Building site: Do not enter

This article originally appeared in the September edition of Your Investment Property Magazine.

Another day, another eight building company collapses.

The figure is staggering but the latest data from the Australian Securities and Investment Commission (ASIC) shows almost 3,000 building companies went into administration in the past financial year.

Construction insolvencies accounted for by far the most insolvencies of any industry in 2023-24 at 27% of the 11,000 companies to enter external administration for the first time.

The next highest - accommodation and food - came in a considerable way behind at 15%.

Of course, any business going bust has a ripple effect but a construction company going under hits hard.

Federal government analysis shows the residential construction sector has the second-largest economic multiplier effect of all 114 industries that make up the Australian economy (behind non-ferrous metal manufacturing - who knew?).

So, while the construction industry is a fine generator of jobs and economic growth, it also means when a builder goes under, it pulls a lot of others down with it.

The current conundrum for the economy is that Australians are justifiably wary of building homes at the very time the nation is grappling with its worst housing crisis in living memory.

So, where does that leave investors?

Sure, there’s unprecedented demand for housing but is it a wise idea to dip a toe into building homes given the turmoil that’s wracked the industry in recent years?

To answer that, we need to understand why builders are going bust - or why they’re saying they are.

The road to ruin

Let’s start with the perennial scapegoat for all things that have gone awry on a global scale in recent years, the pandemic.

It saw the Morrison government’s HomeBuilder grants scheme shoot the industry from a cyclic low to a dizzying high without much else in place.

The pandemic disruption to international supply chains saw building material costs blow out as raging demand for materials far outstripped their supply.

It meant builders were forced to absorb costs themselves to meet fixed price contracts, leaving them with little profit or copping a loss to complete the projects they’d signed up for.

At the same time, the halt to international migration fed into worker shortages, creating further major delays on projects with both labour and material costs escalating all the while.

Construction insolvencies began surging from 2021, the inevitable fallout of the perfect storm. But while material price increases and labour shortages have since eased, there’s been no let-up in the number of builders going bust.

In fact, the figure has jumped 28% over the previous financial year.

According to Master Builders Australia, higher interest rates have had a role to play as have planning and licensing delays, “draconian” industrial relations changes, inefficient regulations, and unfeasible lending practices.

CEO Denita Wawn estimates the cost of home building has jumped 40% since 2019.

Despite high demand for housing, she says people are choosing not to go ahead with new builds because “the numbers just don’t stack up”.

Indeed, it would be a confident investor to embark on building an investment property or larger residential development in the current market.

While ABS data shows the number of new loan commitments for investors constructing new homes shows a tentative lift over the past financial year, more than five times as many have borrowed to purchase existing housing.

It’s no secret the home lenders are much happier writing loans for established properties than for construction loans which are considered significantly riskier, especially in the current climate.

Yet there are some good reasons to build an investment property rather than buy an existing home. The big one is that it’s a way to avoid a major stamp duty hit, an unavoidable cost of property investment.

Building a property from scratch means there is no transfer of the title. You only pay stamp duty on any land you purchase which is generally considerably less than for an established home.

As well, there are considerable tax deductions on new-build investor homes including interest costs while the property is under construction as well as generous depreciation provisions down the track.

But with the federal government pledging there will be 1.2 million homes built before the end of the decade, many investors are understandably loath to get on board.

Building back better

So, what would it take to get investors to build in the current climate of endemic builder collapses?

University of New South Wales Business Insights researcher Bradley Hastings says the first step is actually quite basic - protecting the funds clients pay to builders to build their homes.

Dr Hastings told Your Investment Property Magazine the lack of protective mechanisms for consumers in the building industry is “woeful” - acknowledging his choice of word might not sound entirely professional.

“If I compare home deposits [and ongoing builder payments] to other large investments that Australians might make in their lifetimes, like superannuation or even having money in the bank or other financial or legal service transactions, the protection for consumer funds in those industries is quite significant,” he says.

“The typical approach is the funds are ringfenced in an account where they can only be spent for the intents and purposes they were meant for but for the building industry, that’s not the case.”

Dr Hastings cites examples of builders using client cash to buy a new Toyota Hilux or go on overseas holidays rather than progressing a client’s project.

He also says builders' insurance designed to provide a safety net in cases of builder insolvency is also highly inadequate.

“In some jurisdictions, it’s not compulsory and there is typically a delay period for claims after builders go into administration that leaves clients unprotected and the insurance can be quite limited anyway,” he said.

Collapsed construction company Porter Davis, which was Australia’s 12th largest home builder when it went under in 2023, had not taken out building insurance despite around 600 customers paying tens of thousands of dollars in deposits and insurance being mandatory in the states where it was operating.

“Right now, we’ve got all these stories of consumers losing their money and being left with half-finished homes so it’s no surprise we’re seeing such a decline in building at a time when we need housing to increase.”

It’s hardly a new issue. Builders have been going bust for decades - some more than once - and there have been multiple reviews over many years recommending how governments might protect owners and subcontractors from wearing the financial losses.

