Commercial construction is suffering, but housing is holding its own

Some areas of construction are threatened with can look forward to
contractual disputes, squeezed profit margins and tricky cash flows, but for others prospects are good.

  • Residential construction is in a ‘good place’ while commercial has seen turnover hit
  • 2021 could see an increase in contractual disputes due to project delays
  • A collaborative approach in place of ‘hierarchical’ culture could be way forward
  • This year’s online boom has driven massive demand for datacentres and warehouses worth millions to the sector.  

The story of the construction sector during 2020 is very much a tale of two cities. While one arm – the commercial side – struggles with cash flow and profit margins, the residential business remains in a relatively healthy state.

Construction and maintenance company Echelon Construction, which works across the housing sector and local authorities are one of the lucky ones.

While the company experienced supply chain issues earlier in the year due to global market shutdowns and temporary factory closures, it is now back on track, despite significant changes to working practices and a few delayed projects.

“Profit margin and cash flow have been a bit of a challenge but not a massive one,” says MD Matthew Baxter. “It’s not been our best year but definitely not our worst. In March, we were very worried because some clients had put a lot of procurement projects on hold. We had a bit of a pause, but procurement activity to date has now normalised.”

Echelon Construction had the foresight to adapt quickly. Early on, it set up weekly industry conference calls with housing providers, suppliers, local authorities and the Chartered Institute of Housing to share best practice, knowledge and expertise to help mitigate the worst effects of the crisis.

A best-practice collaborative approach

These weekly calls helped Echelon Construction stay ahead of the curve. The collaboration between suppliers and local authorities ensured essential services and maintenance to residential properties continued. “I’ve been blown away with how we’ve all got through it,” says Baxter. “The housing sector moved incredibly quickly, with very few slips.”

Within a week, most staff across several local authorities and housing organisations were working remotely. At the same time, Echelon Construction reduced non-essential property maintenance such as kitchen replacements and upgrades by 20% to comply with restrictions. Essential maintenance checks and updates, however, such as gas compliance and boiler checks, never dipped below 99%.

“We all just had to adapt,” Baxter adds. “We do a lot of hands-on work including interviewing contractors, negotiating with clients, scoping out sites as well as the ongoing repairs and maintenance work we do, but we’ve moved as much online as possible.”

Since then, Echelon has even recruited. It has more people on staff now than they did in March.

“The housing sector is fairly busy all the time, so we’re fortunate. If there is a recession, there’s increased demand for social housing, and if there’s a boom, people can’t afford to buy their own place anyway, so the demand for social housing will go up.”

Continued investment

Ben Harwood, Chartered Accountant and Director of construction and real estate consultancy Naismiths, agrees. “Residential construction is in a much better place,” he says. “We’re actually seeing more development happening now than in the past six or seven years.”  

Reduced rates of stamp duty coupled with government investment have seen a boom in the residential market, so much so that developers are now able to sell straight off-plan. “Even three years ago, that just wasn’t happening; you had to show people around the property before,” Harwood says.

Matthew Thorpe, Managing Partner at Haynes Watts, is also relatively optimistic. Turnover has indeed been hit, particularly among SMEs in the commercial construction sector, but the work hasn’t gone away. “We’re not seeing projects being cut off totally; they’re just rolling into next year.”

Contractual dispute issues

There are concerns, however. Postponed project delivery is likely to incur costs, and Harwood warns of an increase in contractual disputes. Although many disputes may not be legally enforceable – it depends on the terms and conditions – it’s likely to leave firms in a difficult situation.

“Once firms realise they haven’t profited as much as they thought or have ended up incurring additional charges, they may try to claw back as much profit as they can,” Harwood explains.

It will put many contractors in a difficult position, especially those who have also taken advantage of delayed VAT payments and bounce-back loans to ensure survival. As Harwood puts it: “If firms haven’t won any additional work and are still completing work they were doing before, where does the money come from to repay the additional debt?”

Firms in limbo

There are also concerns around cash flow. With projects paused and a reduction in available tenders, firms must either wait it out and lose money in the short term or cut overheads until they can commence projects. But therein lies the problem: those who have opted to save money by making cutbacks will be under-resourced and must invest more upfront in hiring and procurement costs. “The industry has been caught on a seesaw,” Thorpe explains. “It’s leaving firms in limbo. How long can businesses sustain themselves on the promise of work tomorrow?”

Thorpe believes it will be the smaller players likely to struggle the most. The larger firms with plenty of cash reserves and strong balance sheets are already in a stronger position. They can also rely on performance bonds when pitching for new projects. But, says Thorpe, performance bonds encourage a potentially damaging ‘survival of the fittest’ situation. Whenever there is a shock to the market, insurers cut bond availability so only larger players with strong balance sheets can obtain them, pushing smaller, more innovative contractors with little or no assets out of the market.

Hierarchical culture

Thorpe also points to a broader issue with the sector which has been exacerbated by the pandemic. The sector’s hierarchical culture means that every firm in a project chain puts more financial pressure on the one below it. This way of working, he insists, is no longer sustainable. If clients are already putting their main contractors under pressure, the already skinny margins will disappear altogether when times get hard. This has a knock-on effect throughout the supply chain.

Speed of change

Despite all this, there are definite upsides for the sector as a whole. Thorpe points to the rate of digital and technological innovation over the past six months. Although it had started to evolve over the past few years, has now accelerated due to the pandemic. During lockdown, there was an ‘online boom’.  Consumers turned en-masse to online retail, creating a need for bigger warehousing and datacentres to respond to increased demand.  

The value of these projects Thorpe says, ‘is huge’ and ‘far outweighs’ anything of similar size. There are also significant investment and development programmes starting in 2021, including the Road Investment Strategy (RiS2), HS2 and the Government’s hospital building programme which will build six new hospitals by 2025 at the cost of £2.8bn.

The outlook for 2021 then, is a mixed picture: contractual disputes due to project delays, squeezed profit margins and cash flow issues. Simultaneously, the residential market continues to do well and continued government investment and the growth in warehousing and datacentres all point to a brighter outlook.

In summary

Baxter, meanwhile, is optimistic that the sector’s collaborative approach this year will help bring about cultural change: “It needs to be about collaboration now and how well clients and contractors work together,” he says. “Hopefully that will be a legacy for the sector going forward.”

Mark Rowland is a journalist and former editor of Accounting Technician and 20 magazine.

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