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What Factors of Production can Affect a Construction Project?

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Published: Tue, 06 Jun 2017

There are four main factors of production that can affect a construction project; they are land, labour, capital costs and an entrepreneur.

Land is defined as ‘land comprises all naturally occurring resources whose supply is inherently fixed’. [1] Land is a fixed resource as there is a limited amount, and price can vary depending on location. There are four main types of land:

Agricultural land denotes the land suitable for agricultural production, both crops and livestock. [2] 

Brownfield Site/Land are abandoned or underused industrial and commercial facilities available for re-use. Expansion or redevelopment of such a facility may be complicated by real or perceived environmental contaminations. [3] 

A green belt or greenbelt is a policy and land use designation used in land use planning to retain areas of largely undeveloped, wild, or agricultural land surrounding or neighbouring urban areas. [4] 

An Investment land is purchased at ones own desire, he/she may want to sell it in the near future or to give it to someone as a gift.

Land Value

Land Value = Aggregate Gross Revenues – Total Excepted Costs

Capitalisation RateThe price of land is determined by the use to which it can be put into, however it can vary overtime, but, not only does price change overtime but also interest rates can change very suddenly, and high interest rates tend to put people off in purchasing land. Site values are generally in the range of 20% to 25% of the total cost dwellings, the following formula is used to determine land value:

Land Value is also affected by:

Supply and demand, the supply of land is fixed although it use can always be altered.

The permitted of land use to which it can be put under planning regulations.

The location of the land, the more versatile the land the higher price it has.

Physical characteristics of land may alter the cost of development.

Land is a factor that can immensely affect a construction project as there are many ‘sub-factors’ which can make one bit of land more attractive to the buyer than the other as each type of land has its own advantages and disadvantages. Therefore if the correct decisions are made when purchasing land, it should minimise delays on a construction project.

Labour

Labour economics seeks to understand the functioning and dynamics of the market for labour. Labour markets function through the interaction of workers and employers. Labour economics looks at the suppliers of labour services (workers), the demanders of labour services (employers), and attempts to understand the resulting pattern of wages, employment, and income. In economics, labour is a measure of the work done by human beings. It is conventionally contrasted with such other factors of production as land and capital. [5] 

The employment rate for the three months to March 2010 was 72.0 per cent. The rate was down 0.3 on the quarter and it has not been lower since the three months to September 1996. The number of people in employment fell by 76,000 on the quarter to reach 28.83 million. The number of full-time workers fell by 103,000 over the quarter but the number of part-time workers increased by 27,000. The number of employees and self-employed people working part-time because they could not find a full-time job increased by 25,000 on the quarter to reach 1.07 million, the highest figure since comparable records began in 1992.

The unemployment rate for the three months to March 2010 was 8.0 per cent, up 0.2 on the quarter. The number of unemployed people increased by 53,000 over the quarter, to reach 2.51 million, the highest figure since the three months to December 1994. The number of people unemployed for up to six months fell by 52,000, to reach 1.21 million. However, the number of people unemployed for more than twelve months increased by 94,000 over the quarter to reach 757,000, the highest figure since the three months to May 1997. [6] 

Large construction companies only tend to employ labourers from larger agencies. Due to the fact that agencies are making labourers redundant, therefore there is a fewer number of labourers for construction companies to employ. This can be a large influence on the overall production of a construction.

Capital Costs

Capital costs are costs incurred on the purchase of land, buildings, construction and equipment to be used in the production of goods or the rendering of services. In other words, the total cost needed to bring a project to a commercially operable status. However, capital costs are not limited to the initial construction of a factory or other business. For example, the purchase of a new machine that will increase production and last for years is a capital cost.

Capital costs do not include labour costs except for the labour used for construction. Unlike operating, capital costs are one-time expenses, although payment may be spread out over many years in financial reports and tax returns. Capital costs are fixed and are therefore independent of the level of output. [7] 

In the construction industry it is very important to look out for capital costs, as some items may have a high capital, but they may have little return. For example purchasing a crane for a construction project would have a high capital but it is a very efficient plant therefore giving a high return. Thus, looking at capital costs can increase the production of a construction project.

Entrepreneur

An entrepreneur is a person who comes up with a new idea or invention and brings together a country’s resources (land, labour and capital) to take the idea to the marketplace.

