This is where you continue part of the property development project as-is to a satisfactory stage and segment the remaining parts. Each segment will have its own restart. For example, you could finish the first stage of a residential development and sell of the remaining parcels to another developer. Or in a mixed-use development you could concentrate on the retail side of development (if that is your expertise) and sell or joint venture with others to complete apartments and offices.
This is where in the property development project you inherited you wipe the slate clean of current contracts and relationships to restart free from historical baggage and constraints. The premise being there is no value continuing with existing contracts.
This is progressively more
difficult to do (or at least carries more risks), the further developed the
project already is. Let’s look at cleaning the slate at various stages:
Conceptual
design. At this stage there isn’t much to lose if you want to ditch the
existing architect and consultants and start fresh. If this project has been
one with a poor payment performance record, the existing team may be low on
motivation. Their emotions may not change with new owners (you). You will lose
some intellectual property and knowledge by abandoning them. But it shouldn’t
be too much of a problem for new consultants to get up to speed. Just check
whomever you replace is not the only expert in their field for your type of
project or has political connections where you may find yourself embarrassingly
having to go back to them in the future. At this stage you won’t have buyers or
contractors involved, so no problems there.
Developed
design and planning consent. Before cleaning slate, get copies of all delivered reports, plans and
specifications from consultants and where possible the raw electronic file
formats used (CAD/BIM for example) so your new team does not have to recreate
all the work previously done. Town planning involves relationships with
authorities so think carefully before changing. Ensure you have all
correspondence from local planning authorities, especially where the town
planning consultant had authorisation on the previous developer’s behalf.
Building
consent. Not only do you want all files, preferably in their raw format,
but also copies of all design statements, producer statements and
certifications. Check that the consent documentation submitted does not
implicitly require that same consultant to undertake inspections or sign-offs
later in the project. If it does, ensure your new consultants can do those
signoffs or make provisions for the existing consultant on a limited scope.
This is very important if building consent has been granted and extremely
important if the element has already been built. I have been in the situation
where an engineer in a legal dispute did everything possible (contrary to
professional ethics) to frustrate us by refusing to hand over a certificate for
an item of infrastructure already built and inspected (with no problems). No
other consultant wanted to sign off this item. It ended up a very costly
exercise to ‘extract’ the certification. Intellectual property and liability
collide at this point though. Ensure any new consultant will take on the
responsibility of previous drawn plans.
Under
construction. Ensure there are no certification or liability issues with the consultants you are
terminating, before you terminate. For contractors, the issues are further
compounded, especially with responsibility over warranties and guarantees. If you are considering
terminating a contractor then you need to plan to get all warranties, guarantees,
certifications and as-built documentation for work in place. Many of these will
come from subcontractors and suppliers and you may have to negotiate with each
separately. If the subcontractor has experienced payment problems, then it may
be difficult to get these certificates. Although you are terminating a main
contractor, there could be key subcontractors who you need to retain just because
it is easier to keep them on to avoid problems gaining final approvals from the
local authority. If subcontractor continuity[1]
agreements exist it will be much easier to deal direct. For
work that is partially complete, or where your audit finds it may have not been
done correctly, be especially careful. Subcontractors may have an incentive not
to help if they have played a part in the project’s failure in the first place.
They may have cut corners as a project deteriorated (lack of payment or lack of
competent inspections) and will no longer want to take any responsibility. Others
may just be holding out for a payment. If the existing subcontractors do not
want to assist you, or you are forced to terminate them because of their
incompetence, then you will need to specifically address how you are going to
complete the works and get the appropriate certifications. You may need to
discuss the circumstances with the local authority, so they will accept a new
contractor’s certification. This could include retrospective inspections, or
unfortunately, rework. Sort all this out before you restart construction in
earnest. Review every official certification or signoff you need in relation to
what has been built and tick off exactly what you need and have a plan to deal
with what may create difficulties. If you don’t do this at the start, and only
find out from the local authority that you need a certificate for this item
many months later, the amount of rework could increase significantly. As an
example, think of the situation where you don’t have certification for waterproofing at the base of building but
now you have built an entire building on top of it. Catch-all guarantees, such as weather-tightness or multi-year warranties
provided by the main contractor, will be difficult to retain if you are
terminating them. Ensure you can get your new contractor to provide this or at
least provide a limited one that excludes work already done. Obtaining an
insurance policy to cover the same risk may be an option. Don’t
forget to cross reference what has been promised to purchasers and lessees in
their contracts as well.
