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What’s happening with home builders?

Over the past few months we’ve been seeing reports of housing industry businesses facing insolvency. Yet at the same time, we’re also hearing that there is plenty of work in the pipeline, and not enough tradespeople to do it.

So where is the disconnect, and what is the solution?

A report released this week by IbisWorld suggests that the problem is due to supply chain disruptions, labour concerns and rising input costs affecting builders. More specifically, however, it is more about some builders’ reliance on fixed-price contracts, which determine a set price for the duration of the contract regardless of the actual costs of production.

As a result, IBISWorld expects house construction enterprise numbers to decline by 9.0% in 2022-23, contracting for the first time in a decade.

The report shows that while record-low interest rates and the HomeBuilder scheme supported house building activity throughout the COVID-19 pandemic, builders have still been affected by a combination of negative trading conditions over the past five years, including:

– Supply chains being stretched to their limits during COVID-19 by logistical interruptions, and then by the Russia-Ukraine conflict.

– A skilled labour shortage caused by subdued apprenticeship rates, pandemic-related restrictions to skilled worker movements and the large number of projects currently being undertaken.

– Upward pressure on input costs for a range of construction materials such as timber, iron, steel, plastic and rubber, following huge demand spikes caused by HomeBuilder and other government stimulus measures.

– Rising interest rates, imposed by the RBA to subdue inflation, increasing the cost of borrowing and lowering housing prices.

As a result, according to the Financial Review, the average cost of building a home jumped by $76,000 or 23.2% over the year through April 2022. The concurrent cost rises have significantly affected many builders, as a large portion of house construction industry players have fixed-price contracts in place.

One of the industry’s largest firms, Metricon Homes Pty Ltd (Metricon), has been compromised by the challenges facing home builders. The company has a high profile throughout Victoria, New South Wales and parts of Queensland and in 2022 was crowned Australia’s leading home builder for the sixth year in a row by the Housing Industry Association, having commenced 6,052 homes.

However, rumours spread in late 2021-22 that the company had overextended itself and was on the brink of collapse. Metricon indicated that it had renegotiated a small number of contracts amid anecdotal accounts of stalled work on sites.

Metricon currently has a reported 4,000 projects in the pipeline, including $195.0 million worth of contracts with the Victorian State Government to build and maintain public housing. In the event of a collapse, it is estimated that the Home Building Compensation Fund, which covers 20% of a contract’s cost, would be an estimated $28 million out of pocket in New South Wales alone.

To the relief of an estimated 2,500 employees, Metricon organised a new financial deal in late May 2022, with the backing of the Commonwealth Bank and a $30.0 million cash injection from shareholders, staving off insolvency for the time being.

Other firms in the House Construction industry, such as Probuild and ABD Group, have not been as lucky as Metricon. Acquiring lenders’ support has proven difficult for smaller firms without the advantage of a large number of projects in the pipeline.

The report suggests that some builders have reportedly requested customers to pay additional amounts outside the scope of their contracts. In response, the Queensland Building and Construction Commission has urged homeowners to seek legal advice before making payments that fall outside the terms of a fixed-price building contract. Other firms have petitioned government bodies for assistance with the cost rises.

It goes on to predict that the insolvencies currently besieging home builders could limit customer willingness for up-front payments in the future. Customers have previously benefited from fixed-price arrangements, which side-stepped rising inflation and input costs. However, as builders go bankrupt customers stand to lose money they have already paid.

Despite the difficult conditions facing house builders, the current macroeconomic trends are forecast to ease in the near future, the report suggests. Falling industry enterprise figures are likely to ease pressures on the remaining firms over the next five years. Lower demand for building materials and a gradual easing of supply chain constraints are projected to make domestic prices of commodities return to affordable levels. This will allow procurement teams to lock-in long-term contracts at favourable prices.

Over the next five years, house construction firms are likely to include rise-and-fall clauses in some future contracts. However, current regulations surrounding rise-and-fall clauses for residential construction projects vary from state to state and may constrain instances of their inclusion. For example, the inclusion of a rise-and-fall clause in a contract priced at less than $500,000 is currently illegal in Victoria.

Skilled labour shortages have the potential to encourage greater worker retention practices among the remaining employers in the house construction industry, and include higher pay, benefits and other career development incentives.

The report concludes that the gradual opening of Australia’s borders and the recovery in net migration rates following the COVID-19 outbreak will also increase the employment of skilled migrants.

About Adam Nobel

Principal
M. Bus, Grad Dip Adv, B.Int Bus, LREA

adam@hugoalexander.com.au

0417 007 001

Adam is the founder and Principal of Hugo Alexander Property Group. With a previous career in advertising, 20 years experience in property investment, and 14 years in Brisbane real estate, he knows the market inside out to ensure his clients grow their wealth faster.

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