The unfavourable real estate market environment is forcing the hand of investors: if they want to realise their projects, they need to make significant cost reductions in the construction process, in addition to the overall technical content. One possible solution may be a construction management service, which tenders and contracts subcontractors separately by specialised field instead of a general contractor, allowing for a more flexible handling of market changes and already getting the best prices at the construction stage. Demand for this model has been growing, and has increased significantly over the past couple of years, which is no wonder, as it can save investors a considerable amount of money. Price competition in the market is increasing, with large domestic contractors now having to face international competitors on larger orders. Portfolio interviewed Beatrix Csallóné Reigl, Business Development and Communication Director of engineering services 3E Group, about the challenges facing the construction industry, the benefits of construction management services and the emerging foreign players in the market.
3E Group, as an engineering services group, operates in the major construction projects market and therefore, has a broad overview of all segments of the construction industry. What are the current trends shaping the performance of the sector and what can be expected in the coming period?
There has been a clear decline in both the number of projects launched and the value of investments. Within the industry as a whole, industrial and logistics investment projects are showing the best performance, with the automotive sector and related developments providing a big boost to the segment. There are also positive trends in the case of warehouses, distribution centres and logistics facilities, but even these cannot offset the major downturn in residential and office real estate and state investment projects. In the tourism sector and office investments, we see some sporadic development, but overall there is not much activity. The negative trend is no coincidence. The economy has been in recession for 3 quarters now, and the high base rate is both making it significantly more expensive to finance projects and reducing the creditworthiness of buyers, leading to a fall on both the supply and demand sides. The costs have increased enormously, whether it’s raw materials, other variable costs or energy. It is very difficult to manage these factors in parallel, and thus it is no wonder that many investors are taking a wait-and-see stance, reconsidering the need for investment or completely changing the organisation and structure that supports investment. The ability to accurately calculate costs, monitor costs and reduce costs has become extremely valuable.
What is the reason for industrial and logistics real estate investment projects continuing to soar?
The market has high confidence in the growth of e-commerce, and big box warehouses all believe that additional warehousing capacity will be needed. There are numerous large international companies that, thanks to their advanced infrastructure and geolocation, are setting up their regional logistics centres in Hungary and supplying their European partners from here. In Eastern Hungary, around Debrecen and Nyíregyháza, a new automotive stronghold is being built, with many foreign companies arriving and attracting a large number of suppliers. They all need new industrial buildings for production, and they have already run out of properties to renovate and expand.
The office market has not stopped completely either, and in Budapest, for example, more people are seeing the potential in the area around the MOL headquarters. There are niche markets, but now there is more competition, more price competition for any given project. These are exciting times, but we have no reason to complain, we are optimistic.
What project management models can investors consider? Do they have any option other than to contract in the traditional fashion with a general contractor which will deliver a turnkey building to the developer?
In the traditional real estate development model, an investor assesses the business opportunities, obtains financing, purchases the targeted development site, clarifies the construction law frameworks, has the building designed with an architectural firm, and then has it constructed by a general contractor with the help of a project management and/or technical inspection organisation. Additional new players then emerge in the sale or other production processes. To date, a significant proportion of investment projects have been realised using this methodology. However, changing market conditions are often pushing real estate developers towards so-called construction management solutions.
The idea is not to have a general contractor build the building, but to split the construction into specialised segments and tender these separately. This is where the aforementioned construction management service comes in, as part of which tendering, the evaluation of tenders and coordination of subcontractor work is carried out. This is advantageous for an investor, because in the traditional model, once they have agreed with a general contractor, the players are entrenched, and they can’t really replace the general contractor during construction if there are any problems.
An offer for full construction must already include all the items that are part of the assignment. These already include the cost of installed sanitary ware, flooring, finishing materials, even though not even a minute of earthwork has been carried out. This also implies that the entire planning and design process must be completed, and the budget must be fully available.
Consequently, for example, earthworks and civil engineering cannot commence because the full design documentation is not yet available. This can lead to huge losses of time and, in some cases, money.
However, in a construction management model, it is sufficient to have final plans for a given construction phase, rather than waiting to start construction because the finishing touches on the plans are not yet finalised. This can also lead to significant time savings.
