In spring 2020, as the gloom of the first lockdown shrouded the UK, millions of Britons turned to their computers for some retail therapy.
The irresistible rise of online shopping is nothing new. Accounting for under 5% of total retail sales in 2008, that proportion climbed to 16% in 2017 and, despite economic uncertainty, lockdown only reinforced that trend. Demographic groups traditionally wedded to the high street were compelled to shop online and, as a result, mid-2020 saw all retail sectors reporting year-on-year growth in online sales, with an average increase of almost 53%. In May, online sales soared to a record 33% of total retail sales, falling only slightly to 28% as shops reopened in the summer. In less than three years, the scale of growth in online sales had outstripped the previous decade.
The effect of online retail on the property industry goes far further than just the high street. Along the arterial routes which transport people and goods into our cities and regions, a new generation of industrial building is rising from the ground – behemoths dedicated to the efficient distribution of goods to satisfy increasing consumer expectations and afford resilience of supply. No longer mere hangars for piled-high storage, modern built-to-suit distribution hubs are the sophisticated infrastructure underpinning both the retail economy and, increasingly, investment value. But within that market there are growing tensions between developers and a new powerful occupier class. Key among them is timing for delivery.
Occupiers driving delivery
Unsurprisingly for an industry committed to rapid service, logistics operators signing into agreements for new buildings aim to minimise programme flexibility, relying on developers to use their expertise in setting out and adhering to fixed development timetables.
That approach is not without reason. As occupiers approach developers for new units, they are preparing for the future, anticipating the requirements of their market years in advance and targeting a capacity able to respond to expected consumer demand. Delays in the handover of new buildings may impact directly on their ability to service their market and, accordingly, on revenue and market share.
But the losses for late delivery may be more direct. The operator may be moving from existing premises and, if so, it will want to time its relocation to minimise any overlap in occupation costs while ensuring it is never left without a building to occupy. In some cases, the need for the new building will be driven by a commercial distribution agreement, under which the operator benefits from exclusivity in providing services for a key supplier, but commits both to create and operate the real estate infrastructure supporting that agreement. If the developer is late in handing over a building, the consequences for the operator may be significant, in having to seek emergency short-term space or in suffering financial penalties imposed by its ultimate customer.
So the occupier looks to the developer to manage the risk of delay, policing compliance through a rigid timetable backed by penalties in the form of liquidated damages or enhanced rent-free periods.
Developers managing risk
For developers, identifying and mitigating construction risk is an accepted part of the job. Developers are used to assuming the consequences of delay caused by factors categorised as “developer risk”. These include, for instance, ground conditions, since the developer will normally have carried out and interpreted extensive ground investigations as part of its design due diligence before making binding commitments as to cost and programme.
But there is a difference between managing risk and underwriting it, and most developers will be reluctant to accept liability for delaying factors they could not reasonably be expected to control. Here lies the tension – who carries the loss if development delay is caused by issues neither developer nor occupier can control? Common examples we are seeing give rise to significant negotiation include:
• Delays in associated works: what happens to the programme if delays result from off-plot works carried out by a highway authority or statutory undertaker? The nature of new logistics sites means they will often require significant infrastructure improvements – a new junction from a major road or an upgrade to the local network to supply the energy needed for power-hungry technology. These works will be critical to completing the overall project, and yet the involvement of third parties who are likely to insist on contracting on their own terms removes control from the developer’s hands. In the current construction market, main contractors will resist, diluting their right to an extension of time and additional costs for such delays (especially as the developer will be generally employing these entities directly), and if the developer’s obligations are not qualified in the same way, it is the developer who will suffer the loss. “Developer’s risk” the occupier may say, but it’s a risk the developer can do precious little to alleviate or control.
• Contractor insolvency: what then of the main contractor? In any development project, the contractor’s financial strength is critical to developers, funders and occupiers. Increasingly on larger projects, occupiers seek a right to approve the contractor’s identity and regulate the terms on which the developer will contract with it, acutely aware of the need for robust rights of recourse against the contractor to offset the liabilities of a full repairing lease. But if the contractor goes bust midway through the build, programme implications are inevitable. If the occupier has shared responsibility for approval of the contractor, should the developer then be penalised for appointing the occupier’s choice, especially when the developer no longer has a contractor on whom to offload liability? Also, if the occupier is insisting on certain terms being used to employ any replacement contractor, then should the developer take the risk of the additional delay this may cause to the programme?
• Legislative change: within its construction obligations, the developer will commit to procure a development which meets statutory requirements. Yet even these are subject to change. Sudden and unexpected failures of materials, or tragedies which reveal the vulnerability of widespread construction techniques, may propel emergency changes in regulation. Another lockdown may be accompanied by government decree to close construction sites or factories producing construction materials, or which may restrict the manner in which the contractor carries out its works. In any such circumstances, the contractor will not expect to carry the can, but if the liability cannot be avoided or deflected, it will be the developer or the occupier who bears the loss.
• Force majeure: who takes the risk of events occurring that are beyond the reasonable control of the developer? All development projects carry inherent risk, but should a developer be expected to take the risk of events that are beyond its reasonable control and which were not foreseeable? The current pandemic has highlighted that unexpected risks and events can always occur, which has brought more focus on who takes the risk for such events.
Conclusion
As the bricks and mortar behind logistics has grown in prominence and value, a new class of occupier has entered the arena. Distributors and online retailers now wield significant power, and they are using it to redraw the lines for negotiation in build-to-suit deals. The point at which a risk becomes “developer risk” is moving. If developers are prepared to accept that shift, they will be well advised to build contingency into their programme as they do their appraisal. As schemes become larger, more complex and increasingly valuable, failure to do so could be costly.
James Needham is a partner in the real estate team and Andrew Outram is a partner in the construction team at Shoosmiths LLP