Entrepreneurs are vital to economic growth and, consequently, to higher living standards. Thus, legislators and other leaders who create economic policies should strive to encourage the innovation and risk taking of entrepreneurs. Enforcing property rights through contract, patent and copyright laws; encouraging competition through free trade, deregulation and antitrust legislation; and promoting a healthy economic climate through Federal Reserve anti-inflation initiatives-these are all examples of policies that empower entrepreneurs to be creative and take risks.

The accomplishments of entrepreneurs in our modern world have been possible because of a climate of individual freedom that is so rare in human history. The society that does not honor entrepreneurial accomplishment will find fewer able people engaged in wealth creation. History has shown time and again that economies that appreciate the benefits created by entrepreneurs flourish, while those that devise laws and regulations aimed at seizing the entrepreneurs’ rewards founder. [8] 

An entrepreneur takes risk and only sometimes does it pay off. Without any risk takers, the construction industry would not move forward. An entrepreneur would perhaps buy a plot of land, and develop it, not only to they boost the construction industry they also employ people to work for them. Therefore, entrepreneurs can enhance the production of a construction project.

Task 2

In the construction industry there are three main markets; public, private and third sector. Each of them has their own ways in benefiting the construction industry.

Generally, during any recession public sector investment tends to run counter cyclical to private sector investment (as government attempt to soften the blow of declining levels of private investment), although this is largely dependent on the state of public finances. The residential and commercial sectors in the UK are likely to be the hardest hit, particularly any speculative building.

However, it should be noted that the sectoral impact of this recession is likely to be slightly different to past experiences, largely because of the effects of PFI. Much public investment is now reliant on private sector financing and this is clearly going to have an effect on the public sectors ability to deliver projects and hence their potential to influence the marketplace.

On the other hand, infrastructure activity increased strongly through 2008 as a number of major projects got on site and this growth is expected to continue through 2009. In contrast the outlook for industrial construction is very negative, with manufacturing output in free fall during 2008 and with little hope of a recovery during 2009.

Infrastructure demand in London saw the fastest expansion. Another major project to be awarded in 2009 in the UK was CrossRail, with a budget of $30 billion; construction is due to start in 2010. CrossRail, along with the 2012 Olympics, could make the South East of England something of a hotbed of construction activity. However, both projects are not likely to be enough to offset the declines in the property sectors and UK construction spending is expected to decline significantly for the first time since the recession in the early 1990s. [9] 

From the graph above we can see that the public sector is more consistent than the public sector. The public sector had a large decrease when the rescission hit, this is due to the fact that private sector is independently funded where as the public sector is funded by the government which uses the tax-payers money.

The third sector is also funded by the government, but they are non-profit making organisations. Non-profit making organisations tend to help the local area or community and all surpluses are not distrusted but it is put back into the company to help it grow and achieve its goal. The presence of a large non-profit sector is sometimes seen as an indicator of a healthy economy in local and national financial measurements. With a growing number of non-profit organizations focused on social services, the environment, education and other unmet needs throughout society, the non-profit sector is increasingly central to the health and well-being of society. [10] 

Task 3

Any type of construction project requires funding no matter how big or how small, and the source of the funding/finance can vary. These are personal savings, retained profit, other loans, overdraft facilities, grants, venture capital, lottery funding and preference shares.

Personal Savings

Personal saving has been defined as disposable income minus personal consumption expenditure. In other words, income that is not consumed by immediately buying goods and services is saved. Other kinds of saving can occur, as with corporate retained earnings (profits minus dividend and tax payments) and a government budget surplus. [11] 

However not many people use this method as a source of finance. The main reason being that not many people earn enough money per annum to be able to afford to fully run a construction project. On the other hand it is perhaps the safest way to get hold of a reasonable sum of money with out any major consequences.

Retained Profit

When a business or a construction company makes a profit and it does not spend it, it keeps it, and accountants call profits that are kept and not spent retained profits. The retained profit is then available to use within the business or construction company to help with buying new machinery, vehicles, and computers and so on or developing it in any other way. Retained profits are also kept if the owners think that they may have difficulties in the future.

This is a more common method used to fund a construction project as it is a more realistic vision, and it is possible to base the size of the construction project on the amount of retained profit that is received per month. Quite often retained profit it used in emergency or sometimes put back into the company to expand it, and even some people do not spend that money at all, the reason for this being is having that retained profit to fall back on to or in other words for a peace of mind.

