MANAGING FINANCIAL RISKS IN CONSTRUCTION PROJECTS

RESEARCH

MANAGING FINANCIAL RISKS IN CONSTRUCTION PROJECTS

CONSTRUCTION PROJECTS ARE EXPERIENCING CATASTROPHIC CONSEQUENCES FROM THE COVID-19 OUTBREAK, WITH A SURGE IN FINANCIAL RISKS. A RESEARCH TEAM FROM WESTERN SYDNEY UNIVERSITY PROVIDES RECOMMENDATIONS FOR ADDRESSING THE RISKS AND FUTURE PLANNING.

With compulsory lockdowns and temporary closure directives, the costs of hiring labour are skyrocketing due to a shortage of construction workers coupled with rising interest charges on contractual loans, additional construction cost overruns, and health and safety expenditure.

Furthermore, the pandemic has risen the possibility of projects missing deadlines, exacerbating the fear that banks and private investors will lose their capital investments if the project fails.

So, what are project financial risks? According to Project Management Institute (PMI), the financial risks of a project extends beyond the construction material costs, it comprises all the potential financial losses recorded throughout the lifecycle of a project such as:

• project design expenses

• low revenue

• operation and maintenance charges

• demolition and waste management costs.

KEY FINANCIAL RISKS

Among all the key financial risks recorded during the pandemic, two of them stand out in observational research and project reports.

1. High overall project costs

The costs of constructing projects have increased astronomically during the pandemic with the compulsory closure of projects and missing of deadlines.

According to the Sydney Morning Herald, the delta outbreak of COVID-19 added $500 million to the cost of building major infrastructures across the state of New South Wales.

This cost is due to construction materials skyrocketing due to inflation from the COVID recession and shortage of labour. In addition, the expenses at construction sites have increased because workers must be provided with COVIDSafe work tools and protective gadgets to limit the spread of the virus. These events have triggered a projection from Rider Levett Bucknall (RLB), a global construction and property consultancy, that the construction costs in Australia have seen the sharpest increase since 2005 due to the COVID-19 outbreak.

2. Default of interest and loan repayments

According to Australian Constructors Association, the mandatory lockdowns, restrictions and stay-home orders implemented during the height of the pandemic denied many project managers the opportunity to operate and recoup the invested capital into projects. These restrictions negatively affected revenue mobilisation from such projects, with some projects recording low or negative net revenue. With this outcome, project managers are struggling to service the loan facility contracted to build projects. Research from Norton Rose Fulbright, a global law firm, indicates that interest payments went up while the principal of contracted loans for construction projects during the pandemic plunged many projects into insolvency and abrupt termination of construction contracts.

RECOMMENDATIONS TO ADDRESS THE RISKS

How do project managers manoeuvre to tackle these and many other financial risks now and once we’re through the pandemic? Here are four recommendations from our extensive research.

1. Identify critical project finance risks

The first major step to tackle project financial risks is to identify what they are and what causes the risk. According to McKinsey & Company, there is uniqueness of project financial risks to every project because of the different underlying capital structures. It is imperative that project managers examine project reports, loan agreement documents, payrolls and cost cards to identify what specific financial risks could threaten the financial success of the project. Moreover, it is relevant to identify the sources (or the causative agents) of the financial risk factors in the pandemic. Is it from construction materials, the supply chain, provision of personal protective equipment (PPE), architectural design or payment of few skilled workers? Make a list of all the financial risks, rank them according to their severity and frequency of occurrence, and address them.

2. Build resilient financial risk management models

In order not to be taken by surprise by the emerging variants of the virus and its associated financial threats, projects must not only rely on current conventional financial risk models.

It is essential that new, resilient and inclusive financial risk models are built to respond to the financial fallouts from the pandemic.

Research from Araya (2021) shows that modelling resilient risk models must include human-centred healthcare and performance of construction workers. It is essential that project managers rethink and redesign the evaluation, monitoring and management of financial risks with a sound contingency plan into the future. Such models must be broadbased encompassing the holistic views of stakeholders together with well-digitised tools to monitor credits and usage of project funds.

3. Share the financial burden with others

It is necessary for project managers to liaise with the other entities, whether they are private or public, to gain financial support for projects in these difficult times. Public private partnership (PPP) financing is an ideal model for this cause, as it can bring funds as well as technical support to manage financial risks associated with a capital project. The technical support will be granted freely or at low costs to save projects from total collapse. It is also important to be open to government support when the opportunity is granted. Through stimulus packages, construction industries in most OECD countries have received enormous support during the COVID-19 chaos. For instance, data from the Australian government shows that in June 2020, $1.5 billion was rolled out to support the construction industry together with a $1,500 fortnightly payment to lockdown construction workers.

4. Choose alternative green financing facilities

Green finance packages such as green bonds are being touted to have lower interest charges for construction firms that can integrate sustainable practices into projects. According to the World Green Building Council, green finance is a game changer to reduce the overall costs of building and operating projects because it has set its eyes on achieving a net zero carbon emission target in the construction industry by 2050. Therefore, project managers are encouraged to take advantage of this package and cut down the expenditure of loan repayments.

Authors: Isaac Akomea-Frimpong is a doctoral researcher at School of Engineering, Design and Built Environment, Western Sydney University. His research topic is about financial risk management in public-private partnership projects. Associate Professor Xiaohua (Sean) Jin and Doctor Robert Osei-Kyei are the Director of Project Management Programs and Advisor of Construction Management Program, respectively, at Western Sydney University. They are both experts in risk management in construction projects and have extensive research experience in this domain.