Australia’s construction sector is facing some of its strongest headwinds in recent years.
COVID-induced labour and material shortages, combined with low margins and high-risk projects, have pushed many companies to the brink, with building giant Probuild succumbing to liquidation at the beginning of March.
Owing more than $14 million to 786 employees, and with at least 1,500 additional creditors lodging claims, the economic fallout of Probuild’s demise is already proving to be catastrophic. Hitec Glazing, a Brisbane glazing company, entered liquidation on March 3. The coup de grâce? A $20M contract on Probuild’s ill-fated 443 Queen Street tower.
Probuild is far from the only COVID fatality, either. Two other notable examples are Queensland firms Privium and BA Murphy, which folded in December 2021 with dozens of projects unfinished and hundreds of creditors unpaid.
In an interview with the ABC, the Master Builders Association pointed to fixed-price contracts as a key issue – combined with higher supply costs and labour shortages, builders operating on already tight margins are forced to absorb the difference, resulting in the recent spate of insolvencies. The association warned that 2022 was unlikely to bring relief, with ongoing shortages predicted for the next six months.
The Problem for Survivors
When the bloodshed stops, though, Australia’s surviving construction firms will still be facing challenges. The low margins and preference for lock-in contracts aren’t going anywhere, but there’ll be an additional issue too – the decreased willingness of banks to supply loans to developers.
The banking sector already has a history of conservatism towards construction loans. Certain types of contracts, particularly ABICs, are looked upon less favourably. Smaller projects are also often considered riskier.
When markets cool, though, banks tighten their lending requirements – that conservatism shifts to outright caution. Typically, this involves lower LVRs, more loan security, longer approval and settlement timeframes, and higher required presale values, which can make funding harder for younger, capital-light developers.
Unfortunately, a post-COVID world means certain types of projects may be hit even harder than others. With the interest rate predicted to rise around June 2022 after a year of record lows, residential builds are likely to slow. The inherent cyclicality of housing investment will play a role, as will material and labour shortages, but banks will also be less likely to lend to homeowners and investors.
Similarly, COVID has made retail development a riskier business. Before the pandemic, e-commerce was slowly but steadily chipping away at in-store sales – the lockdowns pushed an already struggling sector to breaking point, triggering a wave of collapses. Now, it’s staff shortages doing the damage, with even giants like Wesfarmers noting a 10% slide in Kmart and Target sales. Without reliable tenants locked in, banks are much less willing to fund retail developments, and that means fewer projects for construction firms.
Private Debt as an Alternative
2022 is a bleak time for builders. Hemmed in, options dwindling, with no light at the end of the tunnel, surviving will take agility and out-of-the-box thinking.
For the sector as a whole, though, salvation might take an unexpected form: private debt. It’s a relatively new entrant to the mainstream Australian lending landscape, but it could be a way forward for many smaller developers, especially those focusing on retail or residential developments.
Private lenders almost always charge higher interest rates, which allows them to take on higher-risk projects at higher LVRs. Other benefits include expedited settlement times, less security, and fewer or no required pre-sales. That makes them an ideal source of funding in the current development climate, where higher interest is of less concern than actually getting projects off the ground.
Private and bank credit aren’t mutually exclusive, either. If a project can get bank funding for 70% of costs, but needs 90% for viability, a private mezzanine loan can fill in the gaps.
So, while some developers might still be leery of alternative financing, it’s a panacea for Australia’s construction sector that could help companies rebound from COVID. After all, a project killed by lack of funding is a greater financial risk than a private loan with high interest.