Is the construction sector on the brink of collapse?

Speaker 1:
Welcome to CPA Australia's With Interest podcast. Bringing you this week's need to know information for businesses and accounting professionals.

Dr Jane Rennie:
Hello and welcome to CPA Australia's with Interest podcast. I'm Doctor Jane Rennie, general manager media and content at CPA Australia.

Dr Jane Rennie:
It's accurate to say that Australia's economic conditions, which include rising inflation, supply chain disruptions, labour shortages and extreme weather events are presenting challenges for many businesses.

Dr Jane Rennie:
But the fall out has been particularly acute for the construction sector. In 2021, '22 the construction sector recorded the highest number of insolvencies in Australia and now accounts for 28% of all nationwide insolvencies. Household names like Probuild, Privium, Waterford Homes and Pivotal Homes have gone under in the past year. Just last week Langford Jones Homes went into liquidation and the week before that, Snowden Homes went into voluntary administration. Where will the damage stop? Or indeed, will it stop for the construction sector?

Dr Jane Rennie:
Joining me now to discuss the state of Australia's building industry is CPA Australia manager public practise and small and medium enterprises, Kristen Beadle. Kristen, as a former insolvency practitioner yourself you've been a keen observer of the construction industry over the past few months, so tell me, just how bad are things for the sector at the moment?

Kristen Beadle:
Thank you Jane and thank you for inviting me to be here today. Look, as you've suggested it's pretty tough. The various factors that you went through in your introduction are impacting all across the economy, but particularly in the construction industry. I think people need to realise there's always, every generation, there're these issues in the economy because it's cyclical. But I think we're looking probably now at a once a century type issue here. I mean, putting into the shut downs during COVID, there's this lag that's now happening at the moment that probably has been bubbling away for a little bit of time now.

Kristen Beadle:
I was at an event late last week and I think what people aren't realising facing the sector is, we've heard that there're wood shortages for example, so timber shortages. But we're looking at things like 30% of the wood used for pallets comes from the Ukraine, and so that's what you transport bricks on for example, and all the goods that you put into a kitchen, bathroom and that sort of stuff.

Kristen Beadle:
We've got a national shortage of truck drivers and forklift drivers at the moment in Australia. Goods that are taking eight days to ship are now taking six weeks and shipping container prices have increased by 500% to 600%. So it takes that long and it's that much to get it to a construction site and then you've got no one to put it actually into and make it into a home.

Dr Jane Rennie:
Kristen you just mentioned some nationwide shortages, is this a nationwide issue, or are some states and territories doing it tougher than others?

Kristen Beadle:
Oh, I think it's definitely nationwide. I think probably Victoria particularly is doing it quite tough at the moment whether or not that's from lockdowns, or who knows if there's a COVID hangover. But certainly, it is a nationwide problem at the moment. You named them in the introduction, big entities, Condev, Pivotal Homes and Probuild. That's a lot of projects and a lot of jobs.

Dr Jane Rennie:
Another question I'm interested to learn then, is the problem confined to residential home building? Is that the end of the industry that we're talking about, or is this also effecting commercial and infrastructure projects?

Kristen Beadle:
I think we're seeing it quite commonly in the residential sector at the moment, and I think that's always the first cab off the rank as it were. I think those other two sectors will have its own challenges. I think commercial projects will have issues such as the moving to working from home. For example, will there need to be that office building put up in that particular spot, or will that company go to a new building when half of their workforce is working from home? So that will have its own challenges in itself I think.

Kristen Beadle:
Large scale public projects will be interesting to look at because if you have those costs blow out on those particular projects, which can happen, if the government's footing the bill they're still going to want, for example, their hospital built, or their office building built, so they're going to still need that done, so there'll be different challenges for each sector.

Dr Jane Rennie:
I guess I only really know what I read in the papers, what I'm wondering is, are there a number of other insolvency indicators that aren't hitting the headlines that are really just happening behind the scenes?

