. At the end of each month, he would submit an invoice for the work he’d completed to my PM, who would then check it. If the PM was happy, he’d contact the lender, who would arrange for their surveyor to visit the site to double-check that the money they were about to pay had actually been spent. Only once the surveyor’s sign-off has been received will the lender release the funds, enabling the contractor to be paid.
* Top Tip: Your PM must obtain a cashflow projection for the project from the contractor showing how the costs will be incurred over time. This can then be passed on to the funders so that they can schedule their drawdowns. Your PM will then need to monitor and manage the cashflow throughout the construction phase.
Occasionally, you can get scenarios where the surveyor isn’t happy to release all the funds. This necessitates a three-way dialogue between the surveyor, contractor, and PM to agree on what work must completed before the surveyor is happy.
* Top Tip: Don’t allow the construction phase to start until the contractor has provided your PM with a cashflow projection, and make sure you ask your PM for a copy of it.
Cashflow is the great bellwether of how well the construction phase is progressing. If the contractor says they’re on top of things but they haven’t yet claimed an expected drawdown, then they’re not!
* Top Tip: Don’t try to badger your contractor into starting on-site earlier than they feel comfortable with. They need to balance your project with their other workload, and all that will happen is that they’ll bring a few tools to the site on your preferred start date, but nothing much else will happen until they’re good and ready!
You always need to ensure that, as the developer, you DON’T have the authority to instruct the contractor directly. You don’t want the contractor to ‘interpret’ an informal chat with you as a license to change the specification or cost. I made it clear to both my PM and my contractor that only the PM could give instructions to the contractor and that any such instruction would need to be in writing with all costs and quantities spelled out. That way, if I wanted something changed, I’d need to channel it through the PM.
* Top Tip: Your PM is acting on your behalf, so technically, you don’t need to be very involved during the construction phase. However, it’s prudent to keep a watchful brief on how things are progressing, and it’s also educational to see how construction works in practice.
My PM sat down with the contractor, and they agreed on a schedule of monthly on-site meetings. PMs will be working on multiple sites simultaneously, so they must be on top of their diaries. Another prerequisite is that any new items agreed upon at these meetings are formally noted, together with any associated quantities and costs.
Another key issue that needed to be addressed pre-commencement was health and safety (H&S). My independent H&S consultant reviewed the contractor’s pre-construction health and safety plan and made several amendments. They then visited the site with the contractor to make sure they were happy with things in situ. Once they gave me the thumbs up, we were good to go.
Next month, we see work on-site really get motoring and witness Ritchie taking a step back while maintaining enough control to ensure he avoids any nasty surprises, a key requirement for a successful developer.