Development Cycle and Associated Risks in the Construction Industry

Economic and property research has established the nature of the link between the economic or business cycles and the property market. According to Warren (2000), there is a strong relationship between business cycles and property cycles. Three important cycles were identified, all of which exhibit different periodicity – the business cycle (which derives the occupier market), the credit cycle (which influences bank and institutional funding) and the property development cycle its self (Wilkinson and Reed, 2008).

A property cycle is a logical sequence of recurrent events reflected in factors such as fluctuating prices, vacancies, rentals and demand in the property market. Economic cycles typically last over a decade and they influence property cycles in different sectors. Measured by peaks and troughs in performance, property cycles have durations ranging from 4 to 12 years, with an average of 8 years (RICS, 2012).

Figure 1 The development cycle

Source: (CEM, 2009b)

In a nutshell, the rise in capital values, stimulates development activity leading to competing projects in the office and industrial property sectors, as individual developers attempt to exploit the space shortfall. When the economy turns downward, the business demand for space falls with it, pulling down rental values and raising the yield that investors will require if they are to hold property. The combined effect of these two factors lower capital values and remove the incentive embark on new development projects. Nevertheless, there are lags in this chain of events, as Figure-1 shows. Economic growth can be rising sharply before it is reflected in rising rental values. Development activity may not be fully geared up until rental values have been increasing for some time. Such lags frequently result in the need for space declining before it is filled out, a common problem compounded by the duration of the construction period.

The whole process is therefore fraught with risk as failure could occur at any point due to unexpected events like the; economic crisis, oil and gas price fluctuations, inventions, government policies, wars, act of God, etc. Failure to complete buildings after the property collapse leaves the developers and creditors in financial distress (CEM, 2009b). There have been examples of boom and bust in the 1970s, 1980s and 1990s and 2000s. Due to the cyclical nature of demand for construction, tender price inflation fluctuates much more than economy-wide measures such as the consumer price index (CPI). In a relatively small construction market, with limited locally developed resources, the ability of the supply chain to absorb these fluctuations in workload is limited (Tommason et al., 2014).

Source: https://www.westcore.com/

Compared with the overall economy, the construction and development industry have a high-risk potential owing to the internal and external forces that influence the development process and the outcomes such as profit, cost and duration of a project. Many different classifications of risk have been developed so far. However, in most of these have considered source as the most important criterion (Baloi, 2012). Investors, contractors and developers look to maximise their profit even though they have conflicting requirements. The level of acceptable compromise depends on many factors, such as the financial state of the risk-bearer, their attitude to risk and the state of the economy in general.

In summary, the inflation will certainly compel the clients to control their cost overrun risks by contract arrangements with fixed price lump sum contract and amendments in price escalation clauses in the conditions of contract. Therefore, the contractors need to be equally alert to safeguard their interests to avoid business failures. These include expansion and diversification of business to other countries having different economic cycle as well as maintain a flexible organisational structure.

References:

BALOI, D. 2012. Risk Analysis Techniques in Construction Engineering Projects. Journal of Risk Analysis and Crisis Response, 2, 115-123.

CEM 2007. Risk Analysis in the Construction and Development Industry, Reading, UK, College of Estate Management.

CEM 2008. Risk Analysis Using Simulation, Reading, UK, College of Estate Management.

CEM 2009a. Assessing the Risk, Reading, College of Estate

b. Finance for - Princig, UK, College of Estate Management.

DUFFY, M. 2014. Qatar's Construction Sector Blasting Ahead in Region. Business Monitor International.

RICS. 2012. Property Cycles. Available: https://www.rics.org/ga/footer/glossary/property-cycles/ [Accessed 20/08/2013].

TOMMASON, T., DARBY, P., NEEDLER, P., RAWLINSON, S. & HIRST, J. 2014. Avoiding The Inflation Bubble Qatar Construction InflationC Harris.

WARREN, M Economic Analysis and Business, Oxford, Butterworth Heinemann.

WILKINSON, S. & REED, R. 2008. Property Development, Oxon, Routlegde.

ZAVADSKAS, E. K., TURSKIS, Z. & TAMO?AITIEN, J. 2010. Risk Assessment of Construction Projects. Journal of Civil Engineering and Management, 16, 33-46.