Chapter 4 Tendering the works (sketch)

After the design comes construction. The majority of business cases struggle to survive this phase of a project unless they have been well thought out from the outset. Consultant fees account for only a small proportion of the total costs of a development project. Construction is where the money is. As we shall see later, land acquisition and construction are the main cost drivers of a development project. These two cost items need to be realistic to ensure the project's success. Usually, since the land has already been acquired based on the construction costs, it is the construction budget that is either right or wrong from the beginning.

I have worked on projects where the land value was not significant. These tend to be industrial projects located outside city centres. However, when it comes to residential and commercial property, land acquisition costs are usually significant.

If the budget is incorrect, we either go back to the design board and start the value engineering process, or someone has to find the extra money, which is normally a not-to-go-to scenario.

I have procured and negotiated millions of dollars worth of construction work. The process is often twofold. First, we compile our documentation and send it to a number of builders for pricing and give them several weeks to price it. When the tenders are returned, we normally conduct a tender analysis, followed by a meeting to clarify matters and award the contract to the most attractive builder.

There are many different ways to approach construction. For example, when I was working on the delivery of 122 Leadenhall Street in London — informally known as the 'Cheesegrater' — the procurement method used was called Construction Management. The developer, who was experienced in property development, was in contract with all the subcontractors, and the contractor’s only responsibility was to manage them. The developer carried all the risk. This was an interesting approach to construction at the time, and unusual.

Most of the time, once the project has been approved by the local council, the developer is in one of the two scenarios: (1) the council has forced us to present the technical drawings, or (2) the local council is not so interested in these unless we change the look and feel of the building. In the first case, the project documentation is already well defined when we start looking for a contractor. The only thing left to do is the shop drawings, which is common practice for the contractor to do.

Option 2 is more open-ended because the developer has to choose between two options to move the project along, in general terms. They can either instruct the design team to start working on the detailed documentation, or ask the builder to do it instead. Both options have their advantages and disadvantages.

If the developer asks the contractor to do it the main advantage is that design risk can be transferred to the contractor. If something goes wrong with the documentation during construction, the contractor will have to fix it at their own expense. The disadvantage is that the developer no longer controls the design. Anything that the project brief doesn’t cover is an opportunity for the contractor to save money.

We could say a lot more about the above procurement methods. Also, almost every single project is unique, so a combination of the two above is also possible. Sometimes the contractor joins the design team in an advisory role. A partnering agreement can be used to deliver the project on a cost-plus basis. Different arrangements are possible, but regardless of which option we choose, the focus is usually the same: to achieve value for money during construction.

Value for money means that contracts are usually awarded to the cheapest contractor, but, as the saying goes, 'cheap is expensive'. The construction industry is full of examples where this approach has gone badly wrong. The main focus of most of my clients is to transfer project risk to contractors as much as possible, and procurement is usually carried out with one objective in mind: to find the contractor willing to carry out the work for the cheapest price. Once the contract is signed, they have to deliver the works at the agreed price. This practice works in most instances, as I have seen many contractors deliver below fair value. However, in one particular instance, it can be a recipe for disaster – let me explain.

Tales from the underground (sketch)

One day, I was asked to drive to Avoca Beach on the Central Coast for a client meeting. The journey there would take more than an hour, and I would still need to come back. Asking me to do that for just one meeting was a bit too much. This was before the pandemic, and thankfully things have changed for the better since then. Back then, however, this was a physical meeting that I had been asked to attend.

'What are they expecting from me?' I asked my boss. 'I don't know anything about the project.' I had literally just been asked to join the meeting with no information whatsoever about what we were planning to discuss. The only thing I knew was that the meeting was supposed to be at a law firm.

‘Nothing,’ he said. ‘Just go and pretend to be interested.’

I wasn't interested at all — I had better things to do — but my boss was a good man, so I did what I had been told. Getting there was a bit of a challenge. I'm not used to using Google Maps while driving. I ended up parking the car badly and was more than 30 minutes late for the meeting. I called my boss to check if it was still meaningful to show up.

"No problem," he said, ‘They've started, but they still want to see you.’

So I managed to find the law firm's office. I knocked on the door, and a kind lady showed me to the meeting room. Apparently she had been waiting for me. As I entered the room, I could sense that the meeting had already been going on for a while. I apologised for being late, blamed it on Google Maps, and started listening to the conversation.

