Building industry fallout is uncertain following Australia’s property boom
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The property boom of the last 18 months is leaving in its wake a mixed bag of winners and losers. Whilst owners of existing real estate leading into the boom are clearly grinning, what has not yet played out is the impact on the construction industry and most particularly, the builders who are in equal parts frantically building and bracing for the perfect storm.
Build costs across Australia are grabbing news headlines for good reason. The Courier Mail recently painted a startling picture of reality in Queensland, warning of a potential tsunami of builder insolvencies heading into the Christmas season.
They weren’t wrong. Most recently, Privium went into administration, leaving debts expected in excess of $28m and more than 160 projects across the country affected. BA Murphy was another Queensland-based builder now in liquidation, despite being based on the booming Sunshine Coast.
The situation in other states is similar, highlighted by the collapse of two prominent mid-tier builders in WA, Pindan Group and Jaxon, in the last six months. Nationally, the fallout from the collapse of Grocon and Ganellan, a subsidiary of Icon, a year earlier is still being felt.
Building material costs are continuing to rise nationally (Source: HIA, Master Builders Queensland/Rowlinsons)
Build costs have blown out due to a powerful concurrence of factors. The pandemic saw the Government introduce several stimulus measures to support the housing and construction industry. This provided home purchasers and renovators with cash, which in turn increased the demand for housing.
Indeed, housing approvals in the period Aug 2020 to 2021 jumped 46% increasing demand for materials, which are already under pressure from increased global demand. Supply demand was exacerbated by lengthy delays in receiving materials due to shipping and port disruptions, not to mention cost escalations in transport costs.
To this we add a reduction in the export of steel from China and massive US demand for timber to meet their own housing boom. Finally, lets add in a shortage of labor due to international and state border restrictions and a boom which was (and continues by all accounts) across all Australian states at the same time.
These financial pressures, combined with several home builder collapses, have a flow on effect to apartment buildings as pressure mounts on the subcontractors left with unpaid contracts across the industry.
Fig.1 Rolling Annual Dwelling Approvals (Houses) - Australia Private Sector (Source: ABS)
Builders are at the end of the supply chain. They can contract a house and then not get access to the site for another 6 months, by which time the costs have risen. This places financial pressure on the builder, who under a fixed price contract is absorbing these ever-rising costs.
The pressure exists also for commercial builders constructing medium density, who have moved to steel in response to an undersupply of timber, which has in turn driven up steel prices.
For many developers, in a bid to secure finance, pre-sales are secured against a backdrop of an already high build cost. This makes feasibilities difficult to stack up and builder risk remains as costs continue to escalate on a month-to-month basis.
Perhaps now more than ever, choice of builder is critical to the success of any development. As construction funding partners, Dorado Property asks several critical questions about the builder:
Does your chosen builder have enough clout to get access to limited supply? – it's no secret that suppliers are prioritising their main customers , leaving many out in the cold.
Does your chosen builder have a lot of work on – are they too stretched? Are they at risk of contagion, they’re under pressure on another site impacting you on yours? Time delays are a key risk on any development and can significantly impact the profitability of the project.
Does your chosen builder have a strong balance sheet – are they able to absorb any costs which may arise that haven’t been provisioned for in the contract?
In addition, it is critical to look closely at the building contract. Increasingly, building contracts are being amended with clauses that can leave you at risk, including variation clauses, schedule risk clauses, escalation clauses for specified building materials. These changes to ‘fixed-price’ contracts now act more like ‘cost-plus’ contracts.
Have you built in enough buffer into your feasibility in the form of a contingency allowance and do you have a good quality QS to work with at the early stages? Are payments made on work completed to date verified by a quantity surveyor, and what levers do you have in the contract to protect yourself and provide incentive for the builder to get your project completed on time?
As these amendments become more common, working with a construction funding partner with real industry experience can be the difference between a solid contract and landing in trouble.
Fig.2 Quarterly Change in Construction Costs vs. CPI, National (Source: Cordells, Feb 2022)
Developers can maintain a strong measure of control on many risk facets of their development and often the strategies behind the levels of control and risk mitigation are what many good funders will interrogate. However, whether you have a tightly written, fixed price, fixed term building contract or not, a development project’s greatest risk of failure in these times can often be the builder you chose and their own financial governance. Developers may feel a false sense of security if they have contractually locked in their build costs, but if the builder hasn’t intelligently done the same, pre-letting the most volatile trades and their material costs, then both parties suffer down the track.
All major financial vested interests - the builder, the funder, and the developer - need to critically assess the builder’s financial strength as a priority. If a builder prefers to provide retentions via a Bank Guarantee, this may be a sign that they have some financial strength. The bank issuing the Guarantee will often only do so if there is a strong level of security held and it is a sign the builder is managing their business as a true Going Concern rather than a building company surviving on a project-by-project basis. If a builder is hell bent on a cash retention, then maybe the opposite is true.
Engage your funder early on the due diligence of any builders you’re entrusting your project to. The relationship you have with your funder can be crucial to help wade through the experience and capabilities of the builders who are tendering for you, especially in an environment of added pressure on material costs and the building profession. Their experience with other developers and builders can be invaluable and the earlier you engage, the more you may be able to find the right builder.