Kristen Beadle:
Yeah there is. Behaviour by people in financial distress can be a little bit erratic. If you have a client or you know someone that's evading your calls and not returning emails, those kind of things, that's usually a sign that there might be some financial problems going on in the background. If you think about it, I've been following quite closely Creditor Watch lately and probably over the last year they've been saying that the payment terms in the construction industry have ballooned out to over 60 days, which is quite considerable in that particular industry. We're also seeing, and members are telling us, there's a significant increase in discussions on financial difficulty in the sector, so members as well as insolvency practitioners are saying that these are the bulks of the conversations that they're having.

Dr Jane Rennie:
For me, I guess the burning question for this episode is how close are we to a systemic collapse in the construction industry? And by that I mean a collapse that threatens the future of the industry, or indeed the health of the economy more broadly.

Kristen Beadle:
We have, in most of the states and at a federal level, a labour government, so I can't see the sector being abandoned as it were. It might be smaller at the end of this when this crisis is over, but I think the industry will remain, I think it just needs some support.

Dr Jane Rennie:
At what point in fact would it become systemic? I mean would it take one big builder to go under, say of the likes of a Metricon Homes, or could the continued failure of small building companies bring the industry unstuck?

Kristen Beadle:
Jane, I think everything is cyclical. I don't think the industry will become unstuck, but the businesses that have more robust business models may be able to weather the cycle a little bit more. The problem that you'll find is you've got those large volume builders, like a Metricon, that use trades people that go from one project to another and they just roll through. So those smaller players that rely on the big players, if a big one goes into administration or liquidation, that's a big problem for them because they haven't diversified their client base.

Dr Jane Rennie:
Kristen, you just mentioned that reliance of say smaller players on the bigger players. Now there are a lot of associated industries that rely on construction, can you tell me a few of these, and are they also bearing the pain of the insolvencies that we're seeing now?

Kristen Beadle:
I think so. Everyone just thinks it's businesses that put the bricks in or put the windows in, but there are those other players that come in that do the cabinetry in the kitchens, that bring in the tiles and those kind of things. So all of that demand, once that demand goes down, is going to effect those industries.

Dr Jane Rennie:
So I guess it's not ring fenced if you like, there's that ripple effect. To that end, what I was wondering is, say you've got a smaller player that's collapsed that's not going to have an impact at a state or a national level, but it could still be very regionally damaging couldn't it, or localised damage to the area where that builder is focused?

Kristen Beadle:
That's exactly right. It might be in the scheme of things a small player nationally, but in that area it could be quite substantial. I know of one in regional Victoria that went into liquidation recently, a media report said that they had 55 unfinished homes in that area. That's a lot of consumers without finished homes that are now trying to source a new builder to complete that build, it's a lot of unpaid trades. Anyone who has lived regionally knows how difficult it can be to get people to service your area. I've lived regionally and it was fairly hard to get anyone out from Melbourne where I live up to where I was at the time.

Kristen Beadle:
So with players going out of the market, consumers aren't being serviced, local trades are being overworked, if a major player goes down it's a massive loss of revenue to those local trades. It can lead to mental health issues as well.

Dr Jane Rennie:
Well, at what point would or should perhaps the government step in and intervene? How bad does it need to get before we get action at a state or at a federal level?

Kristen Beadle:
I think help is certainly needed at the moment. Governments need to get out of this obsession with we'll just throw money at the problem. This problem can be assisted by fixing regulation and making it easier for business.

Dr Jane Rennie:
So is there any company that is just too big to fail though, that the government shouldn't let go under because it'll bring so many people in its wake, do you think?

Kristen Beadle:
Another very good question, Jane. I think part of any business cycle is closure. Any business that starts is more than likely going to stop at some point, whether that be through succession, retirement of key players, or financial distress. So I think bailing out businesses certainly sets a precedent that I'm sure no government really wants, so I know media reports have seen that Metricon has been provided some assistance. But I think no one is too big to fail to directly answer your question, but I think there are some things that governments can to do help strengthen the industry in the short term.

Dr Jane Rennie:
Certainly I mean the issue of inflation and rising material costs is a global issue. In other countries for example, Italy I understand that price rises in these sorts of circumstances are built into building contracts, is that something we should be considering in Australia to assist the construction industry?