It took me about five minutes to understand the purpose of the meeting.

I had heard of many crooks operating in this industry. I had dealt with my fair share of them, but what was happening was hilarious. As the story goes, my client had received an attractive tender from a contractor for a project. I think we were looking at a residential block with over 55 apartments. The price was probably very attractive, but the bank had advised them that the company they were dealing with had an ongoing court case.

Court cases are not uncommon in the construction industry, quite the opposite, however, according to the lawyer in the meeting, in this particular case the contractor was completely innocent. It was all a misunderstanding. Apparently, one of the firm's directors had used company funds to extend his house. The only reason he had done so was to increase the value of the house so he could remortgage it and borrow more funds from the bank to reinvest in the company. The other two directors didn’t agree with this strategy and took the case to court.

I listened to the conversation without saying pip. When the meeting was over, everyone shook hands. I felt it was about time to leave when my client invited me to have coffee with him. I just wanted to return to Sydney, but I obliged, as many consultants do.

At the coffee shop, my client ordered me a slice of chocolate cake, even though he and his colleagues didn’t order anything. Having three people look at me while I drank my coffee and ate my cake felt rather awkward, but I managed the situation the best I could.

Eventually, I was asked, ‘So, what did you think of the meeting?’

Lesson #1 cheap is expensive

Lesson #2 the balance sheet of a contractor

In comparison to their turnover, contractors don’t really have balance sheets. They normally have very few people on the payroll. I was once surprised to discover that some contractors in Scandinavia, or the Baltic countries own other companies and keep concreters, carpenters and other tradespeople on the payroll. This is rarely the case in Australia.

Personally, I don't blame them. Tendering is often a competition for the lowest price. The more desperate a contractor is to win a contract, the greater their appetite for risk.

Value for money versus cosmic prices (sketch)

The story above is not an isolated case. It is important to highlight that we can transfer most of the risk to the contractor, but once they start losing money, it is just a question of time before they become insolvent. But let’s assume that the contractor knows how to weather the storm, but it is likely to lose money anyway. In similar situations a different pattern can emerge.

First let's define the concept of 'cosmic price'. I came across this term when I was working in the Baltics. I liked it so much that I have been using it ever since.

A cosmic price is a price that is so attractive it cannot be refused. In fairy tales, cosmic prices are often used to lure people into doing something they might regret later, but for some strange reason, in the construction industry, cosmic prices are a great deal or godsend.

I once worked on a project worth over 70 million in construction costs. It was another residential project. When we reached the procurement phase, we approached six contractors; two didn’t have time to price the job. Four were interested. We put together the tender package and gave them five weeks to price it.

When the tenders were returned, three were within a few million of each other, all coming in at around the 70-plus million we expected the project to cost, slightly over budget. However, one tender came in at 55 million.

Our initial reaction was to disregard the lowest tender outright, as it didn’t make sense. It didn’t require a great deal of forensic analysis to see where they had gone wrong. In this particular project, the cladding was well underpriced.

We interviewed the main tenders, as we felt was the right thing to do, but the client had a different approach. They told us to negotiate the contract with the cheapest tenderer instead. There wasn’t much to negotiate. We knew the price was wrong. Rather than having constructive meetings, we spent time in restaurants eating and talking shop.

The client had a problem. The bank required our tender recommendation to unlock the project funds, but we weren't planning to recommend the cheapest contractor. Eventually, the client dismissed us and appointed the contractor as project manager.

The contractor promised the client that they would strip the project bare and bring the cost down to 55 million. The design and management teams were sacked. As is common in the construction industry, the promises were not kept. The company became insolvent a couple of years later. It was rescued by a foreign player, but a few years later it was finished for good.

Sometimes contractors hold clients to ransom. Once they are signed, the project is underway. It is not easy for a client to go against it, as we shall see in the next chapter.

The lure of a low price is sometimes too appealing, but it is important to remain rational. It is important to understand that if a contractor is offering a price below fair value, they will need to find a subcontractor, or subcontractors, willing to do the work at a loss.