Sales or
Leasing. Assuming you have the control and right to cancel,the formula is straightforward. If the
value of contracts in place is greater than the current market value, then
retain them. If they are less, then you renegotiate or terminate. Although it
may be more difficult than that. Some buyers or lessees could have been given so
many broken promises that their existing relationship with the project is
fractious (and litigious). The pain to continue with them may just be too much.
Illustrating some of the complexities that need to be thought through:
Say you have taken over a commercial project, 50% complete, where one of
the tenants signed up is a medical laboratory. Substantial work has been
undertaken to customize the base building for this tenant. There are no
potential replacement tenants, and a lot of work (money and time) would be
required to reconfigure the space to attract alternative tenants. Canceling
this tenant may simply be too costly. This tenant likely has strong negotiating
power in this situation, even if they have signed up at below market rates. Your position will be stronger if this tenant
has no alternative options or are under pressure to occupy the premises.
Suppose you have existing agreements to lease on a retail shopping center
development. All the minor tenants are
signed up at above current market value rates. However, the large anchor
department store tenant has been signed at a rate so ridiculously low with such
large incentives they are the main reason this project has failed. You want to
terminate the anchor but keep the minor tenants. The only problem is the minor
tenants have clauses linking them to the anchor’s presence, and in the current floundering
market you definitely don’t want to terminate all those minor tenants.
Or
consider the scenario where you have taken over a 50-unit terrace home
development that is completely presold. Construction costs
have ballooned out and there is not enough revenue to cover the required
development budget to complete the project. Given your high opportunity
acquisition price, canceling sales contracts is necessary; however, some
contracts are below market value, some are at market and some are above market.
Do you just cancel some or do you cancel all contracts? The residential market
is also slowing down so resales at the price required will take some time. The
project is high profile and canceling agreements is likely to generate
consequential negative publicity that could put off resale buyers. Plenty to
think through!
[1] A subcontractor continuity agreement is
typically put in place between developer, funder and main contractor within a
tripartite agreement. It allows the developer or financier to step in and
manage subcontractors directly if there is a default by the main contractor.
This is when you intend to complete the property development project primarily as-is, but you need to sweeten the deal to get the project to a suitable state to continue, or simply to increase the financial return. Essentially, you attempt to embrace what positives remain and renegotiate out of any negatives. That means renegotiating contracts and re-setting relationships.
Circumstances limit what you can
renegotiate. How you approach negotiations also depends on what level of
project commitment you are in. If you now own the project, you will be trying
to both protect your current investment as well as obtain better terms. You may
be restrained from using the walk away option. If you are negotiating before
you have ‘brought’ then you can be more aggressive. The negotiation trifecta is
to increase revenue, decrease costs, and reduce risk. Targets for renegotiation
include:
Construction contracts
Fee agreements
Sale and purchase or lease agreements
Loan agreements
Construction Contracts
You will be in a strong position when renegotiating
construction contracts if builders are owed money and your involvement may be the
only way they can recoup that loss. Even if you have no obligation to pay the
contractor for work already done, it might be advantageous to do so. This is to
help reach favorable terms to move the project forward. There is only so far
you can go. There is little point cornering the builder into a position where
they will lose more money on the project and go bankrupt before it is complete.
That situation typically does not translate financially well for the developer
either.
You can afford to take a stronger stance
if the construction market has deteriorated to the extent that the contractor simply
cannot afford to ditch this project, walk away and find work elsewhere.
But your position will be weaker
if costs have risen significantly since a fixed price contract was signed. Not a lot will be achieved from
trying to renegotiate a price where all the contractors, subcontractors and
suppliers have no room to reduce price.
If you are a developer-builder,
then you might have a strong walk away position from existing contracts by
simply completing construction yourself.
Assuming there is a potential
advantage to renegotiating the construction contract (and you still want to
progress with the current builder), then consider these elements:
Can the
price be reduced? Can the main contractor contact each of its suppliers and
subcontractors and renegotiate their prices, to bring down the overall price
they are charging for this project? One way is to set a target for the
contractor to achieve. If they fail, then you will have to (or threaten to)
walk away and procure a new builder. You could bring on a new materials
supplier who wants to undercut the existing one to increase market share. What
leverage can you get over subcontractors to better their prices? Are you willing
to sacrifice some for others that are keener for the work? Are the contractor’s
profit margin and preliminaries and general excessive?