Kristen Beadle:
Yes, I think we need to help these businesses be able to go through this cycle at the moment. The costs of building are increasing at a rate higher than inflation, let's just state that as a fact. We've been hearing from builders that something, a piece of timber for example that might've cost $3 last year, costs $6 this year. I mean that's a significant increase when you use the amount of timber that you do. So inflation is absolutely hurting this particular industry, as I'm sure it is across the economy at the moment.

Kristen Beadle:
So those building contracts need to keep up with these rising prices, so going forward, I think these contracts should at least have a CPI increase built into them and I think businesses need to consider the way in which they've done business before. So construction is usually high volume, high margins. They need to consider whether or not that practise stops and that they build in significant margins into their contracts now if they don't want to put in a CPI increase for example.

Kristen Beadle:
But I think what this will do is, we're probably looking at a revolutionization of the way the business practises occur in this industry at the moment.

Dr Jane Rennie:
You commented that insolvency levels in the construction sector are at once in a lifetime levels. I guess for most people, unless they're employed in construction or perhaps building themselves, their only experience of this is what they read in the papers, but the reality is that for those involved it's actually deeply personal. I know you meet with CPA Australia members, that is accounting professionals who are on the front line of this. What are some of the stories they're telling you about what it's really like if you're in the construction sector right now?

Kristen Beadle:
Thank you Jane, it is fairly tough out there. There's a lot of genuine concern and even mental health issues coming out of this. I was talking to a member last week who was mentioning he has a client and is in the building and construction space and this particular client was calling him at 6:50 in the morning saying "What if my company is the next one that's in the papers, what do I do?" That's really stressful for everyone.

Dr Jane Rennie:
So in a nutshell, I guess what are the options? If I'm a builder ringing up my accountant, what are some of the options in these circumstances?

Kristen Beadle:
Look I think it's important to point out insolvency is not the first point that people should start at, it's the last point. Despite some recent stats coming out in the media, the level of insolvency across the economy is down and has been down year on year for quite a few years now, so I think people need to consider that.

Kristen Beadle:
So what our members should be doing with their clients, or what their clients should be asking them is go to your CPA and then have look at, is the business salvageable basically, and if so, what assets are in the business that can be sold off that are not crucial to the operations to help inject some cash flow? Is a refinance required? Do you need to go to a different lender and have a refinance? Or, do you need to inject some capital?

Kristen Beadle:
I often would look at expenses, is the business paying for non-business related items? It happens more than you think. Have a look at whether or not there're payments for living expenses that really should be coming out of that business. Is your spouse driving a luxury car that perhaps could be better at a model a bit more mid range?

Kristen Beadle:
The key is, if the business is insolvent, so after speaking to your CPA, there is no viability in the business and you should be looking at some kind of insolvency administration, it's then key to speak to a registered liquidator or bankruptcy trustee, because they're the only ones qualified to assist you through that process and give you the correct advice.

Dr Jane Rennie:
There is a sting in the tail for builders that enter voluntary administration, and I didn't know about this until you told me, it can lead to the suspension of their building licence. What can you tell me about this?

Kristen Beadle:
Well that's right, Jane. The concern for builders is that they're going through what they're going through in this once in a century circumstances. At the moment they go and speak to an insolvency professional, the professional says you need to enter a small business restructure, a liquidation or a voluntary administration, whatever the circumstances are. Builder follows that advice and then loses their licence because they no longer meet the compliance of state based laws, so there's that issue. The next issue is the home owner who is then left without a builder and a partially completed home.

Dr Jane Rennie:
Is that requirement being strictly enforced by the building authorities in the different states and territories?

Kristen Beadle:
It is. We are hearing from members and insolvency practitioners different things out of different states. We understand that in Victoria for example the building authority there does have discretion to allow a builder to retain the licence and finish projects. I've been speaking to some people in the insolvency industry on that and they've said that they've never experienced that discretion being provided before.

Kristen Beadle:
New South Wales are a little bit different, their act is very prescriptive, so I've been informed that the small business restructure for example is something that is being supported, which we're trying to get in writing at the moment so we can give this to our members.