Risk transfer (sketch)

Risk transfer is an important concept in the property industry. So far, we have managed to turn our vision into a plan and convince the local authorities to approve it. This process probably took several months, but construction will take much longer. It will also involve more people. The costs are not comparable, and it comes with a number of associated risks.

There are the obvious risks, such as, inflation, ground conditions, inclement weather, material shortages, these are simple risks that have to be managed throughout the lifespan of a project, but other risks lurk in the shadows. We will talk about some of these in the next chapter.

It is important to understand that during the tender stage and contract negotiations, one of the parties will have to take ownership of the project risks. The general rule is that the party better equipped to manage a given risk should take ownership of it. This is all well and good if the client is willing to pay the associated risk premium.

I have seen contractors accept low pay in exchange for taking on a great deal of risk. Although the client is usually happy with the outcome of the contract negotiations, this is not normally a good scenario for a contractor.

Let's imagine that a client has offset most of the project risks to the contractor and is now happily waiting for the project to be completed. There shouldn't be anything to worry about; the risk management is in capable hands. Well, not quite.

For example, ground conditions are one of the main risks for a contractor. No matter how many geotechnical reports we carry out, there is always a risk of finding something unexpected. Although these reports can provide a good indication of the type of soil we are dealing with, they should never be considered foolproof. There is always the possibility that things were quite not as we expected and this only becomes apparent during excavation.

I once worked on a project where the contractor accepted these risks during the tendering process. It was a design-and-build contract. So the design was not 100% complete. The contractor still had some work to do. Eventually, they finalised the design documentation and sought a subcontractor to carry out the groundworks.

The subcontractor accepted the work, but not the risk relating to the ground conditions. This was excluded from their offer. Once work began, it emerged that one area of the project had poor ground conditions. They were so bad that the design had to be re-addressed and a new structural method had to be considered.

Ultimately, the contractor had to pay the subcontractor for the new construction method, which involved a lot more excavation and concrete. The contractor escalated the extra cost to the client, but the client was against paying for the extra costs. The ground conditions, as they liked to put it, ‘is not our problem.’

To win the job, the contractor had accepted the risk of the ground conditions. The works could have been delivered successfully, but the ground conditions forced the whole team to redesign the project, which cost a lot more money. The subcontractor was a small company that could not accept this type of risk.

Had the subcontractor accepted the transfer of risk, it would have brought them to the brink of bankruptcy. This would have meant that the contractor would have had to find someone else to carry out the work, and the same scenario would most likely have happened again.

In this particular project, however, the contractor had good cash flow and was able to survive the cost overrun, but this is not always the case, and sometimes pushing too much risk onto the contractor can backfire. Experience tells me that contractors can easily go under and they rarely have a balance sheet that is good enough to cover their outstanding bills.

In Berlin, I read about two World War II bombs that were found during excavation. I was so fascinated by them that I researched the news further and discovered that it was not an uncommon occurrence. (expand).

For experienced developers the best course of action is to de-risk the project.

Early works packages (sketch)

Let’s consider the risk of ground conditions one more time. Since we are not quite sure what is lurking in the soil, we can either instruct the contractor to begin work and deal with unforeseen events as they arise, or carry out the work ourselves.

There is nothing to stop us from employing a subcontractor, in this case a company with expertise in excavation, and asking them to start the work. If something unforeseen happens, we will pay them directly rather than dealing with the situation via a third party, which in this case would have been the head contractor. The end result is cheaper since we don’t have to pay for the contractor’s overheads and profit.

I once worked on a project where we had to blast quite a lot of rock. The saying in the Sydney market is that breaking rock is expensive, but in places like Sweden is common practice. This project was in Finland.

We did some calculations and assumed that a contractor would need to be on site for at least three months just to blast the rock. Three months would have been OK, but the client wanted to start the work at the beginning of the summer to ensure that the structure would be completed before autumn will start. This would allow the remaining works to be carried out indoors during the winter.

Procurement normally takes 4–6 weeks. Another two weeks is needed for analysis and recommendations, assuming the contractor is on budget, and maybe a few more weeks if lawyers get involved and the company paying the bills has its own approval process.

It soon became clear that the contractor would finish the blasting by the end of the summer. So, we decided to split the work into two contracts. One for the early works and one for the balance of works. The early works package scope was to do the blasting and levelling up the site.

