Summary: In this BLP Expert Insight, Adriano Amorese considers the current market for industrial floor space and the key legal and commercial considerations that developers need to bear in mind when procuring "big sheds".
Big sheds (by which I mean warehouses, logistics hubs, fulfilment centres and the like) are hot property right now. Industrial floor space is in short supply due to the slowdown in construction during the last recession, and demand is exceptionally high due to the rise of e-commerce and online retailers promising ever-shorter delivery times. Recent reports suggest that over 1.3m sq ft of additional industrial floor space is required each year in London alone, where just eight months’ of supply remains based on current levels of take-up.
This unprecedented demand coincides with a weak pound, which has caused an uptick in overseas investment, and prevailing market uncertainty (whether due to the EU referendum, the general election or simply our position in the economic cycle) that appears to be driving investors towards “safer” alternative assets such as light industrial, build to rent and student housing.
The role of technology
Commentators are already predicting that technological advances (including 3D printing, predictive analytics and autonomous modes of delivery – drones and driverless lorries) will eventually drive down levels of demand for industrial floor space. However, these technologies are still some way off, so for the time being it is expected that developers will continue building to serve the current levels of demand and investor appetite across the sector.
Staying on the subject of technology, while big sheds are relatively simple structures, those developing them have been quick to embrace new technologies in a bid to attract sophisticated retail tenants and deliver the sustainable and “future proof” environments they desire. This is beginning to change the way in which big sheds are being designed and constructed. A recent example is the use of photovoltaic panelling and battery technology from tech innovators, Tesla, as an alternative (not supplementary!) source of power. It is hoped that applying this technology will deliver cost savings to occupiers (by allowing them to avoid spiraling utility costs) as well as bolster their green credentials. Reduced reliance on local utility grids will also mean greater flexibility in terms of location.
Key issues for developers
So, what other issues should developers be considering when procuring big sheds, particularly where, as is increasingly the case, they are being built to order as part of a pre-letting arrangement?
Programme is the big one. The urgent need for floor space, coupled with the desire to be operational ahead of peak trading periods, will often lead occupiers to insist on aggressive and immovable completion dates, with the usual sanction of delay damages for late completion and the right to walk away if completion is not achieved by a pre-agreed longstop date. Recent caselaw has opened the way for claimants to seek “enhanced" liquidated damages where there is compelling commercial justification for doing so. In any event, developers should always ensure that the pre-let agreements and building contracts they enter into give them adequate protection from the consequences of late completion. This may be done in any one or more of the following ways:
- Ensuring that the developer is entitled to extensions of time for matters which are beyond its reasonable control (including tenant variations and acts of prevention).
- Ensuring the liquidated damages payable under building contracts are sufficient to cover the damages which may be demanded by occupiers, as well as any other losses the developer may incur as a consequence of late completion; similar considerations also apply to the achievement of target floor areas and the liquidated damages or rent adjustments that may be triggered by any shortfall.
- Creating a buffer by fixing an earlier date for completion and narrower grounds for extensions of time under the building contract than under the pre-let agreement.
- Building enhanced rights to instruct acceleration into the building contract.
- Agreeing financial incentives (for example, bonus payments) to encourage the contractor to achieve an earlier completion date.
In addition to avoiding liability for delay damages, developers will also wish to realise a return on equity at the earliest opportunity. It is therefore important that developers are given the necessary contractual machinery to safeguard their programmes; for example, by restricting the scope of tenant variations and/or the periods within which they can be requested and by allowing certain developer variations, such as the substitution of materials of equivalent or superior quality, to be implemented without occupier consent.
Flexibility is another key consideration
As construction projects go, big sheds are comparatively quick and easy to design and build. However, technological advances and evolving floor space requirements may call for a procurement model that can accommodate tenant variations without adversely impacting price or programme. Two-stage procurement can help in this regard. Done properly, it should allow developers to prioritise certain packages and leave other packages or design decisions until later in the tender programme without jeopardising the start on-site date. Pre-agreed variations (namely, variations, the cost and time implications of which are agreed with the contractor upfront) is another good way of preserving flexibility while maintaining cost and programme certainty.
What about defects?
Big sheds are not especially complex structures and the scale and intrusive nature of occupiers’ fit out works can often conceal, or make it difficult to pinpoint, defects in the developer’s base building. However, a feature that does merit further consideration is the stability of the concrete slab around which most big sheds are constructed, which is critical to the correct operation of occupiers’ plant. The size and expansive nature of these slabs makes them prone to failure, often as a consequence of the ground conditions on which they are constructed, and this can have serious and costly implications for occupier productivity. Developers should therefore ensure that the performance requirements (load bearing capacity, maintenance levels, life-cycle and so on) which the concrete slab must meet are clearly stated in the building contract and that the contractor warrants, ideally without qualification, that those requirements will be met. An incremental testing regime is also advisable to ensure that any issues are identified and addressed as early as possible. Well-advised developers will also seek appropriate limits on their liability to occupiers for any defects in the base building, both in terms of time and, ideally, in scope (for example, by excluding liability for loss of profit or productivity).
Unforeseen ground conditions
There is also the perennial question of who, as between the developer and its contractor, will bear responsibility for the delivery risks associated with unforeseen ground conditions. Big sheds will often be constructed on sites that have previously been used for other industrial purposes, so the risk of encountering unforeseen obstructions and other adverse ground conditions can be material. Developers will need to assess these risks on a case-by-case basis and decide whether or not it makes commercial sense to pay their contractors to bear responsibility for them. Again, early contractor involvement may be helpful; giving contractors an opportunity to interrogate design and site information and carry out their own investigations should allow them to price risks more intelligently. Tenants fitting out industrial properties (or developers refurbishing them) should refer to my blog Refurbishment projects: scratching beneath the surface for ideas as to how they might transfer to their contractors the delivery and performance risks associated with existing structures.
One final point to consider, given the current investment appetite for big sheds, is exit strategy. If a corporate sale of the asset is anticipated, would it make sense to ring-fence development obligations in a separate vehicle, so the target property company remains clean? Similarly, developers disposing of assets on or soon after practical completion/occupation should consider how and by whom residual obligations such as the rectification of defects, settlement of final accounts and release of retention monies will be managed.
This article first appeared on Practical Construction Law Blog on 14 June 2017.