Other Loans

In a loan, the borrower initially receives or borrows an amount of money, called the principal, from the lender, and is obligated to pay back or repay an equal amount of money to the lender at a later time. [12] 

Typically, the money is paid back in regular instalments, or partial repayments; in an annuity, each instalment is the same amount. The loan is generally provided at a cost, referred to as interest on the debt, which provides an incentive for the lender to engage in the loan. In a legal loan, each of these obligations and restrictions is enforced by contract, which can also place the borrower under additional restrictions known as loan covenants. Although this article focuses on monetary loans, in practice any material object might be lent.

Long Term (Mortgage)

This is by far the most common loan used through out the world. A mortgage loan is a loan secured by real property through the use of a mortgage note which evidences the existence of the loan and the encumbrance of that realty through the granting of a mortgage which secures the loan. However, the word mortgage alone, in everyday usage, is most often used to mean mortgage loan.

By looking at the mortgage calculator, we can see that for an average £250,000 house, with a deposit of 5%, also an interest rate of 1.97% and is to be repaid over 30 years that give a total repayment of £880.06 per month, and the interest is £389.90. This is the general idea of a mortgage, it is considered as a long term loan

Short Term

A short term loan is used for emergencies, money that is required in short notice and paid back in a short time. However interest rates are catastrophically high.

We can see that to borrow £200, and pay it back in 15 days, the interest is £35.90 which is very high. The advantage of a short term loan is that is it very flexible, the person borrowing the money has control when they wish to pay.

Overdraft Facilities

An overdraft occurs when withdrawals from a bank account exceed the available balance. In this situation a person is said to be “overdrawn”.

If there is a prior agreement with the account provider for an overdraft protection plan, and the amount overdrawn is within this authorised overdraft limit, then interest is normally charged at the agreed rate. If the balance exceeds the agreed terms, then fees may be charged and higher interest rate might apply. [13] 

This is similar to a short term loan but, it is not applied for. An advantage of this is that it is great for a short term loan, or that little extra that may be required for buying that television. However if is not paid back soon, then interests rate will rocket. Some major banks or building societies do offer 0% interest on overdrafts but only for a while. In terms of construction an overdraft should be the last resort for funding, and it should not be looked at as a solution.

Grants

Grants are funds disbursed by one party, often a Government Department, Corporation, Foundation or Trust, to a recipient, often (but not always) a non-profit entity, educational institution, business or an individual. In order to receive a grant, some form of “Grant Writing” often referred to as either a proposal or an application is usually required.

A grant is great for any one and everyone, they are given to people and they do not need to be paid back. In most circumstances they are only small sums of money. In addition to this, these grants are only given for specific purposes or given to those who need it. For construction purposes they are given out but only for specific part of the project for example the windows or exterior finishes, it all depends on the client.

Venture Capital

Venture capital is provided as seed funding to early-stage, high-potential, growth companies and more often after the seed funding round as growth funding round in the interest of generating a return through an eventual realization event such as an IPO or trade sale of the company. Venture capital investments are generally made in cash in exchange for shares in the invested company.

Venture capital is attractive for new companies with limited operating history that are too small to raise capital in the public markets and have not reached the point where they are able to secure a bank loan or complete a debt offering. In exchange for the high risk that venture capitalists assume by investing in smaller and less mature companies, venture capitalists usually get significant control over company decisions, in addition to a significant portion of the company’s ownership.

Young companies wishing to raise venture capital require a combination of extremely rare yet sought after qualities, such as innovative technology, potential for rapid growth, a well-developed business model, and an impressive management team. VCs typically reject 98% of opportunities presented to them reflecting the rarity of this combination. [14] 

Venture capitalists are typically very selective in deciding what to invest in; as a rule of thumb, a fund may invest in one in four hundred opportunities presented to it. Funds are most interested in ventures with exceptionally high growth potential, as only such opportunities are likely capable of providing the financial returns and successful exit event within the required timeframe which can typically be 3-7 years that venture capitalists expect. [15] 

Lottery Funding

For every £1 that the public spends on Lottery tickets 28 pence goes to the Lottery good causes. These are the arts, charities and voluntary groups, heritage, health, education, the environment and sports. Lottery funders are the organisations that distribute the good cause money to local communities and national projects.  [16] 

This method is finance is only used for larger projects such as the 2012 Olympics games and mainly used as a last resort. ‘The £1.5 billion to be derived from Lottery income itself breaks down into two equal parts: £750 million to be raised through sale of Olympic-themed Lottery tickets, and a further £750 million to be diverted from the National Lottery Distribution Fund, which is the source of funding for non-Olympic distributors.’ [17] 

Preference Shares

Preference shares offer their owners preferences over ordinary shareholders. There are two major differences between ordinary and preference shares. Preference shareholders are often entitled to a fixed dividend even when ordinary shareholders are not. Preference shareholders cannot normally vote at general meetings.

