Contractors’ services are evolving, and with construction making up the majority of project costs, they should have a greater role in project development
by Manuel H. Lazerov
It has now become apparent that the federal government is severely cutting back on its assistance to state and local government, especially in the development of infrastructure. While this seems to be a setback to infrastructure development, the local impact may be minimal.
The truth of the matter is that small and medium sized contractors would never have benefited from the massive federal programs being considered. Also, there may actually be more opportunities for small and medium sized contractors to build infrastructure at the state and local level, which do not rely upon federal appropriations. Smaller projects also tend to be reviewed and built faster than larger ones.
There are measures that smaller builders can take that will provide them with a competitive edge. One step is to encourage their clients in the use of Guaranteed Maximum Price (GMP) contracts. GMP contracting provides clients with the assurance that the bid price will be the final price, and not just the base price, unless the client changes the scope of the work. It also protects the profit margins of contractors and prevents a race to the bottom on price. Why?
Well, the builder’s GMP fee is fixed, as is the price, which is extremely important. Before construction even begins, a developer must have locked down the construction loan, and have gone to closing. Any change in price thereafter cannot be borrowed, but must be put up by the developers – out of their own pockets. Anyone in the business can tell you how painful that is, including asking for cash calls from investors. To provide the type of assurances in a GMP contract, the fee must be adequate to do both the work and the adequate inspections required to keep the price fixed.
It has also become increasingly important to consider another step: incorporating environmentally beneficial elements into design where possible, or informally as part of a response to a request for proposal, or RFP. For the most part, today’s building codes already include most of what it takes to have a green building. Just a little thought given to a set of drawings can transform the final product into a green building at little or no expense. For the client, it may make it easier to lease and to finance. For example, there is a demand for “green bonds”, or loans for building environmentally sound buildings, which are also frequently less expensive to operate.
What’s the demand for green bonds? Or are they just a new gimmick? Well, from $800 million issued in 2007, $37 billion were issued in 2014, and, this year, it’s anticipated that $250 billion of green bonds will be issued. That’s exponential growth in an area which offers some real opportunities for builders.
Green bonds are used to finance projects which have a positive impact on the environment, including energy, buildings, and waste and pollution, to name some areas – fields in which builders already have relevant experience. Investors obviously have a strong interest in them, which should encourage builders in that direction.
There are, however, some voluntary process guidelines which contractors, building for their own account or for developers, must follow in using this type of debt financing. Aside from proof of economic sustainability, which is essential for any project, “Green Bond Principles” include four components: (1) Use of proceeds; (2) Process for project evaluation and selection; (3) Management of proceeds; and (4) reporting. The legal documentation in the bond should indicate what the environmental benefits will be, how they will be assessed and quantified, and what concerns are being addressed, such as climate change, or air or water pollution.
The issuer of the bonds must be able to communicate to investors in green bonds what their objectives are, and how the project meets the criteria of a green project. They should disclose any green standards or certifications that may be relevant to the project. It’s a process which requires a high level of transparency, which is important in letting investors know what the expected and realized impacts of a project are.
To validate what the issuers of the debt are saying, there are external reviews by consultants, who may be qualified to: (1) Address environmental sustainability; (2) Audit and verify the underlying value of assets; (3) Certify whether the bond proceeds are being used in accordance with certain externally defined green assessment standards; and (4) Give ratings. A full or partial disclosure of third party evaluations is encouraged in helping to sell the bonds to investors.
Builders should consider aligning themselves with organizations which provide financing, which can include both green bond or traditional financing.
All of this suggests that contractors’ services are evolving, as is their ability to increasingly shape their futures even more than in the past. For example, software is available for preparing GMPs. The active measures that builders take, such as bringing financing to smaller and medium sized projects, helps clients to better coordinate their activities, such as a design and a construction budget, and to maintain them. With construction costs totaling 80 percent of project costs, there is no reason why they shouldn’t be seeking a more prominent role in project development, and locking in bigger profits for improved services.
Manuel H. Lazerov is president of Infrastructure Financial, Inc. providing tax exempt infrastructure financing. He can be reached at email@example.com.