We ran a small-scope tender and involved a number of subcontractors. It was a quick process because there wasn’t much to price. We soon entered into a contract with a suitable company and they started work immediately. While they were working, we finalised the project documentation and obtained the municipality approval for the design. We also ran a tender for the remaining works.

This saved time and money because, when the tender was sent out, the main contractor did not have to factor in the risk premium for site blasting. The end result was that this was the first tender I had seen where the four bids were within 3% of each other.

There are several advantages, but this approach does require a developer with a certain level of experience.

Overall, as we shall see in the final chapter, de-risking a development project should always make it more profitable in the long term.

The tender package and tender analysis (sketch)

Value for money is a balance of opposite forces. The contractor wants to make as much money as possible, but they are in competition with other contractors. An experienced property developer wants to pay as little as possible, but doesn’t want the contractor to go bankrupt.

Thus, a solid and well-prepared tender package is one of the best “insurances” against construction disputes. ‘I am, therefore I exist' could not be more relevant when inviting contractors to price the works. Included with the tender package should be a navigation document that should cover the following items:

+

Standard contracts versus bespoke and claused that we tend to argue a lot (sketch)

A good tender package should include a draft version of the construction contract. This document is important because it allows the contractor to understand the project's risk profile. However, this does not mean that the contractor will accept all the requirements, nor does it mean that a “legally” well-written construction agreement will be able to fully counterbalance ambiguous design descriptions and vague requirements. Nevertheless, it is an important document.

Vitruvius, one of the most famous builders from Roman times, wrote in his ten books on architecture that “if a contract is skilfully drawn up, each party may obtain a release from the other without disadvantage”. Although his book comprises 10 volumes and goes to great lengths to discuss the celestial bodies, this is the only reference to construction law throughout the entire book.

I have yet to experience a contract that doesn’t seek to take advantage of the other party, but I do admit that some contracts are more balanced than others. In some jurisdictions, like Sweden and Australia, it is common for the construction industry to use standard contracts. In places like Latvia, for example, no such templates exist, so with each project, the contractor has to review and assess what they are signing up to.

Most of the projects I have been involved with have ranged in value from a few million to billions. With so much money at stake, negotiating a construction contract with a contractor can be an intense experience. It is also a delicate position to be in because contractors know that they are not alone in the race to win the contract, and that not all of them play fair.

Regardless of my role during negotiations, the most important thing is to ensure that everyone is on the same page. This means having a good understanding of the risk profile of the development project for both parties.

Although I have worked on projects where the contractors refused to use any contract template other than the standard version, the reality is that all contracts are amended to some extent to suit the client's interests, regardless of whether they are standard or not.

The following clauses tend to be contentious during negotiations:

Time-barred variations – I like to impose these on construction contracts. The last thing I want is for a contractor or consultant to submit a claim through the system six months after the variation occurred. While I am always happy to assess the merits of a variation, assessing something that happened six months ago can easily turn into a work of fiction, as nobody remembers what happened anymore. In Sweden, for example, time-barred variations are quite common. Not so much in Australia. Common law dictates that no one should profit from a free service; as a result, if a claim is valid, someone ought to be compensated for it.

Project completion date

Payment terms

Definition of ground conditions

Idle time

Entitlement to extension of time

Conflict of information

+

Value engineering (sketch)

It’s not unusual for tenders to exceed the budget. Unfortunately, the true cost of a development project only becomes clear once the tenders have been submitted. If the budget was incorrectly allocated from the outset, clients will try to blame the designers for the shortfall, but there are several reasons why they are normally not to blame.

The value of a quantity surveyor.

The problem with value engineering is that, most of the time, the project has already been designed, and redesign incurs extra costs that consultants are reluctant to carry out without being paid for it.

The doctor jekyll and mr hyde syndrome (sketch)

As I keep emphasising, construction is a people business, and understanding what motivates people is a great recipe for success. Personally, I like to work with contractors who demonstrate a high level of professionalism during contract negotiations.

There is a group of people who approach contract negotiations with a wide smile on their face, reassuring the client and myself at every meeting that 'everything will be alright'. This is normally not alright.

I can’t judge people from face value, but I have often observed that contractors who are all smiles and positive attitudes during the pre-contract phase do change their behaviour after the contract has been signed. Especially as soon as there are contentious bills to pay.