Can the
price be fixed? If you are not inheriting fixed prices, then reduce your
risk moving forward by having them fixed. Similarly replace provisional sums with
fixed prices. For example, kitchens may have a provisional sum allowed based on
concept. But that leaves the final price up in the air and open to escalation.
Either improve documentation to allow a fixed price or put a design-build
cap on the cost. It might be desirable (from a budget risk point of view) to
have a new price that is higher and fixed rather than lower and open to
escalation. Alternatively, if you are already in receipt of a fixed price, is
it fixed at a rate that compensates the contractor more than the additional
risk deserves? Savings could be available if you take on some additional
escalation risk and unfix prices.
Can
cashflow be improved? A dollar today is worth more than a dollar tomorrow,
so the saying goes. Contemplate deferring payments thereby reducing finance
costs and improving near term cashflow. Can you extend payment terms from say
weekly to monthly? Only pay for materials once they are onsite? Deduct higher
retentions? Or stage larger payments later?
Can the
contract be separated? Take the example where a main contractor on a house
and land subdivision runs both civil infrastructure works and house building. They
are mainly a house builder but subcontract to a specialist civil contractor and
in the process make a margin on that subcontractor’s price. You could split that
contract into two and remove one margin. Or you could separate out discrete
areas like landscaping or fencing. Of course, how far you go needs to be weighed
up against the additional management and coordination required as well as who
is best placed to take on the risk.
Can the
program be improved? There may be an opportunity to re-program works to
speed up delivery with more tasks running concurrently. Better payment terms
(for example, bi-monthly rather than monthly) or a completion bonus could be
just the incentive.
Can works
be staged? Is it better to stage the works rather than try and complete
everything at once? For instance, take an apartment project comprising
two buildings. The original developer had started construction on both but only
had sales to sell out one. You could suspend construction on the second
building with the intention of moving any purchasers to the first.
Can the
builder take on more risk? The existing contract may be a fixed price
contract based on the documentation supplied. You may consider it better given
your project circumstances to have the contractor take on design risk and run
the consulting team themselves. Or as described above, are you better placed to
take on more risk and reduce the builder’s role?
Can you
make the contract terms developer-friendly? Who knows what motivation and
pressure the original developer was influenced by when they signed up the
construction contract. This may have been the only builder the developer could
find to work with them and the contract may reflect that. Do liquidated damages
exist at a suitable level of penalty? Has the contractor provided a bank or
performance bond? Is quality carefully
defined? Are there processes to minimize variation claims and extensions of
time?
Fee Agreements
Your ability to renegotiate fees with existing consultants
will depend on the current resource demand in the market place and if they have
any outstanding debt owed by the previous developer. Do they have something
better to get on with and cut their losses on this project? Or is there an
incentive to claw back fees now you are in charge? Ascertain just how crucial
this consultant is for the project moving forward. You don’t
want to get over aggressive, have the consultant leave but find out later you
still need their design statements or other certification to complete your
project. When renegotiating, look at reducing the price, speeding up the
program of deliverables, having more senior staff involved at the same price,
having more delivered for the same price, securing higher professional
indemnity and liability insurances and securing better rights to intellectual
property.
Consultants might be convinced to
take an ownership stake in lieu of fees.
If you are taking over an office development, why not offer the
architect space for their business at a discounted lease term in lieu of not
paying any further fees? At a minimum you save leasing commission and you fill up part of the building.
Sale and Purchase or Lease Agreements
What rights do you have to renegotiate existing agreements
to buy or lease? There may be a force-majeure clause or other condition that you can call
upon as a valid reason to negotiate. If you have the right to quit contracts
(such as in a liquidation) are you assured of making more money by securing new
contracts? Or is it better to continue with existing ones?
Your negotiating position is
stronger when the market has improved since the agreement was signed and you
have the right to terminate the existing deal. Of course, you don’t have to
terminate, you could simply go back to buyers and ask for a price increase.
