August 12, 2020
Over the last few decades, Dubai’s construction industry has delivered countless iconic projects, many considered to be world firsts. These include the Palm Jumeriah, a man-made island in the shape of a palm tree, and the Burj Khalifa, the tallest building in the world.
Despite periods of lower oil prices, cuts in government spending, supply and demand variances, and geopolitical uncertainties across the region, Dubai has always managed to demonstrate strong resilience while maintaining its lead position in construction activities and delivering its ambitions.
Along this journey, many industry players have contributed to this success story including the untold numbers of owners, investors, developers, contractors, design professionals, suppliers, consultants, and craft workers from across the world who have invested, commissioned and delivered successful high-quality projects. The utilization of talent, sourced from across the globe, has contributed greatly to the transformation of the UAE in general, and Dubai in particular, into a cosmopolitan locale where many expats aspire to live and work.
Recently however, this success trend has slowed, evidenced by the drop in construction output. To illustrate, the graph below shows the rise and fall of Dubai’s construction activity culminating in its current low that began in mid-2017.
[Source: MEED Projects]
The decline in construction activities, has put a strain on contractors’ finances and forced many international firms to exit the Dubai market or to alter their model to employ lower cost staff to compete for work. The consulting landscape and its providers (architects, engineers, and project managers) doesn’t seem to tell a different story either. Even though many local firms have been affected, and some have indeed ceased to operate, it seems that international firms have experienced a greater impact and are being replaced by local competitors and ever-increasing Asian contractors — a trend that looks set to continue.
Our Top Six Recommendations for a Sustainable Industry Framework
In addition to the recent decline in construction activities, Dubai faces a decline in economic activity. However, this slowdown presents Dubai with a tangible opportunity to pause and critically assess current challenges to improve market performance. To help revive the market, we have identified six recommendations which provide a blueprint for a sustainable industry framework preventing further disruption and providing an environment to re-attract expertise. In addition, we recommend measures to implement in parallel thereby mitigating further decline.
- Changing the Procurement Balance
Project procurement in Dubai is typically undertaken through a tender process that is either open, allowing any bidder to tender, or selective, where clients preselect bidders. It is normal for the client team to preselect or screen a long list of contractors through a pre-bid process to pre-qualify those they deem most capable.
If done properly, the developer is assured that the best and most suitably qualified contractors, subcontractors, and suppliers are selected to bid. However, with a lowest-priced procurement culture, many in the industry have concerns that the pre-qualification process has become ineffective at filtering out less capable project participants. This approach can pose risks to quality, time, cost, and safety. Moreover, the process has been allowing unsuitable contractors to bid and secure work that they are unlikely to be able to deliver at the tendered cost. This is impacting the more established contractors as they are unable to recover their bid preparation costs and are discouraged from bidding for new projects.
To resolve this, lowest cost culture should be evaluated with an assessment of a shift to a culture that guarantees fair competition. It is suggested that more stringent value-based procurement controls and policing, together with the adoption of a better-balanced time/cost/experience procurement approach, be promoted across the whole industry. The adoption of a more value-based procurement culture would aid in the selection of the ‘right contractor for the right job’ for a competitive price. Furthermore, it would likely reduce delays and claims often submitted by unprepared or inexperienced providers, as well as return confidence to the international players on equitable and sensible procurement rules.
- Rebalancing the FIDIC Form of Contract
The FIDIC (Red Book) lump sum fixed price procurement has long been the established contract of choice for many clients. However, many in the industry, especially contractors, see this tried and tested industry norm increasingly diluted and skewed in favour of the project owners through heavy clause amendments.
This growing imbalance of risk: reward is not only discouraging some providers from bidding but is also causing them to increase their prices. This has resulted in unsuitable and/or inexperienced contractors bidding and securing work that they are unlikely able to deliver at the tendered cost, causing growing distress.
To address this, the re-establishment of FIDIC in its truest unamended form could help to re-establish the contractual equity and balance. Moreover, it could encourage a fair market approach rather than a buyers’ or sellers’-market approach, which has proliferated in recent years. If properly reviewed and reset to a standard universal form, the future would be a balanced market across all cycles, benefiting all.
- Improving the Adequacy of Design
A major challenge over the last few years is that project owners are struggling to define their own requirements, resulting in incomplete specifications that are passed via the contract through the supply chain. This has led to the current norm where contractors are increasingly asked to work with incomplete designs thereby taking on unfair design responsibilities, exposing them to unforeseeable risks through changes, re-work, and delay in delivery. This process also significantly reduces the ability of all project stakeholders to design and construct effectively and expeditiously. Instead, a more fragmented, time consuming, and therefore more costly process prevails – the recovery of which is sought by the contractor via claims.
To address this, we recommend undertaking additional time and diligence, pre-contract, to complete the project requirements, specifications, and designs before commencing the works – or at least in parallel. This will minimise change and claims as it allows clients to clearly define their projects, reduce rework (and unnecessary costs), improve the efficiency of the project team, and promote a needs-led approach to allow earlier and better value delivery.
