Development monitoring and due diligence

Citation

(2002), "Development monitoring and due diligence", Facilities, Vol. 20 No. 3/4. https://doi.org/10.1108/f.2002.06920caf.001

Development monitoring and due diligence

Development monitoring and due diligenceKeywords: Risk assessment, Construction industry, Due diligence

Construction can be a roller-coaster ride of unforeseen variations, changes in scope, cost increases and delays. How does a fund assess the risks? David Pincott, Partner at Edward Symmons & Partners explains.

Introduction

Due diligence is the assessment of a property asset or development proposal; a forensic process to validate how good the thing is. Solicitors assess the strength of title or the apportionment of risk in a contract while surveyors carry out pre-acquisition surveys on property investments and development monitoring on new build and refurbishments. This article aims to explain development monitoring and to guide the developer through the processes involved.

What is development monitoring

The risk of lending on development projects is greater than on investments because the construction process is complex and uncertain. In the past, banks were happy to carry out their own review of the developer's proposal – the scheme, budget, and programme. But the period of construction, from approval of a credit facility to completion of the building, can be a roller-coaster ride of unforeseen variations, changes in scope, cost increases and delays. As a result, a bank might lend on one proposal, such as a hotel extension, and find a year later that costs have doubled or that the funds have been applied to a new sports and leisure centre instead, with implications for the loan-to-value ratio and cash generation.

Funds now tend to appoint surveyors to assess the degree of risk involved from the start and to be their eyes and ears during the construction so that surprises are kept to a minimum and safely managed.

Why is development monitoring necessary?

Banks are looking for a degree of certainty about their customer's development proposals. They need to know in advance exactly what the scheme involves and how the money will be used. And corporate managers don't relish going back to their credit department to arrange top-up borrowing should a project go over budget. Therefore, the specialised property departments of commercial banks generally consider that the current scale of lending and potential risks warrant specialist construction advice.

You may wonder why the bank does not rely on the developer's team and simply use the quantity surveyor's valuation and architect's certificate for the monthly payment or "drawdown". Partly, they want independent advice, outside the internal pressures of the design team. There are two key questions we get asked. Can the development really be built for the finance requested? And can it be done in the time available?

More importantly, however, the bank's risk is not solely a drawdown issue. A project can run into difficulties for any number of reasons and some of these can be identified by the monitor as part of his initial construction appraisal – party wall and rights to light issues, untried design solutions, ground contamination, geo-technical difficulties or weaknesses in project management and contractual arrangements. Once a development is under way, the bank relies on the monitor to identify cost over-runs and delays. We normally visit monthly and attend site meetings before issuing our report on the drawdown and progress.

Who does the monitoring?

Monitoring surveyors are commercially minded construction experts who understand the detail of procurement, contracts, insurance and building design. They offer a different perspective to the developer's own design team and provide a useful second opinion during disputes and cost/time over-runs. In recent years, they have come to be valued not just by the funds but also by developers because of their experience and knowledge of programming, performance bonds and collateral warranties.

The process involved in development monitoring

Once the valuation has confirmed the project is financially viable, the monitor is then ready to issue a schedule of information requirements. The list below is a typical schedule of information requirements and the wide scope of enquiry can sometimes take the developer by surprise:

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  planning consents;

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  building regulations application;

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  structural appraisal;

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  archaeological reports;

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  ground contamination investigations;

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  geo-technical investigations;

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  specifications and drawings;

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  bills of quantity;

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  cost plan;

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  tender report;

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  programme;

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  design team;

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  terms of engagement;

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  professional indemnity insurances;

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  draft contract;

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  draft collateral warranties from main contractor, suppliers and sub-contractors with design liability;

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  insurances – all risks for the works, endorsement of the existing building policy (if applicable), third party, loss of liquidated damages, terrorism cover, non-negligent damage, business interruption.

Forget trying to get it all on the back of a courier; try a shopping trolley! It's something of an art sieving the piles of documents and reducing them to a 20-page initial construction appraisal.

The initial construction appraisal highlights the safeguards required by the bank (usually prior to agreeing the facility). Depending on the size of the project these could include:

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  execution of the contract;

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  arranging collateral warranties to the fund from the main contractor, consultants and sub-contractors with design liability;

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  formalisation of terms of engagement of the consultants and requesting evidence of professional indemnity insurance;

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  effecting insurance;

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  clarification of design liability; and

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  adjustment of the cost plan.

Banks may wish to be named on insurance policies as an interested party and often require terrorism cover. Insurances on existing buildings must be endorsed by the insurer because refurbishment or alteration works carry a higher risk. Let's say the developer is working below an existing building to construct an underground car park but the existing insurers are not aware of what is happening. If there was a fire or explosion during the works the insurers could refuse to cover the loss. Undertaking repair and maintenance is one thing but very often with alterations and new work a premium must be paid for this additional cover; without it the whole project and the bank's security is at risk should there be an uninsured total loss.

The scheme must be soundly conceived. We have previously found four-storey residential buildings designed without lifts and the conversion of wharf buildings that had inadequate river defences. Management issues are important too. We once looked at a project where large-scale building work was being run by an electrical sub-contractor, with predictable results.