Kristen Beadle:
I'll tell you a story, up in Queensland I was speaking to an insolvency practitioner up there and he was saying that a company had approached a registered liquidator to be appointed as a voluntary administrator. There was sufficient money in the bank account to complete the projects, so the voluntary administrator approached the agency up there to say, "Look, we'd like you to make sure that we can complete these projects. The builder retains their licence, there's plenty of money, they're also considering a deed of company arrangement."

Kristen Beadle:
To their credit, that agency said, "Yep, we're very happy with what you've put out to us," they saw cash flows, "we're very comfortable." But that decision came four weeks after the initial approach by the voluntary administrator and by then the horse had bolted. The administration process was almost completed and that company, actually, couldn't be restructured.

Dr Jane Rennie:
So it's clear we need a longer term policy solution. What is that solution? Is it just to junk this provision in the legislation?

Kristen Beadle:
Well I think we need some pragmatism by governments. We can't have an entire industry not able to access federal insolvency laws while others can, it'll just lead to phoenix activity. They need to re-think what they're currently doing and by that I mean have a think about whether or not if there is sufficient money there, projects can be complete, should there be limited licences for builders to be able to complete builds so people aren't left in the lurch. If there's a no fault by the builder, they want to propose a restructure, so a small business restructure, or a voluntary administration to deed a company arrangement process, those give returns to creditors. Builders can go through that process, insurers come to the party to make sure that those builders, because they have their licence, they can complete those projects.

Dr Jane Rennie:
I wanted to finish by touching on some of the consequences for consumers. I can only imagine the personal toll involved for being in those circumstances. In terms of the practical implications, in the lead up to the builder going bust, what sort of choices or requests are a consumer likely to face in these circumstances?

Kristen Beadle:
So it's a bit of problem, Jane, when this happens because you might find the builder will ask for more money up front when money is already tight. By that I mean they might be saying, "Well we've got a payment schedule, but we need a payment brought forward," because they need to fund certain parts of the project. Or they'll push through some kind of variation or push back against a variation for example to the build to save money.

Kristen Beadle:
I think the flow on from that is there will be issues around access to cash by the home owner and if the builder, for example, does go into some kind of external administration, then the home owner has that uncertainty around what's going on with their build, what happens next. Then they'll need to also appoint a new builder in a shrinking market.

Dr Jane Rennie:
So having listened to these episodes and listened to you talk about the construction sector right now Kristen, if I were someone who's planning to build or renovate, I'd really have a question mark in my mind, is it actually safe to do this, or should I just put those plans on hold for the time being, what do you think?

Kristen Beadle:
It's a really good question and it's hard to crystal ball these things. I think what people should be doing is speak to your CPA and figure out where your finances are at, what you can afford, how much more you need to either do a renovation or get a new home built. Speak to your bank or your broker to see what sort of wriggle room you've got in that. And also too, you may need to even speak to a lawyer to understand what's in a contract, what might be hidden that will come out down the line if there's a problem.

Dr Jane Rennie:
That sounds like very sound advice. Is there anything I can also do to check the financial health of the builder that I'm looking to engage?

Kristen Beadle:
Definitely, there are actually reports that you can pay a fee for to understand the health of a particular business in which you're about to trade with. This is quite normal, when it's business to business. So if you're concerned about appointing a builder and whether or not the builder will still be around in six months' time, it might be something that's worth investigating.

Kristen Beadle:
Also, keep an eye out for signs of a builder evading you or not getting back to you, because no longer engaging with you is a usual sign that someone is going through financial distress.

Dr Jane Rennie:
Well that's all we've got time for today. Thank you very much Kristen for appearing on our With Interest special, is the construction sector on the brink of collapse? If you've got a question about any of the topics we've discussed today, or you'd like to suggest a topic for With Interest, please email [email protected]. Don't forget to subscribe to CPA Australia podcasts on your favourite podcast channel.

Dr Jane Rennie:
From all of us here at CPA Australia, thanks for listening.

Speaker 1:
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