Inflation, Construction Costs, and Risk Allocation: Managing Volatility in Development Projects

The construction sector continues to face significant challenges triggered by inflationary pressures, supply chain volatility and regulatory developments. For developers, understanding how these risks can be allocated and mitigated is essential to protecting project viability and returns.

The elevated interest rate environment has made securing development finance considerably more challenging. Lenders have become more selective, often requiring higher equity contributions and enhanced pre-let or pre-sale requirements. Developers with existing projects contracted at lower rates may face difficulties refinancing maturing facilities at the elevated rates, which affects projected returns. Funders are also imposing stringent prerequisites to practical completion, such as requiring performance security throughout the supply chain.

Project budgets are being affected by increases in UK landfill tax rates, which have risen 26% in two years, from £103.70 per tonne in 2024 to £130.75 per tonne from April 2026. The EU has also proposed a 50% tariff on steel imports, which could significantly impact costs for build projects. Such pressures warrant careful attention to pricing mechanisms in construction contracts – while fluctuations mechanisms are traditionally unusual in a fixed price contract for commercial building development, contractors are likely to increasingly push to share the risk of such measures with developers. 

Legislative changes in the UK, particularly the Building Safety Act 2022, have also fundamentally altered the regulatory landscape for certain kinds of development, particularly higher-risk buildings. Since October 2023, the gateway process for such developments has required developers to submit applications for approval at three key stages: planning (gateway one), before construction begins (gateway two) and before occupation (gateway three). Gateway two is creating material delays to projects, with some developers reporting approval timescales of several months. Gateway three imposes a hard stop for the Building Safety Regulator to decide whether to issue a completion certificate. In practice, decisions are taking longer than the allotted eight to twelve weeks, causing delays to occupation.

Recent contractor failures are reflective of these market pressures. Between 2023 and 2025, several major UK construction firms entered administration, including ISG, Henry Construction and Ardmore Construction. Contractor insolvency causes project delays, increased completion costs and complex negotiations with subcontractors.

Successfully navigating risk in the current development landscape requires managing third-party expectations, carefully structuring contracts and making good use of performance security. 

To limit barriers to securing funding, developers should stress-test against a range of interest rate scenarios at the outset of a project. Also, engaging early with lenders is key at the refinancing stage to understand available options well in advance of facility maturities. 

Given the rising build costs, fixed-price contracts may not always be appropriate, and developers may instead benefit from agreeing cost-sharing arrangements such as target cost contracts.

Early contractor involvement to manage and mitigate the gateway two approval process should also be considered, with this being incorporated into letters of intent and building contracts from the outset. Developers should also build realistic allowances for gateway approvals into project programmes, including time for potential requests for further information. Gateway approval delays are seemingly inevitable, so contracts should address responsibility for them with appropriate relief mechanisms being in place for contractors where delays are outside their control.

To mitigate the risk of contractor insolvency, developers should ensure adequate security is in place, whether through performance bonds, parent company guarantees or retention bonds. Employers may also incorporate financial monitoring provisions in construction contracts and ensure step-in rights and collateral warranties are secured from key subcontractors early on to maintain continuity of work in the event of main contractor default.