Only if they refuse do you terminate. Even if the right to terminate is not
black and white, you might get purchasers to agree to a price increase if you
plead your case. This is more likely for the more emotive residential home
purchaser[1]
than for an investor and definitely not for a commercial lease (where they are
much more likely to simply lawyer up and fight for their position). Consider
this example:
You are taking over a 100-unit
apartment project where the average sale price was $1,000,000
and 90 sales have been made. You have the legal option to terminate contracts. At
that price there is zero profit in the project because of delays and budget
overruns. You need 20% more income to make the project work. The real estate
market for apartments has appreciated by 25% since these contracts were signed
with buoyant (but not rampant) demand. Canceling all contracts and
reselling for an average of $1,250,000 is an appealing option as that now puts
the project into a fundable position (you can secure a bank loan to complete
construction). However, securing another 90 contracts will take time and
marketing expense. Plus, the risk is the market turns south. Rather than cancel
contracts, you determine the best option is to ask existing purchasers for a
20% increase — they are still buying under market value and you can get the
project to work. Through a lot of face to face meetings and difficult
conversations[2] you get
50 buyers to agree to this increase, have to terminate 30 and agree to a
smaller 10% increase for the remaining 10 buyers. You then sell the originally
available 10 units plus the terminated 30 for a higher than expected average of
$1,300,000. These sales though do take some time and the market appears to be
flattening out with the final few sales as low as $1,200,000. That achieves an
average sale price of $1,230,000 — just enough to convince funders and continue
the project. Whilst some money may have been left on the table, the risk of
selling the entire 90 units was too great.
When asking for more money,
understand the implications from a public relations and marketing perspective. Asking buyers for
more money, contrary to their original contracts, is not the best look. As I
have experienced, you can find yourself as the developer villain in a local
news article. Framing the increase as the only way the project will proceed may
get a more sympathetic reaction — providing your assertion is justified and buyers
remain in profit.
There are other items that can be negotiated
with buyers and lessees. Sunset dates and other deadlines, which because of the
current delayed state of the project, cannot be met and will need to be
extended. Additional works that the purchaser has requested may no longer be
feasible. Warranties and guarantees may need to change. Design changes may be
required, contrary to what the purchaser has originally signed up to. Whether
you need to make concessions to obtain agreement or can take a firm line will
depend on who holds the contractual negotiating power. That will be you if you can
walk away and they have signed up at a below market rate (that presumably they
want to keep at least some of that windfall).
Finance Agreements
Are you coming in with your own equity and debt financing or
are you looking to take over existing financial obligations? If you are looking
to take over existing financial obligations, then what you can negotiate will
depend on where those financiers currently stand in relation to their security and how much you need their money. Once again,
who knows what predicament the original developer was faced with when they
sourced financing. They could have agreed to exorbitant fees and interest rates
because no one else would fund them. If you are the financier’s best hope of
recouping their investment (let alone the interest) then they may be very
motivated to work with you. To help them out of this project, you might be able
to secure a very low interest rate moving forward. The existing situation could
be so poor that you can get them to write off some of the principal and reset
interest on a smaller balance. Or if you have secured funding from other
sources at better rates and more favorable terms, you might be able to buy
existing financiers debt out (at a discount of course!).
Financiers
might entertain swapping debt for equity. This transfers a debt
obligation where the developer must pay interest and return principal to the
lender irrespective of how the project goes, to an equity stake where the
financier only gets their money back once the project is complete and there is sufficient
profit to pay for it.
Alternatively,
there may be existing equity holders whose original investment is now severely
depleted. To regain some of that back you could negotiate their shareholding
down. Or convert their equity with expensive preferred returns and profit share
into debt. Contemplate offering (or
forcing) financiers and investors ownership into the final product. For
example, in a housing development rather than the project having to pay an
interest rate it can’t afford, an investor’s loan repayment is restructured
into receiving a completed home. This also helps you sell down the project.
With complicated projects can come
complicated existing financial arrangements. For such projects in trouble,
navigating the existing financial arrangements can be like opening Pandora’s box. However, whilst securing a
project where all previous financial interests have been eradicated is cleaner,
you can lose unique opportunities to maximise value.
Throughout any renegotiation,
ensure that you still maintain a good working relationship with all those involved
as there is a long way to go!
[1] Note, some jurisdictions have legislation in
favor of home buyers that prevents this.
[2] I won’t get into the details, but I have had to endure this less than enjoyable task a number of times — in lawyer’s offices, places of work with burly workmates present, cafes with professional negotiators attending and even people’s living rooms surrounded by an entourage of extended family. My approach: lay all the facts on the table, don’t hide anything and try and turn it from an emotive issue to being purely financial.
This is where you have no appetite to continue the project but
there is some work required and value to be extracted before you liquidate. Basically,
you massage the project into a stable state to make it attractive to a
purchasing developer — for a premium, of course. Preference may dictate though,
to sell the project into a joint venture. This can be a way to retain a
financial interest in the eventual (but shared) profit. The project risk
profile may be so elevated that this is a better exit strategy than a hugely
discounted sell off.
