Residential construction companies in Australia have been toppling like dominoes, and this has left many depositors in a very difficult financial position.
Like an uncontrolled demolition, construction companies have been collapsing at a rate that has not been seen for almost a decade.
Data from the Australian Securities and Investments Commission shows a gathering pace of construction insolvencies in the past three years, with 2196 builders going bust in the past financial year through to April 7, a 34 percent increase from the 1635 insolvencies recorded in the 2023 year.
For the nine-month period from July 1, 2023 to March 31, 2024, construction firms accounted for nearly 28 per cent of all insolvencies.
This figure dwarfs the next industry sector (accommodation and food services) of 1013 companies and makes up the lion’s share of 7231 companies in total that have folded over the same period.
These are not small companies either. Clough Group, Probuild, Dyldam Developments, Snowden Developments, ABG Group and Condev have been some of the larger construction companies to fold, while one of the more recent casualties was Porter Davis Homes Group (rated the 13th biggest builder in Australia) – which alone put 1700 projects in jeopardy across multiple states. Collectively these companies had billions of dollars of home construction projects in their pipelines.
This is despite the fact that Australia faces a shortage of 106,300 new homes over the next five years, according to the National Housing Finance and Investment Corporation, which warned the number of apartments and townhouses being built has fallen by about 40 percent since the 2010s.
These statistics beg the question: is the great Australian dream of home ownership becoming a nightmare? It certainly has not been a dream for many – particularly those who put down (often hefty) deposits to construction companies that have subsequently gone bust.
Why have construction companies been collapsing?
There are a number of reasons why residential construction companies have been going bankrupt.
From COVID shutdowns, extended periods of inclement weather and chronic supply chain issues to cashed-up infrastructure companies competing for construction labour, first home builder stimulus packages being wound back and the end of a prolonged cheap credit-fuelled surge, the industry has been at the centre of a perfect storm.
Dr Peter Swan, a Professor in the School of Banking and Finance at UNSW Business School, said that much building in the residential construction industry takes place “off the plan” when a fixed price contract is signed along with the payment of a deposit.
“Covid lockdowns and hundreds of billions paid to people not to work caused supply shortages, both locally and overseas. Lax fiscal policies and massive printing of money by the RBA led to inflation. The cash rate has been raised from almost zero to over 4 percent per annum,” he syas.
“All of these changes have put pressure on builders financially, as has the decline in house prices which has now levelled out and gone into reverse. Far fewer properties are being listed for sale,” he says.
The numbers do not paint a rosy picture. In its most recent Building Approvals report, The Australian Bureau of Statistics (ABS) found that in April 2023 (seasonally adjusted), total dwelling approvals fell by 8 per cent, while private sector houses fell 3.8 per cent, private sector dwellings (excluding houses) fell 16.5 per cent and the value of new residential buildings fell 2.7 per cent.
These numbers are supported by the ABS Lending Indicators report, which found that the value of new borrower-accepted loans (seasonally adjusted) has fallen by 25.8 percent for the year to-date, with owner-occupier loans falling by 24.3 percent and investor loans dropping by an even larger 28.6 percent.
Dr Rob Nicholls, Associate Professor of Regulation and Governance in the School of Management and Governance at UNSW Business School, also noted that the cash flow risks associated with increases in material costs and shortages of labour are borne by the builder in the residential home building sector.
This is different from the commercial building sector where lenders typically require that material contracts are either fixed or hedged for the duration of the project.
“For a residential builder, increased material costs and longer than usual material delivery times stretch working capital requirements. Some builders cannot deal with this and collapse,” he said.
Impact on the residential housing market
The collapse of such a high number of residential construction companies has had two major impacts, according to A/Prof. Nicholls, who also leads the UNSW Business School Regulatory Laboratory.
The first impact is a reluctance by consumers to build new houses because they recognise that they have the risk of construction delay and a builder insolvency risk. The second is that suppliers to the industry recognise the insolvency risk and seek payment terms that put further pressure on builders’ working capital.
“The impact is compounded by builders trying to manage multiple builds where the prepayment on one build may be used on another. The effect is that if the builder folds, multiple projects halt,” he said.
To illustrate, the Housing Industry Association has found new home sales in the three months to May 2023 were more than 40 percent lower than in the year before when interest rates started to increase, and 25 percent lower than prior to the pandemic.
Furthermore, cancellations of new home sales also remain elevated at a rate of 25 percent in the last quarter. This means, for every four new projects a builder is recording, a previous project is being cancelled.
Prof. Swan noted that, because these residential building company collapses have contributed to reduced supply of housing stock, this has contributed to the current rental crisis, and rents are now rising further – a multifaceted challenge that has led to calls for rents to be frozen.
“Investors in rental housing have been discouraged by the threat of rental control and more ‘protection’ for tenants,” said Prof. Swan, who observed that house prices have turned around and are now rising.
What recourse do depositors have if their builder folds?
The collapse of so many home construction companies has left many creditors – including those who put down deposits for a house – in the lurch. There is “very little” individuals can do in response (other than expensive legal action), says Prof. Swan, who observed that bankruptcy, particularly of home builders, is very hard to predict.
His one recommendation is to avoid buying off the plan and this is “always risky” and can and should be avoided. “There are large, reputable builders who have been around for many decades. This offers some protection but far from complete,” he said.
A/Prof. Nicholls concurred. “Currently, the house buyer is just an unsecured creditor to the builder,” he said. “This means that they have two problems. Some of their funds will be lost and finding another builder to complete the work is difficult because of increased material costs.”
He also noted that home warranty insurance (under the Home Building Compensation Fund (HBCF)) could only be claimed five weeks after an insolvency event, which is the case under the Master Builders’ Association standard contract. “The cover is also based on the original cost of works, which is likely to rise because of the same events that led to the insolvency,” said A/Prof. Nicholls.
Improving legal coverage for new home buyers
A/Prof. Nicholls is conducting investigative research into consumer protection in the construction industry as part of a UNSW Business Insights Institute project with Tip Group, an ASX-listed financial institution focusing on transferring knowledge and wealth between generations. If a superannuation fund goes into liquidation, members’ investments are protected, and if a bank goes bankrupt, customers’ deposits are protected, but if a homebuilder collapses, he said new homebuyers’ deposits are not protected.
“Our research focus will be to understand how to reduce systemic and systematic risk in residential construction by learning from financial and professional service regulation,” says A/Prof. Nicholls. He explained the outcome of the research would be to propose a regulatory framework that will minimise risks for those looking to buy and build new homes.
“There is a need to change the regulatory settings for the residential building industry in order to minimise the insolvency risk for both the builder and the consumer,” he says.
“Unfortunately, previous performance is no guide to future outcomes. Under the current and inadequate protections for both the buyer and the builder there is always an insolvency risk. This is the motivation for the research at UNSW.”
This article was written by UNSW’s Craig Donaldson and republished on Architecture & Design.
Image: https://www.businessthink.unsw.edu.au/articles/construction-company-collapse
