Peer panel: Construction – Rebuilding
7 April 2014 | By Kate Beioley
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Beyond the headline infrastructure projects, UK construction work is still recovering from the clobbering it took during the slump
Q: What is the state of the domestic market in construction?
Tim Reid, partner, Ashurst: The market is still patchy but there are some big projects such as Crossrail and, potentially, HS2. The Budget brought the announcement of a commitment to extend the Barking to Gospel Oak overground rail link and to continue to regenerate that part of London, but it does not appear that office development or other major parts of the industry such as house-building are by any means at full stretch.
The possibility of interest rate rises may keep the domestic sector at a low ebb for a time. Perhaps the silver lining from the recent bad weather has been the announcement of millions of pounds of investment in flood defences, but overall there remains capacity in the market.
Gillian Thomas, partner, Hogan Lovells: Both domestically and internationally the industry is getting busier. While domestically this had been limited to London, we are now seeing an increase in activity beyond, with major developments in Birmingham and Manchester.
We’re getting reports of clients with smaller projects (below £10m) struggling to maintain competition in their tenders because contractors do not have sufficient resources in their tendering departments.
Jon Hart, partner, Pinsent Masons: Some parts of the industry are doing better than others. According to the latest indicators, some growth is visible. However, given the base from which we started it was to be expected that growth would be slow.
More than 18,000 construction companies have gone to the wall since 2008. It will take time to build that back up and there are some capacity issues. The positive point is that the growth appears sustained. House-building has seen a sharper resurgence, encouraged by Government intervention, with the extension of the ‘Help to Buy’ scheme.
Nick Downing, partner, Herbert Smith Freehills: Within the M25 top-tier contractors are busy in the commercial development sector – less so elsewhere in the UK, although activity levels are rising.
We’re seeing a trend towards two-stage contracting rather than the single-stage competitive tender. There are also a number of examples of contracts being negotiated rather than competitively tendered at main contract level, particularly where repeat deal flow is on offer.
A strong and effective relationship with the management teams of leading contractors frequently crops up as key to project success.
Q: Where have clients been most active in the past year?
Reid: There has been something of a resurgence in Middle East investment, both in infrastructure projects and in the services sector, such as operations and maintenance projects.
In the UK there are still a significant number of energy-from-waste/waste treatment projects, as local authorities address the need to reduce landfill and the country seeks to cut carbon emissions.
There are also signs that London remains a place where investors see significant returns.
Thomas: UK developers and institutional investors such as pension funds are investing in new developments. On the infrastructure side there are a lot of non-conventional energy projects and, of course, the big projects in the rail sector.
We’ve seen some activity from Chinese investors in the UK and our US colleagues have been doing a lot of work on projects with Chinese outbound investment.
Hart: China is shifting its focus to advanced economies – access to technology and innovation has become more important than commodities. On these measures, Britain comes out as one of the top destinations for investment. Britain is a safe haven, offering a home for investment not only from China, but also from nations such as Korea. Top of the list are real estate assets and projects funded by China, but also energy assets. And, increasingly, China is eyeing transport and other infrastructure developments.
Downing: A broad spread of our clients are active, all household names in the industry. A number of schemes are procured through joint ventures in partnership with investors (often from overseas) to spread risk and not overcommit to one project.
International interest in developments in the right locations – primarily London – remains high. Overseas money is coming from a variety of locations.
A common theme is that the international investor relies to a great extent on the UK developer’s expertise to run the show, but it would be a mistake to think they are not rigorous in overseeing the project.
Q: Has there been a notable increase in PPPs and, if so, what impact has that had on legal work?
Reid: Although there has not been a notable increase in PPPs there remains a steady flow of work. The waste sector is buoyant and road projects continue, but there have been fewer schools, hospitals and prisons projects.
The fact that government spending cuts have reduced the number of new projects has been offset in two ways. As projects come onstream or approach the end of the construction phase there have been disputes involving substantial sums and significant legal input. And the PPP model, tried and tested in the UK, has been exported – principally, but not exclusively, to other common law jurisdictions. UK law firms and banks have been in the vanguard of those exporting their know-how.
Thomas: Domestically, there has been a drop in PPP work as the present administration rejects procurement programmes launched by the previous Labour government. Recently, there have been a number of hospital deals reaching financial close, while batches under the new Priority School Building Programme have entered the bidding phase.
In the health sector in the UK, which has typically seen a lot of private finance initiative schemes, there will not be so many major development projects as there’s a reassessment of the form health services will take in future.
Hart: There’s been no real increase in PPPs. The highs of 2008/09 are gone, never to return. Much of the pool of UK-based talent in this space, whether working for sponsors, contractors, funders or consultants, has been dissipated and spread to other jurisdictions where PPP has had more support and been used less like a political football. The wait for PPP to gain a hold in emerging markets continues.
Downing: No. We’re seeing traditional methods of procurement on capital infrastructure projects in sectors ranging from power to transport. In the UK, the use of the NEC3 (Engineering and Construction Contract) is seen in a variety of guises. On the larger and more complex projects there is a recognition that collaborative contracting is key to success, often using a variety of payment structures. These are not necessarily straightforward contracts and it is essential that legal advice is aligned to clients’ commercial objectives.
Q: What effect has the crisis had on deal flow and the location of key clients?
Reid: The financial crisis plainly had an effect on the construction and engineering sector but government investment has continued throughout and there have been a number of landmark developments – the Shard, for example.
In keeping with the entrepreneurial and international nature of the industry, clients have successfully diversified and exported know-how in emerging sectors such as renewable energy.
As the UK emerges from difficult times, construction and engineering will have a fertile domestic market and continuing success overseas, which it will be the task of UK law firms to service.
Thomas: The financial crisis created an instant drop in activity in this sector, with few projects able to weather the storm. In terms of activity at that time, we saw a growth in refurbishment schemes and isolated developments.
While there has been interest from overseas there’s still plenty of activity from UK-based developers and investors.
Hart: Deal flow remains lumpy. The worst facets of the UK infrastructure market in terms of procurement and the race to the bottom on fees continue.
Despite outstanding work driven by the Treasury and clear thinking in documents such as the Government’s Infrastructure Procurement Routemap, there are still many projects coming to the market which are half-baked in respect of the proper preparation has not been carried out by the procuring authorities. Banks and other investors are willing to lend to the right projects, but where are the projects?
In terms of location, clients firmly wedded to the UK market have been forced to look beyond PPP to other sectors. The construction industry appears to be going through one of its periodic reinventions, whereby it is not enough to build things – rather it is necessary to describe yourself as ‘a service-based organisation’.
Downing: The construction and engineering sector is volatile, and swings from boom to bust. There was a time when domestic projects dried up, even for the biggest developers. We’ve always had a strong international practice and investment on infrastructure projects around the world is strong. The deal flow for this type of work has been much more robust than, say, commercial development in the UK.
That said, commercial development – including high-end resi – is very active right now, particularly in London.