The preference dividend is fixed in the sense that preference shares are often issued with the rate of dividend fixed at the time of issue and you might see something like this:

‘4% preference dividend £0.25’

This is a preference share with a nominal value of £0.25 per share that carries a dividend of 4% that is 4% of £0.25 every year for every share issued. If a company has issued 100,000 of these shares at par then it will have received:

£100,000 x £0.25 = £25,000 from shareholders on issue

It will pay an annual dividend of:

£25,000 x 4% = £1,000 each year. [18] 

This can be used as a finical source; however it can be very complex and very risky. Ideally specially trained people must look at the shares and look for funding. On the other hand, once completed it can be a reliable source depending on the current share prices.

Task 4

All sources of finance are different, in terms of cost, and the conditions that are imposed by the provider are also different. Therefore, depending on the type of construction project a suitable source of finance should be chosen.

Personal Savings

When personal savings are used to fund a construction project, the provider has no worries about monthly payment or even interest, because they have earned their money and it has already been taxed, it can go in for immediate funding. However the bank will need to be notified to allow large sums of money to be withdrawn in one go.

Retained Profit

Many people mistake this as being similar to personal savings. There are some similarities; the provider will have no worries about monthly payments. But there are some differences, the provider does not need notify the bank to gain access to their own funds, also when they do withdraw their funds, they will be taxed.

Other Loans

Loans are the most common source of finance used for construction projects. As many people do not have the money to be able to afford to run a construction project. Most loans are given out by a bank or building society, and repayment dates are agreed. For most loans, there are monthly repayment dates; also there are interest rates as well which are added on to the monthly repayments. The provider will require full payments each month, if not they have the power to seize goods that are equivalent to the monthly repayments. If monthly repayments are still not being met, then the bank or building society has the power to re-posses the construction project.

Overdraft Facilities

The overdraft facilities are not used as a main source of finance, but they are used to aid those sudden expenses that can not be avoided. Once the overdraft limit has been used, interest is charged on the amount that has been taken from the overdraft.

Private Finance Initiative (PFI)

The private finance initiative (PFI) is a procurement method which secures private funding for public institutions in return for part-privatisation. PFI is also an operational framework which transfers responsibility, but not accountability, for the delivery of public services to private companies. PFI projects aim to deliver infrastructure on behalf of the public sector, together with the provision of associated services such as maintenance

Prior to the financial crisis of 2007-2010, large PFI projects were funded through the sale of corporate bonds, issued by the company running the PFI. Since the crisis, funding by senior debt has become more common. Smaller PFI projects – the majority by number – have typically always been funded directly by banks in the form of senior debt.

Refinancing of PFI deals is common. Once construction is complete, the risk profile of a project can be lower, so cheaper debt can be obtained. This refinancing might in the future be done via bonds – the construction stage is financed using bank debt, and then bonds for the much longer period of operation. In most PFI contracts, the benefits of refinancing must be shared with the government.

The banks that fund PFI projects are repaid by the consortium from the money received from the government during the lifespan of the contract. From the point of view of the private sector, PFI borrowing is considered low risk because public sector authorities are very unlikely to default. [19] 

Public Private Partnership (PPP)

Public-private partnership (PPP) describes a government service or private business venture which is funded and operated through a partnership of government and one or more private sector companies.

PPP involves a contract between a public sector authority and a private party, in which the private party provides a public service or project and assumes substantial financial, technical and operational risk in the project. In some types of PPP, the cost of using the service is borne exclusively by the users of the service and not by the taxpayer. In other types (notably the private finance initiative), capital investment is made by the private sector on the strength of a contract with government to provide agreed services and the cost of providing the service is borne wholly or in part by the government. Government contributions to a PPP may also be in kind (notably the transfer of existing assets). In projects that are aimed at creating public goods like in the infrastructure sector, the government may provide a capital subsidy in the form of a one-time grant, so as to make it more attractive to the private investors. In some other cases, the government may support the project by providing revenue subsidies, including tax breaks or by providing guaranteed annual revenues for a fixed period.

When choosing a source of finance it is important to select one that is suitable for the construction project. For example there would be no point in taking out a long term loan for a kitchen extension, but it would be suitable for some one whishing to build a house from scratch. Thus, financing for a construction project should be done with great care, and every member in the construction team should be notified of what finance route they are going to take.


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