Design liability is a complex issue and frequently the monitor advises on the need for collateral warranties between the sub-contractors who design mechanical and electrical services, proprietary systems, pre-cast concrete flooring etc. and the fund. It is also possible to assign subcontractor/employer warranties by way of security to the fund. Banks look for contracts and warranties to be executed as deeds, with a 12-year validity rather than contracts under hand (six years).

Case study – the Eden Project, Cornwall

Following Edward Symmons' work on Somerset House (public events facilities) and Shakespeare's Globe Exhibition Theatre, we were appointed by NatWest Corporate Banking as monitors on the £80m Eden Project scheme to build the largest greenhouse in the world. It is located in a disused china clay pit and features a precision engineered steel spaceframe covered with ETFE foil inflatable pillows. One of the eight domes rises to 55 meters and together the conservatories cover the area of 29 football pitches.

We examined the property and planning issues – the purchase of the Bodelva pit from a local china clay operator and the option agreements to secure other parcels of land so as to construct the access road. There were two planning permissions required; one for the main site and buildings and the other for the access road.

One of the early construction challenges was the bulk earth-moving and slope stabilisation during what was an exceptionally wet winter period. This happened even before the new engineering contract (design and build option with a guaranteed maximum price – GMP) had been signed. Even though costs were above budget, we recommended agreement to the GMP and execution of the contract in case costs started to rise with the water levels! The bottom of the pit was built up by 20 meters using spoil from in and around the pit. Structural embankments supported concrete foundations under which vital drainage and dewatering services had been installed.

We reported regularly on changes in the scope of the contract; value engineering reduced the height of the largest biome from 65 to 55 meters and biome mass boilers, emergency generators and under-soil heating were omitted. The visitor centre was totally redesigned.

The new engineering contract comes with a design and build option. This endeavours to foster a partnering rather than confrontational approach to working together. The contract was amended to allow for a profit share for the contractor (capped to £1m) so long as savings were achieved.

The main funding came from the Millennium Commission who initially granted £37.5m in matched funding. Also, the European Regional Development Fund, English Partnerships, NatWest Corporate Banking and Royal Bank Leasing, besides numerous other commercial sponsors. In this, as in other cases, banks sometimes "stop" expenditure on certain items until funding is fully available. Certain facilities not essential to revenue generation were put on hold until a later stage.

Throughout this process it was our role as monitors to protect the bank's interests and to ensure that funds were being expended on agreed activities. For example, we reported monthly about obtaining outstanding planning permissions, the procurement of horticultural planting, the catering and retail facilities. Despite delays and funding shortfalls at various times, McAlpine JV and the project manager from Davis Langdon Management were able to reschedule activities to take advantage of float time and’the Eden Project opened a couple of weeks earlier than the original April 2001 target.

Top ten tips

The top ten tips for getting your project through the due diligence process are:

1. 1.

   Spend time on consultant selection and if you are engaging someone new for the first time find out as much as possible about them before you instruct. Take care to formalise terms of engagement with your consultants e.g. their scope of services, professional indemnity insurance and let them know that collateral warranties will be required for the bank and future purchasers.

2. 2.

   Develop the scheme to a detailed design stage before going to the bank with your proposal. Don't avoid up-front design just to save expense. This can lead to a rushed design later on and mistakes being made in the contract and procurement process.

3. 3.

   Get your planning permissions and, if applicable, the agreement of English Heritage, Scheduled Monument approval and resolution of rights to light and party wall issues. Consider carrying out enabling works first to remove asbestos, de-contamination or methane control. Until these are dealt with and a scheme price obtained the monitor won't feel confident about cost and programme.

4. 4.

   Think very carefully about using any new building techniques e.g. factory fabricated pod construction or lightweight metal external framing. Establish close relationships at an early stage with specialist contractors whose systems will form a significant element of the scheme and pay for their up-front design development or manufacturing set up costs; use advance payment bonds to cover such payments. Build models or mock-ups to check assumptions. Ensure specialist designs are co-ordinated into the whole scheme by your architect and quantity surveyor.

5. 5.

   If there are unusual circumstances and contract amendments are likely to be incorporated to standard terms, use a law firm with a reliable construction department to advise on the contract, otherwise it is better to take your quantity surveyor's advice and stick with a standard form.

6. 6.

   Bring your project manager and/or cost consultants into your thinking about the total budget, not just the construction costs. Let them see your developer's budget. They should have expertise in capital allowances, VAT, briefing your consultants/setting consultant fees and’procurement of FF&E so ask for their advice about the complete project cost.

7. 7.

   Give the monitor full access to your design team and all the information he requires. Take him into your confidence. If something goes badly wrong ring him up and put him in the picture. OK he's working for the bank but if he can help the scheme go better, he will – that helps the bank and the developer.

8. 8.

   Synchronise the project meetings and the regular valuations of work. Circulate minutes and cost reports promptly. Then the monitor gets a snapshot of the project at a single point and can issue his report quickly. Otherwise he may charge for extra visits/meetings.

9. 9.

   Circulate a schedule of dates for meetings/valuations, issue of the quantity surveyor's valuation/architect's certificate and payment. Then everyone knows the drill and the banks drawdown payment won't be delayed.

10. 10.

    Make the most of all the professionals around you with their widespread project experience. "A wise man has many advisors", says the proverb.

You can contact Edward Symmons & Partners on +44 (0)20 7955 8454.