Insurance Backed Building Guarantees – The lights are on but is anybody at home?
Peter Vinden Managing Director of The Vinden Partnership explores how the same insurance-backed guarantees used for domestic properties should be, and are, available for commercial buildings
If you are thinking of buying a new house you will be aware that in order to obtain mortgage finance from a building society, bank or other lender approved by the Council of Mortgage Lenders (“CML”), you will need to make sure that the house comes with a minimum 10-year insurance backed guarantee. The guarantee might be provided by the NHBC or come from one of many other insurers who offer similar products. The guarantee is put in place to protect both the home owner and the CML funder should a problem arise with the building in the future. This is all quite logical, sensible and is a system that we have all come to recognise as the “norm” and one that works.
So, if the system of insurance backed building warranties works with domestic property, why don’t we adopt the same system for other types of building? If I may say so, this a good question and one which I have been asking myself and talking to clients about for many years.
Finally, it does look like the “penny has dropped” and enlightened property investors are finally waking up to the massive impact that the lack of an insurance backed building guarantee can have on a building’s current and future value when things go wrong. Our enlightened clients have started to insist that insurance backed building guarantees are put in place at the outset of a project. The idea is a simple one. If you have a problem with your building in the future you will make one claim on one insurance company. Is this not a good idea? Well let’s look at how things are currently done.
Let me paint you a picture. Let's assume you are planning to have your own purpose-built office building designed and constructed for your own occupation. You may be being really smart and are using your own pension fund (SIPP, SASS or other approved scheme) as the developer and intending to lease the property back from your pension fund on completion so that you can pay your tax-deductible rent in your business to your own pension scheme which will then grow in value. All very smart and tax efficient, at least so far.
So, you arrange for your pension fund to appoint its own Architect, Engineer, QS and so on and in due course your pension fund will borrow money from a bank to finance the development, who will insist on taking a charge on the site, before your pension fund finally enters into a building contract with a builder based on the lowest tendered price. Are you with me so far? This same builder will then sublet various elements to specialist sub-contractors, who may also be doing design work. Does any of this sound familiar?
The next question you should then ask yourself is how do I protect my pension fund and my business as the future tenant if something was to go wrong with the building? What if we discover a design, materials or workmanship defect at a future date? Ask a solicitor this question and he will advise you that you need a plethora of collateral warranties from every man, dog, builder, sub-contractor and consultant who has looked at the project, oh and by the way, you will be charged a prince’s ransom from the same solicitor for the trouble of putting all these warranties in place.
This is all great, but what happens if there is a major building defect that you discover two years after your office is built? How are you going to decide who to pursue? Which member of the design team, builder or sub-contractor are you going to sue? Your solicitor will probably suggest you hedge your bets and sue everybody – just in case. Oh, and what if one or more of the people you are going to sue have failed to keep their insurance policies up to date or, worse still, go bust? Do you get the picture? What an absolute mess! Where does this leave your pension fund as Landlord and your business as Tenant? Let me tell you, you will be up “sh1t creek” without a paddle!
My firm’s Quantity Surveyors and Project Managers are busy helping a number of clients who are badly affected by Carillion’s demise so please don’t tell me that things never go wrong on construction projects.
OK, smart arse, I hear you say, what is the answer to this potential nightmare? The answer is pretty simple and where I started at the outset of this article. Procure one insurance backed building warranty at the outset of the project that covers both your pension fund, your business and your funder from any losses arising from the madness I describe above.
Is this sort of insurance cover freely available? Yes
Is this insurance cover expensive? No, and certainly less than the cost of the potentially useless warranties you will otherwise be asked to pay for.
Is insolvency cover available? Yes, provided your builder’s account doesn’t indicate that it is about to go into administration!
Can I get longer than 10 years cover? Yes, 12 years is pretty much standard for commercial buildings but you can insure beyond this period in certain circumstances.
So, if you are one of those businesses out there that is thinking of building your own factory, office building, school or whatever, it really is time to think again about how to protect your position. An insurance backed building guarantee provided by a rated insurer will allow you to sleep at night during the design and construction of your building and for 12 years thereafter. Sounds like a complete “no-brainer” to me.
Let me look into your eyes. The lights may be on but is there anybody at home?