While it is generally accepted that Dubai always delivers to tight schedules, taking this upfront, clear, and collaborative approach could greatly reduce risk, resulting in a faster delivery through innovation.
- Less Change, Better Payment
Universally, contractors, consultants, subcontractors, and suppliers report that payment terms are worsening with a significant detrimental effect on their cash flow and business. While many contracts stipulate 28-day payment terms, it is not uncommon for this to be extended by two or three times, causing huge damage across the construction supply chain causing withdrawal or bankruptcy.
Another trait that has been identified is the growing number of consultants delaying approvals and payment certifications, with many fearing their clients will try and recover additional costs from them. By doing so, they are not acting independently — as required under FIDIC — to evaluate and agree on cost and time change/variation orders, to the detriment of the contractors.
As outlined above, improving project design pre-contract would significantly reduce change (and therefore variations) reducing cashflow delays caused by extended reviews of changes and variations.
Rather than taking advantage of worsening payment terms, leading project owners and developers could choose to lead the market by paying in accordance with their contracts, thereby elevating themselves to become the project owners most sought after by contractors, suppliers, and vendors.
- Better Structuring and Availability of Finance
While current liquidity is a significant issue in the market, with local banks less willing to support developers and aiming to reduce their exposure to the construction and real estate sectors, the pivotal role of finance in the industry moving forward cannot be underestimated.
In order to stimulate a return to lending, clients must work harder in the feasibility stage to show the “bankability” of their scheme, de-risk good development based on stringent needs analysis and revenue inflows and differentiate themselves from less well-conceived or speculative projects. Having a strong business and financial case should ensure that only the best and most financially viable schemes are financed.
- Changing Demand, People, and Other Markets
Dubai has historically been resilient to the peaks and troughs over the decades as a developing market. As part of its rise to becoming a world city, market, and destination it has been exposed to external and international funders and investors. As a result, Dubai’s construction market challenges have been increased by the economic headwinds felt in other key investor markets including Russia, China, and Europe. This has resulted in weakening fiscal performance (as seen by a fewer new expats and buyer investors in Dubai) as they come to terms with economic instability at home.
Dubai’s “destinations of choice” crown within the construction industry has gradually been challenged by other Gulf Cooperation Council countries, and more recently the Kingdom of Saudi Arabia (KSA), tempting resources, capability, and finance away to newer markets.
Mitigating the Immediate Effects Of COVID-19 on the Construction Industry
The COVID-19 outbreak resulted in a near halt of construction activities worldwide and significantly lowered consumer business confidence. Weak purchasing power will no doubt impact revenue streams of construction projects as demand softens. Moreover, given the overall drop in construction activities over the past few years, many developers are undoubtedly feeling the pressure with lower liquidity and growing numbers of late receivables. As a result many developers will face financial distress and potential insolvency, especially where highly leveraged.
It is evident that there is clear and unanimous desire to improve the market. Accordingly, we have identified the following key measures to mitigate the immediate economic effects of the pandemic which should be considered in parallel with our six recommendations to achieve a sustainable framework:
- The real estate committee: It is imperative for Dubai’s newly formed real estate committee to join forces with the Land Department and Department of Statistics to find ways to control the supply of new projects while maintaining steady and stable demand with good pricing levels. Singapore, for example, has been controlling supply through stamp duty tax and tighter land to value norms to better regulate high levels of speculation. The current pandemic pause could be used by Dubai to reset this balance to better control supply levels to match demand.
- Work-out controls: A greater focus is required on the delivery of current under construction projects, while avoiding launching new ones — at least in the short term — until demand recovers. Thanks to the 2007 escrow accounts law, developers should have enough funds to complete ongoing projects.
- Dubai project review: An overall projects review is advisable to prioritise projects deemed necessary to maintain a healthy GDP, create employment and support local social infrastructure initiatives. In addition to a review of operations with the aim of achieving efficiency and increasing productivity, an activity-based costing exercise could prove very beneficial here. Moreover, investigating the possibility of reducing governmental fees and utilizing Public-Private Partnerships, where applicable, to help stimulate the economy. Additionally, Dubai may consider adopting a temporary measure whereby government entities re-focus on their core functions, rather than forming more risky JV partnerships in an attempt to create new revenue sources.
A Compelling Case for Dubai to Act Now
Against a backdrop of its recent and continuing construction market challenges, Dubai needs to undertake swift action. Not only does it need to renew the image of its construction market as a revered market known for its capability and ability to deliver on ambitious projects, but it also needs to re-establish itself as a progressive city that demonstrates industry leadership both regionally and globally in how to create a more balanced and equitable market.
By developing a new construction industry strategy that is grounded in collaboration with its industry leaders, Dubai can build a more resilient construction market, regain its pre-eminence and revive its construction industry. It is only when it has the confidence of its industry participants in its sails can it continue to enthrall the world with iconic projects the world has come to expect of Dubai as a leading world city.