Summary

The first of our 2010 quarterly updaters on the hotel and hospitality sector focuses on the different procurement strategies for constructing a hotel and the associated risks with each method.

Unique Asset

The usual risks associated with the construction of any project also apply to hotel construction, however, hotels are a unique asset and require extra consideration when embarking on a particular procurement strategy. Luxury hotels are extremely design intensive; layout, interior design and fixtures and fittings are all critical to the successful operation of the hotel and ensuring a steady revenue stream once the hotel is up and running. In addition, hotels are usually operated by a separate entity to the developer, one with experience in the industry and who can bring a “brand” to the hotel. With this brand will come very specific design requirements and demands which mean it is crucial for the developer to retain design control over the asset.

Contrast with this the need to ensure the hotel is built on time. If completion is delayed so are revenues and as luxury hotels are frequently being built to coincide with the staging of international events, delays are not an option. The new Yas Hotel that sits across the Yas Marina Formula One Grand Prix Circuit in Abu Dhabi is a prime example of this.

To balance the need of design control against fixed completion dates careful consideration must be given to the correct procurement method.

Construct-Only

Using a construct-only contract procurement strategy, the developer will appoint its own design team enabling it to retain complete ownership and control over the design throughout the life of the project. The design team will develop the design from concept through to detailed design and then the construct-only contract will be issued to tenderers. The successful tenderer will be responsible for the construction of the hotel but with no design responsibility. This will enable tenderers to bid a lump sum price at a stage when the design is complete. This method allows the developer to preserve the integrity of the design and will drive down cost as the contractor takes on less risk.

However, a construct-only method can have significant impact on the timing of a project. Until the design is finalised no work can begin on site - design development can take a number of months if not years to complete, then the tender process will begin and finally the contract must be awarded before any actual work can take place. If the developer has a tight timeframe to stick to this may not be a viable option.

In addition, if the developer requires finance, lenders will be put off by a construct-only procurement method. Lenders look for a single point of design and construction responsibility along with time and cost certainty when assessing the bankability of a project, a construct-only contract will not provide them with this.

Design Build

Under a design build procurement, the developer will retain its own design team to develop the concept and possibly schematic design. Once finalised the design-build contract will then be issued to tenderers. The successful contractor will take all design responsibility upon execution of the contract, usually by way of novation of the design team from the developer to the contractor. This will allow the contractor to continue to develop the detailed design whilst work can begin on site.

The advantage to this procurement method is that works can begin earlier and, as the contractor is taking on design responsibility, it limits the risk of extension of time claims due to design error. However, this increased responsibility will be priced into each tenderer’s bid and the developer will generally lose the crucial design ownership and control. The finished design of a hotel is an important consideration for developers; operators will demand certain standards and these are unlikely to be clear until the design is further developed. Any significant changes to the design introduced by the developer or operator after issue of the contract, will result in increased costs and extension of time claims. Developers can mitigate the consequences of losing design control by appointing a team of design monitoring consultants to try and ensure that design standards are maintained. However, this is not perfect and the interference of monitoring consultants can result in time and money claims from the contractor.

Construction Management

An alternative method is the construction management route. Under this method a construction manager is appointed who will advise the developer how best to split the works into various packages and tender each package. The developer will then enter into separate contracts for each package of works and the construction manager will manage the process. This will enable pre-construction services and enabling works contracts to be let whilst the design for the full hotel is still being developed. Once the design is complete a contract can be issued for the rest of the works or this can be further broken down to distinguish between sub and super structure and fixtures and fittings.

This method will give the developer a greater degree of control and flexibility whilst maintaining design ownership. The developer, in consultation with the construction manager, can decide when and how to instruct additional works packages to ensure the project continues to progress. The significant disadvantage of this method is that developers will not have a single contractor or consultant responsible for time and cost. Pinpointing responsibility for any errors to an individual contractor could be costly and time consuming. It was an extremely popular method of procurement in the United Kingdom; particularly in the hotel sector but has gone out of favour owing to problems experienced on some high profile projects - the Great Eastern Hotel in London being one such example.

As with construct-only contracts this will not be an attractive procurement method for lenders as there is no single-point responsibility. It should also be noted that construction management should only be undertaken by developers with significant in-house construction expertise as it is a resource intensive procurement process form a developer’s perspective.

Two-Stage Tendering

The two-stage tendering method is becoming an increasingly popular procurement strategy for developers across a wide range of sectors and lends itself particularly well to hotel procurement. Under the two-stage route a contractor will be appointed early on in the design process to carry out pre-construction services whilst the design is further developed. These services may include procurement of sub-contract packages and long-lead items, assisting the developer’s design team to further develop the design and even some piling or enabling works.

This will allow the construction process to begin whilst the employer still retains design ownership. It would also enable the contractor and developer’s design team to adopt a collaborative approach to develop a design that takes account of the contractor’s views in relation to buildabilty, sequencing and sub-contractor selection without the developer relinquishing control.

Such a contract would be let on a guaranteed maximum price basis to ensure cost certainty for the developer during this time. Once the design has been sufficiently developed the contractor will enter into either a construct-only contract or a design and build contract with the developer (whereby the developer’s design team would likely be novated to the contractor). This would be priced on a lump sum basis which would be reached through negotiations between the parties or through a pre-agreed formula set out in the pre-construction services agreement, usually based on the aggregation of sub-contract packages and the percentage for overheads and profits proposed by the contractor upon entering into the pre-construction services agreement.

This strategy will enable developers to retain control over design, whilst providing cost and time savings. From a cost perspective, by tendering the project in two distinct parts the developer is able to engage the contractor early and achieve a fixed price at a later date when the design is finalised. From a programming view, sub-contractors and long lead items will be procured earlier on in the process to avoid delays and certain early works can be carried out before the design is complete. Most importantly this strategy allows the developer to preserve the integrity of the design which is crucial to the future success of the hotel.

Conclusion

Given the importance of design when developing a hotel the construct-only procurement strategy is likely to continue to be the method of choice for developers, as design ownership will normally outweigh time and cost considerations. However, it does have its drawbacks and where design control is not of paramount importance the other strategies will provide the developer with more time and cost certainty and the single-point responsibility will ultimately make the projects more attractive to lenders.