Home building faces new threat as demand picks up
Home builders and subcontractors are putting themselves at risk as demand picks up by taking on larger projects without restoring their finances to sustain such workloads with sufficient cash balances and working capital, new figures from Equifax show.
Subcontractors and suppliers employing fewer than five people are most at risk, as they have lower cash reserves and resources to draw on than larger businesses – and the likely failure of more of these smaller companies will keep total construction insolvencies high, the ratings agency says.
The worsening position in residential construction contrasts with signs of improvement in companies in the non-residential commercial and infrastructure sectors, where the rate of insolvency growth is slowing.
Last year 32 per cent of companies in the civil engineering sector had credit rating upgrades, while the figure was about 25 per cent in non-residential building and it was just 14 per cent in residential construction, according to Equifax.
“Residential has a highest proportion of more highly vulnerable businesses than non-residential and civil,” Equifax head of product and rating services Brad Walters told The Australian Financial Review.
“As they’re looking ahead, taking on larger value contracts, do they have the level of resilience, reserves, capital, collateral – the right metrics to properly support growth into the next few years?
“There will be a number of reliable, capable, well-capitalised businesses that can do that, but there are still a lot out there that are in that vulnerable space.”
Overall, things are looking up for construction. While insolvency numbers were up about 2.2 times on their pre-pandemic level, they were stabilising, indicating fewer insolvencies to come in the year ahead, Walters said.
As companies cycled through their workbooks, they were completing loss-making work tendered before or during the pandemic and replacing them with newer ones more in line with today’s pricing levels, he said.
“The first couple of months of this calendar year have also seen a notable slowdown in the insolvency rate in construction,” he said.
“The various data sources are all pointing to the fact that we’ve hopefully got over the worst of the hump, and there is a light at the end of the tunnel.”
But big differences remain between sectors and between states.
Analysis by the Financial Review last week showed Victoria had overtaken Queensland as the state with the fastest-growing total of construction industry insolvencies – a point Equifax underscored, saying residential builders in the southern state reported lower margins and lower levels of working capital relative to the median across the rest of the country.
Residential companies are also loading themselves up with more work than they can sustainably take on. A company’s overall financial performance and viability – and ability to meet commitments in the course of its normal business – varies according to the strains it faces from specific contracts.
The requirements of an individual contract for a large project, for example, may exceed a company’s borrowing ability to buy materials needed.
The divergence between ordinary corporate ratings and job-specific commitment ratings was widening in residential construction, Walters said.
“We’re seeing an elevated number of assessments where there’s a lower commitment rating than there is to the corporate rating,” he said.
This indicated businesses were taking on larger projects than their business would ordinarily be able to support, Walters said.
Overall, the swings in building companies’ financial positions were greater than anything since before the global financial crisis, he said.
“This has been a significant period of turmoil for the industry,” Walters said.
“More mature, resilient businesses with the right levels of governance can navigate this well, but unfortunately, there will be a cohort that do not.”
