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Collapses in the industry highlight structural weaknesses, but there were danger signs in the data and so it’s time for a rethink.
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Cracks in construction won’t be filled by home owners warranty
06 April 2023
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13 minute read
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The building sector has witnessed another two large-scale collapses in the last 10 days with the demise of home builder Porter Davis in Victoria and community building constructor Lloyd Group in Queensland. According to some in the industry, more collapses are likely in the next few months. The reasons include supply chain issues, the rising cost of products and labour, reduction in funding appetite from banks and investors, a slowing housing market, interest rates hikes, and fixed-price contracts.
I think industry experts saw this coming. Supply chain issues and increased costs have moved down the list of challenges, but builders say interest rate hikes have cooled demand and clients are waiting for certainty before they commit.
In fact, things are only going to get trickier.
Holes in home owners warranty
First, home owners warranty (HOW) will only provide some relief to buyers when a builder has failed. Consumers will now have to deal with price hikes in labour and materials as well as construction delays. In my time dealing with insolvent builders, the relief from HOW almost never covers the additional costs of completing the original build. In some cases, the build has been varied down to accommodate the lack of funds.
There is also an assumption the consumer receives value for the money paid to the builder, but this does not hold true where construction ceases in the early phases. Builders front-load progress claims, so customers lose the money they have effectively paid in advance when the builder fails. Deposits will be lost.
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Time to change the rules
In reality, HOW is not working as it should and, in some cases, is being gamed. I am confident there is data in the HOW assessment process that would assist in identifying failing businesses. The fact that home owners are losers should provide incentive for a reassessment between builders and their customers. A builder should be able to negotiate with the home owner about rising costs because the alternative — a failed builder — is far worse.
In the case of a sizeable builder such as Porter Davis, with over 1,500 homes under construction, that would be difficult. But it could be achieved through some large-scale mandated mediation.
It would be worth considering, especially if you were about to lose your deposit. Some buyers would be retirees downsizing who have put money on a fit-for-purpose build. There must be a better way.
Too big to fail?
Another conclusion to reach here is that bigger is not always better. One strategy considered in the Porter Davis case is for another builder to take over the work of unfinished homes. In my experience, other builders are sympathetic and come together for the good of the sector to help complete the work. However, in the current climate, there will be fewer builders capable of taking on further demand unless the buyer pays a premium for the attention and is prepared to wait.
There is another challenge: the additional costs will need to be funded by the consumer. Fixed-price contracts are popular because the banks funding the home owner want to ensure their loan-to-valuation ratio stacks up — they want certainty about the costs the borrower will face.
In other words, a bank won’t lend to a borrower if they can’t fund the loan repayments.
This is why you hear a lot of builders complain of slow-paying customers when they have applied variations to the next progress claim — the bank is not funding that variation, only the agreed fixed-price contract, so the extra must come from the home owners’ spare cash. (This applies to builds of around $1 million, higher-cost homes have different bank criteria.)
Now if the home owner has locked in a loan, they will need to fund the extra cost to complete the build of their home with spare cash. How do you recover on a lost deposit?
I can’t see loan-to-valuation ratios changing given the flattening of the values in certain sectors of the housing market. That will limit equity redraws as a source of funding for home owners.
Tradies and subcontractors
Let’s not forget about the subcontractors and allied trades. Some trades take out insurance for bad debts and can recover their position, even if only in part. Others may have an opportunity to renegotiate a position with the new builder once the fallout settles. The rest will miss out. The suppliers of materials and labour are critical to the operation of the building industry. They are also the most vulnerable, particularly when working for a major player. While you might get paid on time, that month you don’t get paid will hurt.
This has always been the case and won’t change. During times when demand for services and materials exceeds supply, the power in the industry sits with suppliers and labour. But what they see — the information and data from the industry coalface — could be used as a proxy for impending disaster. It is time for this sector to become more proactive.
Large-scale collapses might be avoidable or at least handled better when we realise that the building system contains enough information to identify issues and take corrective action before disaster strikes. It’s time for a rethink.
Eddie Senatore is director of Eddie Senatore Advisory.
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