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Fixed-price contracts signed months ago are squeezing builders out of business, says CPA Australia.
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Construction industry ‘on collision course with insolvency’
14 July 2022
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The construction industry is hostage to fixed-price contracts signed months ago that will force many builders into insolvency, said CPA Australia’s SME manager.
Strong economic headwinds combined with materials shortages had banished certainty and trapped builders between rising prices and decreasing access to finance, said Kristen Beadle.
She said CPA Australia members told of cost-squeezed builders in the middle of renovation work trying to renegotiate to cover rising prices, only to find home owners constrained by loan-to-valuation ratios or their inability to service a bigger loan with interest rates rising.
The amounts involved were often substantial – many tens of thousands of dollars – and insolvencies would have domino effect, she said.
“Most construction contracts are fixed-price and that helps in the lending process so homeowners can go to a lender and say, ‘It’s going to cost this amount to build’,” Ms Beadle said.
“But everyone’s margins are tightening and what fat was built into these contracts has disappeared pretty much overnight.
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“Access to building materials is drying up, the cost of building materials is escalating, there are other inflationary costs in the economy. Then when you finally get something out to your building site, there’s insufficient labour to put it up.”
She said recent figures from CreditorWatch that suggested the building industry was at a lower default risk than other sectors – such as food and beverages – were probably skewed by government construction projects.
“They’re still going to want their hospital built because there’s an expectation of a policy that they’ve said that they’re going to deliver,” Ms Beadle said.
“It’s in that residential space – mum and dad. The average consumer is saying build our home and builders are saying we can no longer do it in the current environment … we need more money.
“But there’s been a contract signed and that’s the problem.
“These things might have been done six months ago, even three months ago, and we certainly weren’t in accelerated inflation back then. We were probably in a bit of a hiatus because we were in the run up to an election.”
She said economic conditions were being exacerbated by global conflict crimping supply of building materials, with crucial Russian structural timber no longer available and Ukraine the source for 30 per cent of the wood for pallets.
“Everything that gets moved is on a pallet, basically. So effectively you’re only moving two-thirds of what we were moving pre-Ukraine,” Ms Beadle said.
She said while not every builder was vulnerable, insolvency figures lagged reality and a problem anywhere in the system could have a disastrous impact on trades and professions reliant on construction.
“These sorts of things cascade down the economy. You’ve got plumbers, carpenters, electricians, cabinet makers, kitchen-fitters, architects – all of these people in that supply chain,” Ms Beadle said.
“I was talking to a liquidator yesterday and he was appointed over a decent-size builder. He said out of his unsecured creditor pool of around $17 million, one of the creditors had already gone into liquidation because they were so reliant on his company that’s under external administration. And others were already speaking to insolvency people.
“It’s not going to get better in the short term. Usually, insolvency lags quite a lot. When you have a major trigger point then six months is usually when it happens. So even if we do see an uptick in what’s going on now, you’ll probably still see insolvencies dropping out of the market.”
Builders would need to build higher margins or CPI adjustments into contracts as a safeguard, she said, although this would cause problems with finance.
However, state governments could rethink how they regulated builders’ licences to suspend automatic cancellation on appointment of an administrator. That would give a builder the chance to complete outstanding work and the business the possibility of restructuring.
“You’ve got these federal insolvency laws that everyone should be able to access but because you’re a builder, and you hold a state licence, you can’t,” she said.
“So they have no options. You should be able to restructure because that’s the way the federal legislation is written. And it’s not currently allowing them to do it.”
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