Building and construction is an important sector of the Australian economy, employing over 1.3 million people and accounting for almost 9.5% of the Australian workforce. When the sector is doing well, it can be a broader sign of confidence relating to the economy – building is a significant investment for individuals or organisations to undertake, so people are less likely to make the decision to build if they believe future economic prospects are very poor. This often results in the industry being seen as a bellwether for the broader economy, so it’s no surprise it is a regular target of media attention.
While pressures relating to rising material costs, labour and supply chain issues have been well-documented in the media, a lot of the finer detail doesn’t get reported. I’d like to share some of that detail with readers today, and share some of the important things to look at when assessing the strength or suitability of a builder.
Fixed features, fixed prices, and thin margins
Volume-based home builders must compete for the business of regular mum and dad customers. The way contracts and projects are executed can be quite rigid. For instance, if timber frames were a part of the original plan in the contract, it can be difficult to change this. In the commercial property development sector, these things can sometimes be negotiated. For instance, if there is a 40% spike in timber prices, such as what we saw in 2022, this could cripple a retail home project (or portfolio of projects). In the commercial space, there is sometimes the flexibility for the builder to negotiate a switch to alternative framing materials.
Most of the projects in the volume-based home building sector are fixed-price. Furthermore, there could be a number of months between the signing of the contracts and the final delivery of the last of the building materials.
With a fixed price on the project, any spike in input costs between the time contracts are signed and building materials are secured eats into the profit margin of the builder. If profit margins are already thin due to the competitive nature of the industry, then a project, or number of projects, can become instantly unviable.
Stage prepayments
Generally, project stages in the retail home building subsector are prepaid. The builder is extended funds for the first stage of the project and then, upon completion, they are extended funding for the next stage. In ordinary times, this can assist with cashflow for the builder. It also means a home builder could have many projects in play at one time, as all current stage activities have been prepaid. This means that cost inflation could make a portfolio of already contracted, commenced projects – and more critically, work that has been prepaid, unviable for the builder. Builders may have to absorb significant losses to honour prepaid commitments, and the more projects impacted by the price shocks, the more likely insolvency could occur.
Not all builders operate like this. For instance, in the commercial/property development space, it is more common for a piece of work (for instance, laying the foundation), to be paid for at the completion of that piece of work.
Assessing a builder’s history of delivery and quality
Before funding any building project, it’s important to assess the builder’s suitability for the project. Have they delivered many similar projects in the past? Do they have a history of delivering on time and honouring agreed terms? Again, there is a difference between the retail mum and dad sector, and the commercial sector in this regard. And unfortunately, the typical mum and dad buyer doesn’t have the same bargaining power as commercial property developers or commercial lenders. Mum and dad buyers would typically have access to customer testimonials and other material provided by a prospective builder.
A property developer, however, will often have more sway with prospective builders. A reasonable sized developer may have the ability to assess a builder’s former projects, confirm delivery to agreed terms and get a thorough view of a builder’s appropriateness for a project, including canvassing subtractors who may have worked on projects with that builder before. This information can then be included on any submission to lenders to raise funding.
Speaking to customers and suppliers who have previously dealt with a builder can give further indication of the builder’s history of honouring commitments on time and to agreed terms.
Certain regulatory bodies such as the QBCC in Queensland also provide details on the history of licenced builders. The number of projects year on year, and total value of those projects, can give an indication of a builder’s suitability for a given project. The QBCC also provides details regarding the number of claims made against a builder each year under the statutory insurance scheme, the number of directions each year to rectify works and the number of directions complied with or not complied with.
Assessing a builder’s credit history
Organisations like Equifax provide a credit score for builders. A company that lacks financial strength may default on its invoices. This would impact its credit scores. Alternatively, it may have a history of very late invoice payments. Again, this would impact the organisation’s credit score. Sometimes, if a company’s financial difficulties are influencing the way it interacts with its customers and suppliers, there will be an elevation in the number of credit score enquiries made, as customers and suppliers seek to investigate. Even that increase in enquiry could impact a company’s credit score. Credit scores through organisations such as Equifax can be useful tools to help assess the financial strength of a builder.
Cutting through the noise
We all have to rent or own somewhere to live. Home ownership, house renovations and property investment are big parts of Australian culture and interest. As discussed earlier, building and construction is a big part of the Australian economy. It makes sense that any development in the industry, large or small, will make big news.
External challenges will come and go and every development is sure to be reported in the media. However, the medium and long term trends remain. The current shortage of housing in the economy is clear given the rental crisis, so we already know our economy needs more dwellings built. Additionally, between natural growth and immigration, our population is forecast to add over a million people by June 2025, which will significantly add to the demand for housing.
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