In 2021, the Queensland government became the first state to implement laws requiring head contractors of larger building projects to set up project trust accounts in a bid to secure payments for subcontractors, not specifically to protect owners' contributions.

The requirements will eventually be expanded to cover all eligible building contracts valued at $1 million or more - so generally not standard one-off or ‘two-pack’ residential contracts - and there have recently been amendments to the legislation to try to clarify what and who it actually covers.

The move has drawn criticism from within the industry for its complexity, loopholes, and putting extra costs and administrative burden on contractors.

It’s also been suggested property owners or investors (and their lenders) could be worse off as it is subcontractors who are paid first from trust account funds, putting them out of bounds of administrators or liquidators.

The West Australian government also requires project bank accounts on government projects only and other states are watching on.

But the Australian Contractors Association says such measures are a blunt instrument for a more complex problem with no evidence it will solve the industry’s problems or whether the benefits will outweigh the costs.

It identifies “changing the culture” of the industry as a necessary step in improving payment practices, also calling for risk to be more evenly shared.

As they stand, such legislative interventions also leave owners, investors, and subcontractors on smaller projects without any additional protection.

Yet the insolvency industry sees a green shoot amid the recent carnage in the construction sector, daring to suggest things may improve this financial year.

The optimistically named Australian Restructuring Insolvency and Turnaround Association reports there have been fewer major construction companies entering into administration in the last six months than the previous 18 months.

According to the Association, it is now smaller operators who going under, something it expects to continue while the industry’s focus on fixed-price contracts continues amid a high-inflation environment.

Many investors might not take too much comfort from that but it’s a green enough shoot if you go looking for one.

Why can't Australia solve its building crisis? One woman knows

One Australian woman says she has a solution to addressing Australia’s ongoing building insolvency issues but, in a familiar story, was forced overseas to make any headway.

Louise Stewart (pictured) is the founder and CEO of fintech start-up ProjectPay, a digital payments app with embedded finance from a pool of lenders that endeavours to ensure homeowners have some protection their money is being spent on their project and that subcontractors get regularly paid.

^{Pictured: Louise Stewart, CEO and founder of ProjectPay}

The debt funding is secured against approved construction loans and ensures subbies are getting regular payments for their work regardless of whether client (or lender) funding has come through, thus providing some cash flow cushioning against insolvencies.

Stewart reluctantly relocated to the UK two years ago after running into what she describes as “a wall of resistance” in Australia, something she puts down to deep cultural issues within the construction and political landscape.

The UK government has funded the development of ProjectPay and the platform is now being adapted for the burgeoning US market.

With ProjectPay now operating in both the UK and Australia, Stewart says in Australia, it still remains up to “weak governments” to address the underlying fatal flaw in the construction industry.

“That’s stamping out the criminality built into it that allows bad actors to spend project funds any way they wish without any accountability,” Stewart tells Your Investment Property Magazine from Silicon Valley.

Stewart was once an advocate for the ‘ringfencing’ system, requiring committed funds to be spent only on the projects they were intended for.

As a former chair of the Australian Subcontractors Association, Stewart even stood as an independent in the 2019 federal election on that platform but now acknowledges a trust fund style set-up, such as Queensland’s, is unwieldly and not fit-for-purpose for the cash flow needs of the building industry.

Stewart says a merchant payments platform such as hers, providing relatively low-cost finance compared to builders relying on their personal credit cards to keep projects afloat, is just one safeguard against construction insolvencies in Australia.

But she says the underlying problem is relatively simple to fix and the model has been working in North America for decades - seeing directors of building companies held personally liable for debts to subcontractors and owners.

“In the US and Canada, if it’s found project funds are used for unrelated purposes, building company directors have to settle those debts or go to jail - it’s as simple as that,” Stewart says.

She says multiple inquiries and reports into the construction industry in Australia over many years have recommended the adoption of the North American system in Australia, but it’s never found its way into legislation.

“ProjectPay can provide easy compliance to regulations and address cash flow issues inherent in the industry but until the criminality in the construction industry is addressed in Australia, owners and investors can only feel so confident,” she says.

“There is a cultural and political reluctance to address it and until it is, it’s everyday Australians who’ll continue to pay the price.”

The mighty that have fallen

• St Hilliers. The construction group entered into voluntary administration in February 2024, with 21 development projects underway in multiple states.
• Grocon. The Victorian company involved in high-profile major developments including Eureka Tower and the Crown Casino complex in Melbourne was an early casualty in 2021.
• ProBuild. The large-scale commercial and residential project builder was placed into voluntary administration in February 2022.
• Rork Projects. The residential and commercial builder had construction projects in four states when it collapsed in July 2022.
• PBS Building. The ACT-based company was working on a portfolio of government contracts when it entered in voluntary administration in March 2022.
• Porter Davis. The collapse of one of Australia’s largest residential builders in March 2023 left thousands of customers in Victoria and Queensland with unfinished homes.