Introduction
The building industry has been travelling into a minor head wind for some time, but it seems the perfect storm is about to bring some change. These changes may not be new but perhaps are part of super cycles and events outside of our control.
The UK commenced studies and attempting to rectify the industry in 1934 with the publication of “Reaching for the Skies” Report during the Great Depression following World War 1. This was followed up with the Simon Report in 1944. It seems these cycles are driven by the same factors and affect all contractors including those who manage risk and clients well.
Historically, large contractors continue to grow due to increased demand and the need to feed the 1000’s of employees and subcontractors reliant on them. And we get to a point where the “tail is wagging the dog” similar to the 2008 GFC banking situation, in that procurement risk is passed down from client to the builder to the subcontractor, often with the lowest prices winning the work. When this occurs, the large contractors secure more and more work at lower and lower margins, and heavily rely on fixed costs over long durations of time.
Now the winds of external forces hit such as the 2008 GFC (the current timber shortage is due to the earlier harvesting of most USA timber plantations and mills at the time producing a glut in the market cycle 12 years on), COVID-19, weather events such as the recent floods and war. All projects are affected by these elements, which result in contractors attempting to complete projects by the contract so they tend to use poor quality subbies, use questionable business ethics, cash flow is negative and ultimately leads to massive losses or failures. According to the CFMEU, construction contractors go bankrupt at a rate 2.5x higher than the average of all industries.
The building industry and these winds are more often, than not, driven by commercial arrangements established within the financial markets. Major banks and investors want fixed price contracts, they perceive a “cost plus” contract is not value for money. Yet simple measures and targets can eliminate this. Secured creditors typically focus on the large contractors, not all stakeholders involved in a project.
So, what has happened recently?
Price Increases Examples:
Steel prices are up 80% since January 2021.
Commercial painters costs up 90% in last six months.
Roof contractors not even pricing jobs at the moment.
Shanghai to Sydney shipping rates 100% increase in 2021.
Brisbane (SEQ) was awarded the 2032 Olympic Games and this will result in billions of dollars of both public and private investment.
COVID-19 has negatively impacted global suppliers of all base materials from timber, furniture, paints, steel, etc.
SEQ 2021 had nearly 60 working days of rain – from an approximately 275 working day year – a 22% downtime that costs clients and contractors.
The recent SEQ and Northern NSW floods whilst having a devastating impact to people personally, there is a massive rebuild effort.
Increases in global commodity prices and they are only going to continually increase following the Russia and Ukraine War. 90% of Neon global supply comes from Ukraine and 35% of Palladium global supply comes from Russia. Neon gas is one of the most important inputs to semi-conductor manufacture. Palladium is used in chip manufacture. If Russia secures control of Ukraine, then all purchases of phones, computers, cars, televisions, etc, we will be supporting this regime. How will this impact construction if the West looks for alternatives?
ProBuild collapsed in February 2022 losing approximately $50m just on the 433 Queen St project. Typically, prior to these types of events they would attempt to commercially manage their way out by slapping clients with huge variations and underpaying subcontractors. There is already evidence of this. Eventually the whole house of cards collapses when the cash runs out. This begs the question… should the client, government and insurance companies take some responsibility?
Condev collapses in March 2022. Perhaps they may be more proactive and empathetic to their clients and subcontractors… yet there are 100’s more builders of their size across the country that are still operating. So, it cannot just all be the external factors. In addition, Privium and ABD Group collapsed in the last few months.
So, what is to come?
The ATO is preparing to make changes to companies and subcontractors in attempt to make head contractors more responsible. This has been a multi decade see-saw exercise that has not really achieved much, as most subcontractors want company structure benefits rather than being a sole trader.
The QBCC is continuing to push the project bank account legislation for all projects and sectors. In theory it sounds good. This will impact cashflow and make it difficult to manage the business’ financial affairs, and will not solve the subcontractor payment issue and merely increase costs to the client and end-user, especially in residential and small commercial projects.
Mosiac has mentioned costs increases are unlikely to peak until mid 2022 and prudently builders and clients should be allowing another 5-10% on current pricing. Hutchinson Builders has indicated that current pricing is already up 12% from the start of 2021.
From our experience, many current builders have not been passing on the full cost escalations of materials and labour. Either these cost escalations will need to settle or construction prices will continue to rise or there will be more insolvencies. Banks have increased bad debt provisions for failed loans anticipating increased levels of distress within the industry.
In longer run construction such as civil and residential, many builders have workbooks full for 18-24 months and have ceased taking on new work. This will create cash flow issues for them and increased demand for trades due to the ongoing work required in health, education, residential and the Olympics.
The Council of Mayors SEQ has been working with the Queensland and Commonwealth Governments on the largest “City Deal” in the country. KPMG has modelled a $58 billion boost to the economy.
Surging demand for all trades for insurance companies linked to the floods and large infrastructure projects. It will leave massive gaps in the private commercial sector with prices set to increase further.
The shortages of labour will continue. Roughly one third of Australia’s labour shortage is in the construction sector. The closing of international and domestic borders during COVID-19 added fuel to the fire, and this will continue with the increased project demand and competition from other nations for construction talent. Labour costs will rise and perhaps wage growth is a good outcome.
A potential ticking time bomb is Evergrande. They are struggling to pay creditors more than $300 billion. Chinese supply and viability is dependent on this debt.
The official cash rate remains at a historic low of 0.1%, most financial institutions have priced in 3-4 rate hikes in 2022. Yet, these forecasts were done prior to the Russian invasion of Ukraine. Inflation, unemployment and the economic recovery from the floods will be washed closely by the Reserve Bank. The price of many construction materials such as steel, glass and copper are hedged to the US dollar and will be impacted on what the US Federal Reserve does with 7% inflation.
Conclusion
In this market there are a few things we can all do:
1. Clients (Public and Private Sectors) and Project Managers can work with contractors or builders they trust and plan around these issues which include risk sharing on procurement, programme and price escalation.
2. Clients (Public and Private Sectors) can be more realistic about timeframes and pressures on the industry.
3. Consider alternative commercial and contract models that have been used extensively in the mining or infrastructure sectors.
4. Contractors/Builders can be more transparent with their clients.
5. Contractors/Builders can be more open with subcontractors about performance expectations and risk.
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