Scuttling concrete boots: a “profitless boom”
The construction sector continues to struggle under the combined weight of a skilled worker shortage, material supply shortages and spiking material costs. Tedious supply chain and building delays, unforeseen cost blowouts and building approval declines could soon see the construction industry becoming a “profitless boom”, with an estimated 50% of Australian building companies currently trading insolvent. The nation’s industry-wide crisis has already witnessed Australia’s largest home builder, Metricon, announcing a restructuring agreement between Commonwealth Bank (CBA) and the Biasin family to refinance the company – an agreement consisting of a $30 million shareholders’ contribution and CBA’s doubling of its working capital facility to help keep the business afloat as it renegotiates its fixed-price home contracts.
Rising construction costs and fixed contracts
The battle has been tough for construction companies with increasing construction costs, which are rising at a rapid pace of approximately 15% per year – the fastest rate in over 40 years.
Whilst the majority of home builders have built their growth on fixed price contracts which new homeowners love, this has become a headache for builders when material prices escalate, and where simple rise and fall clauses are either ineffective or unenforceable. With steel prices a staggering 42% higher than last year, timber prices jumping by 21%, electrical products seeing a 14% cost increase and bathroom fixture costs rising by 13%, construction companies now risk being faced with completing a backlog of fixed-priced projects from early 2021. Considering that the average cost of building an Australian home has blown out by between $40,000 and $150,000, this essentially means that no profit is made.
For Metricon's 4,000 homes at various stages of completion, and a base price of approximately $249,000 for a Metricon home, this leaves them with a construction book of $1 billion. The sector has been hit by a perfect storm and whilst the additional funding may be enough to weather the storm, it could also just be a tiny drop in a large bucket if construction material costs continue rising at this pace.
Delivery delays
In the current construction market, the troubles are not just the escalation of material costs, but also the timely delivery and availability of materials and supplies. As the industry is slowly crushing under the burden of the global supply chain crisis, the materials shortage is causing lengthy delays on new builds.
The industry’s supply crisis emerged during the COVID-19 pandemic. Whilst pre-pandemic wait times for frame and trusses were around 4 weeks due to delays in supplying wood, post-pandemic this has blown this out to 16 weeks. Waiting times for finishing products such as laminated veneer has also rocketed from 1.5 weeks to 16 weeks. It is not surprising that when running on operating margins of 5%, a cost blowout of 9% can have catastrophic financial consequences.
Building approval declines
The release of the Housing Industry Association’s (HIA) economic outlook report for May 2022 expects detached housing to start declining from some 147,890 in 2021 down to 99,350 in 2025. That is a whopping 32.8% decline – a decline that is only partially offset by the growth of multi-unit dwellings. However, the HIA is still forecasting an overall fall of 19.8% in home construction starts over the next three years, which are predominantly being driven by broader consumer uncertainty around both inflation and rising interest rates.
What does this mean for construction businesses and what’s next?
If granted sufficient time, any one of these disruptive factors can be managed and dealt with by operators. However, the industry’s horror run, facing all three simultaneously over the next three years is bound to place enormous working capital pressures on small operators, increasingly pushing them towards risks of insolvency. In fact, it is not surprising that according to ASIC, the construction industry was deemed to have the highest number of companies struggling with financial distress and unpaid debt, with 953 companies needing breathing space to deal with these issues – a trend which is likely to continue over the coming months or even years to come.
There is no doubt that the next 6-9 months will be crucial for consumers and suppliers entering new contracts, considering that markets will be at their most fragile due to overwhelming uncertainties around both interest rates and inflation. Operators will need to remain proactive to find sufficient ‘breathing space’ to deal with these challenges or face an uncertain future.
On the other side, homeowners with new homes under construction will need to be pragmatic and prepared to accept cost variations, or risk losing their deposits and their unfinished homes.
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