Builders going bust - what are the red flags?
What’s on our mind: Builders are going bust, and construction costs are rising. This week we compiled a list of red flags to watch out for when choosing a builder.
What happened this week: Aus unemployment rate at 3.5%,
What are we watching next week: Aus June quarter inflation rate (Wednesday 31st July - 11:30 am).Â
Prelude:
What’s on our mind:
Over the last 12 months, some of Australia’s biggest names in the building industry have gone under.Â
Companies like Probuild and Porter Davis - household names who are responsible for some of the east coast’s biggest projects.Â
Probuild, for example, had been in the game for over 30 years.Â
Before its bankruptcy in 2022, Probuild was one of Australia's largest and most successful construction companies.Â
Last week, we saw two more companies go under across Melbourne and Sydney - Millbrook Homes in NSW and Bentley Homes in Victoria.Â
The article above from the Australian showed that insolvencies in the building sector are up 75% compared to last year.Â
The article cites labour shortages leading to increasing costs and shrinking builder margins as the primary reason for all the insolvencies.Â
The article also touches on how higher interest rates lead to new projects being put on hold.Â
But why does all of this matter? What does it mean for the construction industry's future and property prices?Â
Today we look at:
Red flags when looking to appoint a new builder:Â
Why are builders going bust?Â
AND
What do the bankruptcies mean for the construction industry?
Red flags when looking for a new builder:
Before getting into today’s article, check out the following list below if you are:
Looking to appoint a builder.Â
About to kick off a new build.
OR
Contemplating buying an Investment property that will require building works.
Here are some signs we look for when assessing whether or not a builder is in a strong financial position:
Job sites are inactive for extended periods - this likely means they aren't paying trades OR are having trouble getting trades onto a site which is never what you want to see from your builder.Â
Your builder is hard to reach - it's never a good sign if the builder isn't answering or, worse yet, dodging your calls.Â
Aggressive marketing - most builders we speak to are flat out at the moment. If a builder has been in the industry for decades but is offering massive discounts, this is something to be cautious about.Â
Heaps of jobs started in 2020-2021 that still need to be finished - this needs no explaining... Builders are in the turnover game; they aren't making any money if they aren't finishing jobs.Â
Why are builders going bust?Â
It all started with the wave of new work created after the RBA cut rates to 0.1%.Â
Cheap debt and government grants led to record new dwelling approvals and, in turn, new construction work.Â
(Source)
The problem was that the rest of the world was doing the same thing.Â
A rush to stimulate from the rest of the world then lead to materials prices going higher.Â
Builders already operating on razor-thin margins found themselves in a position where fixed-price construction costs were now well below even the materials costs of a new project.Â
Every month that work was delayed made the problem even worse, with almost quarterly material price increases between 2020-2022.Â
Some builders were able to absorb these losses, but most folded.Â
How do the builders recoup those losses?Â
The short answer is by winning new work with higher profit margins.Â
The only way builders can dig themselves out of the hole the pandemic jobs created is by winning NEW work.Â
I.e. where a builder was previously happy to make a $100,000 profit on a job, an identical project will now have a $200,000 profit priced in so that previous losses can be offset.Â
Builders will also look to increase prices in anticipation of future cost inflation.Â
As a result, construction costs increase to levels well above those considered feasible.Â
Increased costs lead to feasibility for new builds not stacking up and eventually less construction activity.
High-interest rates compound all of these pressures and accelerate the downturns.Â
What do we expect to see next?Â
We expect to see builder bankruptcies increase over the next 6-9 months as new work dry’s up.Â
With no new jobs, builders will be forced to front the losses on previous projects with no way of recouping these losses.Â
What do the bankruptcies mean for the construction industry?
In the short term, it will mean there are far fewer builders out there to bid for new work.Â
This will mean higher fixed-price building contracts from operators with the financial capacity to take on new work.Â
In short - builders who have strong balance sheets will thrive even with less work out there.Â
The key takeaway for anyone thinking about building now is that construction costs are increasing NOT due to materials shortages but because of labour shortages.
In 2021 materials costs were the primary reason for prices going higher.Â
Now with most materials prices stabilising (and in some cases coming down), the primary inflationary pressure is labour costs.
What do we expect to see next?Â
Eventually, we expect labour costs to start decreasing as tradies are left with less work and more competition on any new work available to bid on.Â
Thanks for reading,
Aus_Prop team.Â
You can contact us here:
On Twitter @Aus__PropertyÂ
Via email at Auspropertymarket@gmail.comÂ
Or through Substack - Property Down Under