Inflation is already an issue!
My last newsletter raised the issue of inflation – and the risk that it will be higher and more persistent that most commentators seem to expect.
Whilst I don’t want to intrude in the arena of politics, it is ironic that the response of both major parties to cost of living increases seems to be to borrow or print money to give to the public to offset higher prices. Our politicians seem oblivious to the reality that money printing and deficits are a key contributor to inflation!
This is one reason why I also suspect that interest rates will be higher than expected.
In response to a query raised by a client, in this newsletter I will explore 4 case studies illustrating how inflation is already directly affecting many of our clients and the sort of issues that this is creating. The point being that if you are active in the property market there are already issues to look out for – and issues that we haven’t seen for a long time.
Case Study 1 – Building Contract Escalation Clauses
Many builders have been burnt by issues with the availability and prices of construction materials. Over the last year or two we have seen shortages of key materials as a result of covid supply chain disruptions and a booming building industry.
An extreme example of this is the recent insolvency of a number of larger builders. However, many smaller builders have also either lost money or had their profits reduced. (As an aside ensuring that your builder has the financial resources to complete your job is more important than ever).
As a result, we are commonly seeing builders ask for special conditions in domestic building contracts. These conditions seek to allow the builder to pass on material costs or extend the construction period.
Cost escalation clauses can be tricky. To make them work the anticipated cost needs to be documented so that price increases can be calculated. In addition, if you are relying on a construction loan these sorts of clauses may not be acceptable to the lender or may mean you as owner need to fund these increases yourself. Few of the clauses I have seen to date have been carefully drafted.
In some cases we are seeing more extensive lists of prime cost or provisional cost items – which also transfer the risk of price increases onto the owner.
The clauses that allow the builder to extend the construction period are probably unnecessary. The standard contracts allow the builder to seek extensions of time where the delay is caused by factors outside the builder’s reasonable control.
As always, if you or someone you care about is planning to sign a building contract please contact us to have the contract reviewed.
Case Study 2 – Builder Terminating Contract
Over the last 20 years I have seen few cases of builders terminating contracts where there is a delay commencing work.
This is now becoming a real issue. If your commencement is delayed as a result of funding delays, permit delays or other issues your builder may look to terminate the contract in an environment where the cost of materials and labour is increasing.
This requires owners to be much more aware of the conditions that need to be satisfied before construction can begin. Owners also need to be diligent in getting these conditions satisfied as quickly as possible – failing which the builder may terminate the contract and then seek a higher build price.
Case Study 3 – Terminating Off the Plan Contracts
The termination by developers of off the plan contracts has been a contentious issue in recent years. The press routinely blame greedy developers for terminating off the plan contracts with blameless first home owners simply to resell at a higher price. Both politicians and the press seem uninterested in the source of the delays – often painfully slow local government processes which increase developer costs.
However, we are now seeing a subtle change.
One developer had presales in place that the developer wanted to terminate. The issue was that both construction costs and property prices had increased since the contracts were signed. This meant that the developer was unable to get finance approval as construction prices had increased since the feasibility study was done whilst the contracted sale prices had not.
Fortunately, the off the plan contracts we drafted for the developer will allow the developer to terminate the off the plan contracts if funding cannot be obtained. The developer is still likely to have to pay agent’s fees in respect of these sales. (Another aside – are you are aware of your obligations as vendor under the standard Agent’s Sale Authority?)
These sorts of unexpected problems will test many off the plan contracts. If you are selling off the plan you need to make sure that yours is carefully prepared by a professional!
Case Study 4 – HomeBuilder Issues
Many homeowners signed up to new building contracts expecting to qualify for HomeBuilder Grants. We are starting to see cases where builders are defaulting under these contracts. The result is that clients are facing the loss of substantial HomeBuilder Grants as well as increased costs if they have to find a new builder.
Concluding Thoughts
Inflation and its consequences have barely begun. However, we are already seeing substantial changes and impacts in the property market.
If, as expected, interest rates rise, I expect that the number and type of these sorts of issues will only increase.
If you are entering into a building contract or any other property development contracts you need to ensure that you have the right advice and address these sorts of risks before you sign.
You can schedule a time for an initial consultation with me by clicking here. In a property world that is ever more complicated – you need an ally that is unambiguously on your side!
Lewis O’Brien