The formula to optimize your
position requires:
Stabilizing the project
Tying up loose ends
Eliminating risks
Keeping options open
Packaging documentation
Stabilizing the Project
Take to the project like an army triage doctor on the
frontlines. First, determine if the patient is dead, unconscious, or merely
wounded. Then remove them as gently but as quickly as possible from the
battleground to give yourself time to treat. If dead, then you have plenty of
time, but don’t wait too long as the body will begin to smell. If unconscious,
determine if it’s best to leave them in a coma or to revitalise before they
deteriorate further. For the wounded, remove shrapnel, clean the wound and,
most importantly, stop the bleeding. Then dispense a dose of medicine to get
them through the night.
Or put
another way stop everything that is not critical to protect your cashflow — the
blood flow. Prioritise stopping or pausing over continuing where you don’t yet
have a clear diagnosis. That applies to contracts, construction and all design
and planning work in motion.
Tying Up Loose Ends
Check all contracts. Close out those no longer needed. Amend
those that have been affected by deadlines being missed or a change in scope.
Protect warranties and guarantees as much as possible — that might require some
cash outflow. Are there some easy wins? For example, consider an office
building that is half way through leasing, but with no lead tenant. If you
spend a bit more effort securing a lead tenant, you will be better placed to increase
your sale price.
Eliminating Risks
If you have the right to terminate contracts, then get rid of
anything detrimental to achieving a maximum sale price. There may be work you
might as well complete because few buyers will be interested except at an
extremely high-risk premium. For example, completing site decontamination on a
housing subdivision until it is tested clean, or continuing works to ‘close-in’
an office building to protect it from the weather. Also address any pending
legal claims so the project can be sold litigation-free.
Keeping Options Open
Throughout the above, keep your potential buyer’s options
open. They may want to move the project in a completely different direction.
And you could be throwing money into something they see no value in. Canvas
potential buyers early so you understand as many options as
possible — even if you intend to formally list the property. But don’t force
yourself to list if you find a willing buyer at a good price during this
process. If the project is a real mess, there may only be one buyer out there. Keeping
contracts and relationships ‘in place if required’ is important. Give your
buyers every opportunity to extract any value they might find where you can’t.
Packaging Documentation
Lastly, package it all up for sale. Putting the marketing to
one side (the fluffy stuff), let’s concentrate on the documentation (the detail
stuff). It should be simple, but the number of times projects are put on the
market with deficient information is staggering. I don’t know if agents think a
lack of information will make a buyer think an opportunity is better than it
really is or that they are just lazy. From my experience, full disclosure
allows buyers to work out how they are going to mitigate the risk of the
purchase. They may only have limited resource to do their due-diligence. So drip feeding them
information, only when they ask for it, can quickly make their interest wane.
The best way is to create an online data repository with individual client access and an audit
trail of who has done what. That way you can see what potential buyers have
‘logged on’ and what documentation they have reviewed (or at least downloaded).
That helps you follow up with them and can be an immediate indicator of their
interest in buying. One tip is to rename all the files or at least folders so
it makes it easy to review. There may be hundreds of files from consultants and
councils. Unless everything is digitised and searchable by meta data and keywords
(which is the ideal) then finding what you need quickly is difficult. For
example, change xco.2022.gs.masonAve.pdf
to GeotechDesktopReport2022.pdf so it
is easier to find and for buyers to distribute to their experts to review.
All this shows you are organized. That might psychologically influence the buyer that the project they are buying is also somewhat organized and not so much of a crisis case. They gain comfort that the project is wounded, but not mortally, and they are not expected to do the triage themselves.
Continuing the project as-is might be necessary when you are
so far through construction that there is no viable alternative to make
substantial changes. You are trying to recover what you can or stop the
bleeding as much as possible. This is the case if you are working on behalf of
the lender who is trying to recover the outstanding debt on a project and the
discounted ‘fire-sale’ to get another developer
interested is too costly. So the funders decide to keep control and complete it
themselves. Alternatively, it could be that you have now acquired the project
at such a low cost that it makes it feasible to continue as-is.
When
continuing with the project in its current form you are taking on all the
positive and negative factors uncovered during your audit. Make sure you are
catching the knife by the handle and will confidently have everything under control
moving forward.
