Why Many Projects Fail – How to Manage Your Liquidity During a Construction Project
In many years of financing construction projects, we have seen a small number fail, and all have had the one common denominator – lack of liquidity. In contrast, we have seen all sorts of problems occur on sites, including builder liquidations, structural issues, water and granite rock being discovered after construction has started, and difficulties with councils and authorities signing off. However, in every case where the developer had the funds to cover overruns, they still got out of the project ok, often with a good profit level. This is why liquidity is one of the most important factors to consider when going into a project.
Here are some strategies to follow when starting your project to make sure that you are managing your liquidity to the best of your ability:
Detailed Forecasting and Budgeting
It would help if you weren’t going into any construction project without detailed modelling on the likely costs. Include all project costs and be conservative with stress testing for potential overruns. If the project can’t handle a 5% increase in costs, then you likely need to consider if the project is worth pursuing. Some key areas often missed in feasibilities and modelling are council contribution costs, landscaping and other items external to a contract, and unfixed items such as lifts that aren’t funded until fixed.
Carefully Select Builder
Undergoing cost management is important in ensuring a project is profitable, but sometimes the lowest quote is not always the best. Some builders will quote low to get a job, but when construction starts, you will be hit with continued overruns and delays. Conducting a solid level of due diligence on the builder, including reviewing previous jobs and getting references, is just as important as the costs during the tendering process.
Maintain Extra Project Contingency Reserve
Any typical loan facility will contain a 5% contingency reserve for construction. However, a developer should maintain access to a source of funds above and beyond this in case of high overruns and delays. Whether this be a working capital facility, a redraw facility on loans against other properties, or cash being held, at least another 5% of the construction budget should be a buffer.
Borrower More Than You Need
If a project has a good amount of capital, it is tempting to borrow a lower amount to cut funding costs, but the flip side of this is that if your circumstances change and you are relying on outside sources of capital that may or may not eventuate you can be left short. As long as you have a facility with no line fee a fee that is charged on the loan limit rather than the progressively drawn amount), there is little cost to ensure you borrow as much as possible within reasonably priced lending parameters.
Top of Form Managing liquidity effectively is a key component to a successful developer. Hopefully, these tips help guide you in the right direction for your next project.