Despite high growth levels, New Zealand's construction industry is still struggling to keep up with demand.
Statistics New Zealand reported in December 2017 that residential construction was at an all-time high, with non-residential work coming off record levels in late 2016. At a national level, we are currently averaging just over 2,500 new home consents issued every month.
However, data released under the Official Information Act in early 2017 suggests the national housing shortfall is around 60,000 dwellings. We need more construction to match this - but businesses should be wary of the financial risks that come with increased building activity.
New Zealand's construction sector needs to be wary of financial challenges.
Financial barriers for New Zealand construction remain rampant
As we discussed earlier this year, the construction industry faces numerous challenges as it tries to up the ante - and many companies are falling into liquidation as a result.
1. Risks associated with sub-contractors
Data from the Ministry of Business, Innovation and Employment (MBIE) shows that between 2016 and 2022, demand for construction-related occupations (i.e. plumbers, civil engineers and electricians) will increase by some 56,000, reaching a total workforce of nearly 580,000.
By comparison, MBIE estimates indicate the number of people working directly in the construction industry in March 2017 was only 245,600.
The issue here is being able to secure sub-contractors when you need them. With such a high level of construction, demand for related occupations increases, and these individuals have the capacity to pick and choose the work they do.
Many companies can struggle to find the right construction-related workers, leading to cost and timeline blowouts. When these difficulties strike, many businesses can run into insolvency.
2. Maintaining cashflow over long periods
Supply chain issues, changes to terms of trade and zoning or legislative adjustments can result in further delays for New Zealand construction companies and their customers. Additionally, heightened building activity increases competition (and thus supply prices) for building companies.
In a competitive environment, building contractors often price their work with fixed contracts. These contracts can allow for margins of only 10 to 15 per cent, which leaves little room for error, or additional work later on in the construction process.
For residential projects in particular, many contracts specify large initial payments before any work commences. This effectively means that the profit margin has been pre-paid, which can result in a shortfall later on in the building process. Considering that the final stages of a build are often the most expensive, covering this shortfall can result in a significant amount of financial strain.
Fortunately, there are a few ways to ensure protection:
- Only entering into agreements where the price is realistic. If it seems too good to be true, it probably is.
- Having any initial funds held in a trust for protection.
- Understanding the limitations of third-party guarantees (such as when working with a registered Master Builder)
- Specifying that payment will only be made to construction contractors for work completed.
- Regularly reviewing the terms of the contract in relation to work completed.
- If necessary, engaging an independent project manager.
3. Risks to suppliers of construction companies
It isn't just construction businesses that face risks as a result of increasing demand. Suppliers also need to know how to protect their positions, particularly as most will have to deal with an insolvent counterparty at some stage.
The first way that suppliers can minimise their risk is to ensure they have current, signed terms of trade and credit application documentation. Terms of trade are particularly important for suppliers who provide materials on credit, in order to enable the registration of security interests. In addition, tight terms of trade provide suppliers with the ability to trace proceeds, check credit histories and inspect financial records.
Almost all construction projects that involve security interests are subject to the Personal Properties Security Act 2009 (PPSA). It is therefore critical to register any security interests, such as unpaid stock and equipment, on the Personal Property Securities Register (PPSR). Failure to do so might mean the loss of priority against other claimants. Suppliers of scaffolding, cranes, forklifts and portable buildings should ensure terms of trade provide for registration on the PPSR.
Finally, make sure to enforce credit limits, and don't delay seeking payment until a debt is overdue. Stay on top of what a customer is and is not paying, and pursue proceeds claims promptly if necessary,
4. Poor workmanship
Again, this relates to a previous topic we have covered - the rise of the cowboy contractor. High volumes of building work - especially with Auckland's ongoing investment and Christchurch/Kaikoura rebuilds - mean many contractors will fly in for a quick job, do poor work, and leave with their payments before structural issues can be identified.
This essentially leaves building companies having to pay again for the same work, which can strain finances beyond their limit.
However, there is a better way forward. The issues plaguing New Zealand's construction sector may be rampant, but they are also avoidable.
How to manage a construction company in a financially sound manner
Statistics New Zealand anticipates a slight decrease in the pipeline of construction work, but it will nonetheless remain near record highs well into 2018. Meanwhile, MBIE employment projections for construction and construction-related occupations are in double figures for Auckland, Waikato and the Bay of Plenty.
Business in these regions would do well to be proactive about the dangers of taking on construction work in a high-volume environment, by doing the following:
Proper financial planning. Use accountants, project managers and (where necessary) insolvency specialists to help you formulate clear financial strategies for each and every project. You should also ensure that everyone from the architect to the estimator understands the customer's budget before building commences.
Allow for extra costs: Make sure everything is costed out with reasonable increases in material costs, and allow for price hikes and delays, rather than under-pricing. In a competitive environment, it is also important to be aware of any potential bottlenecks by pre-booking or pre-purchasing limited items.
Awareness of your limits. It is tempting to take on as much work as possible, but staying within your means will ensure long-term stability.
Proper documentation: Clearly document, and have customers sign off on all variations before they are started. This will be invaluable in helping to minimise payment disputes and council delays.
Identify and avoid 'cowboys'. Do background research on contractors, checking for sub-standard work or even look at individual accounts on Twitter and Facebook. The rise of call-out culture means if someone has done poor work before, there is likely to be a post or review about it online.
Pay everybody on time. Likewise, if you have a history of financial difficulty, contractors can likely find out about it. Maintain best business practices with paying staff at all times, and work with your accountant to ensure this.
Communicate difficulties early. Rather than waiting until it is too late, make sure to communicate any problems as soon as they arise, and seek advice when necessary.
The residential building peak is an exciting time for New Zealand construction, but a risky one. Stay on top of your finances, and if you have concerns about the stability of your business, give the team at McDonald Vague a call.