On the one hand, it saves the time taken to choose a general contractor, which usually takes one and a half to two months. On the other hand, the first phase is launched immediately, without an implementation plan. On the basis of basic statical data, the deep foundation work, topsoil removal, and the tendering and selection of structure manufacturers and foundations companies are launched. Progress can be made with set-up works, landscaping, large-scale earthworks and on-site organisation, while the design and planning can continue.
Moreover, if the investor divides the construction into sections, then if one of the subcontractors fails to deliver during the process, there is more flexibility to intervene and make replacements. In the classic model, it can take weeks or months for the investor to receive information about a given problem, because the general contractor will try to solve it first. By the time the investor is informed of a serious difficulty, there is bound to be a delay, which is painful in terms of time and/or money. In the construction management model, these situations can be handled more flexibly and smoothly, and in our experience, the savings can be measured in percentages.
I am by no means claiming that the construction management model is better or worse than a traditional investor-general contractor relationship, but it is certainly useful and gives developers more certainty and flexibility if they have a choice. The construction process can be broken down into as many as 8-15 specialised sections, with the investor having the possibility to intervene at many points and the flexibility to adapt to current market conditions.
A general contractor, though more static, also offers substantial guarantees, even undertaking penalty payment obligations. It has well-established subcontractor relationships and is generally seen as a reliable partner. How can a construction management company offer such guarantees? Does this not increase the investor’s risks?
The guarantee is offered to the investor in the same way, but from several contractors. This means that during the warranty period, this requires extra care, as 5-8 companies have to be notified of faults. However, the good news is that the operator can typically easily identify which company is responsible for the given fault, and usually there are no problems in this regard. If required, we can of course also support this process, or take over if necessary. In all cases, the choice is based on weighing up the pros and cons, but the cost and time factors mean that the pros have recently tended to outweigh the cons.
In the current market environment, the role of cost planning and cost monitoring in an investment project has become extremely important. Today, it is no longer acceptable for contractors to work with a 20-25% margin. Think about it: the general contractor prepares a quote this year, which already includes the price of the materials for the final construction phase. Seeing the price variations over the past 1-2 years, how could they know how much bathroom tiles will cost in 2-3 years? The general contractor cannot know, and draws up the prices to ensure that it will definitely not lose money over 3 years.
On the other hand, we always tender every specialised segment in the market, always at the best time, and get the best prices and terms available. It may also happen that a firm frees up capacity at a given time and offers a service at a better price, such as structural work or scaffolding. With more than 300 projects realised in almost 2 decades of operation, we are in contact with all the players in the market and have very solid references.
The construction management model is not necessarily the solution to every challenge, and sometimes it may be better to use a general contractor, in which case we can provide a classic project management-type service, complemented by technical supervision. There are a number of criteria that an investor can use to decide which solution is ideal for them. There are developers that have a certain amount of money at their disposal, and what is important to them is that the money is actually sufficient to implement the project. There are those who want to pinch every penny and realise the investment from the lowest possible amount. One is better served by a general contractor model, the other by construction management.
What is the experience in the market, is there a shift towards one model or the other?
Current market conditions are clearly driving investors to keep their costs as low as possible. The construction management service can be a great help in this, we see that more and more firms are interested in it, and in the last two years there has been a significant increase in interest in this direction. Of course, the general contractor model is still more common, but there is also interest from companies that until now have exclusively worked with a general contractor.
It is also not uncommon for an investor to switch from general construction to the construction management model during the implementation process. For example, we had a major logistics project, where we switched from classic general contractor project management to construction management. 3E provides all types of services, the key is to give the client a choice of options and to find the best solution for them.
Changing market conditions have made cost optimisation increasingly important, and price competition between contractors is growing. In the past few years, large Romanian and Turkish general contractors have also entered the Hungarian market, with significant price advantages. Do the big Hungarian construction companies have anything to fear?
Indeed, there are some companies that bid extremely low for construction projects in a tender, but these are not always able to construct the building to the expected standard and in accordance with the commitments made. We have seen several negative examples of this in the market recently. There is a price level below which all offers are suspect. We know that there are big players that are able to do this for market acquisition purposes because they have the capital to do so, but that is not the case generally. That said, I think that price competition is indeed heating up, and Hungarian companies definitely need to move forward – especially in terms of technological developments – to stand their ground.