Positive data may be masking dire plight of construction sector

A slight improvement in building approvals may be masking a ticking time bomb in the building sector.

New research released on Monday (14 October) has revealed that construction company insolvencies remain nearly double historical levels and the number of business exits across construction is continuing to rise.

Construction businesses are facing increased financial uncertainty, with recent data from Equifax, the global data, analytics and technology company, revealing these troubling industry trends.

The proportion of insolvencies to credit-active constructors has more than tripled over the last two years, reaching 3 per cent of all credit-active businesses in Q2 2024. 

Brad Walters, Head of Product and Rating Services, Equifax, said significant stress remains across the industry, reflected in the data showing a drop in construction credit quality together with an elevated number of rating downgrades. 

Construction entities were nearly twice as likely to have their credit quality downgraded compared to upgraded over the 12 months to March 2024. Specifically, 13.2 per cent of these businesses experienced downgrades, compared to just 7.7 per cent that saw upgrades. 

“Concerningly, construction companies with credit downgrades are experiencing similar trends in their financial metrics as companies that subsequently collapsed,” Mr Walters said.

“Facing eroding profits and falling liquidity, downgraded companies are less able to absorb future shocks to their businesses and are at risk of adding to the construction industry’s insolvency rates, which have increased 24 per cent on a 12 month rolling average to the end of August.  

“While the last few years have seen many constructors experience revenue growth, initially bolstering short-term cash flows from customer deposits, the persistent challenges of a highly competitive market, sticky supply costs, and a tight labour market have weighed heavily on profitability.

“This has been most notable for downgraded businesses, leading to a growing divide between this cohort and those with stable or upgraded ratings.”

Housing demand in Australia has been running above housing supply for the past two decades.

- Simon Arraj, Vado Private

He added that both the commercial and residential construction sectors are showing signs of elevated risk, with 20 per cent of commercial constructors and nearly 15 per cent of residential constructors experiencing rating downgrades.

In contrast, civil constructors have shown resilience, largely due to increased government infrastructure spending.

“While we are certainly seeing some areas of resilience, industry operating conditions remain challenging and many construction operators have limited headroom to deal with issues over a prolonged period. 

“Should this trend of downgrades continue, we would expect to see more rated entities falling into the Very High Risk/Credit Watch category (designated as ‘CCC’ rated) over the remainder of 2024.

“Market stakeholders traditionally avoid engaging with businesses having that rating classification, especially in a heightened risk environment with elevated construction insolvencies,” Mr Walters said. 

“As the construction industry navigates these turbulent times, careful monitoring of credit ratings and financial health will be crucial for stakeholders to manage risk and make informed decisions,” Mr Walters added.

Building costs pick up

It was not all doom and gloom for the sector.

The latest data from the Australian Bureau of Statistics (ABS) reveals the value of new loan commitments in August 2024 for business construction finance rose a seasonally adjusted 7.9 per cent during the month to be 61.9 per cent higher compared to a year ago. That increase in August comes after a rise of 5.4 per cent in July for the value of new loan commitments.

June quarter building activity data reveals the total number of dwellings commenced in Australia fell a seasonally adjusted 1.1 per cent to 40,293 dwellings in the June quarter. However, in a sign of improving conditions, private sector house commencements rose 1.7 per cent to 25,732 dwellings, following a rise of 5.7 per cent in the March quarter.

Simon Arraj, Director of private credit investment manager Vado Private, said the market for construction finance is gaining strength.

“After many years of extremely high inflation costs for the construction of buildings, we are now seeing a rise in private sector housing starts with a normalisation of costs, which is helping to support greater demand for construction funding,” Mr Arraj said.

“Home building starts have bottomed and are now recovering, with market confidence in new home building improving in recent months, after a dramatic drop in recent years due to rising costs.

“With the normalisation of construction costs, I would expect to see greater construction activity and lending to catch up with the huge demand for housing, which may help to alleviate the imbalance between new supply of housing and growth in demand.”

The cost of building a home in recent years have risen sharply. Pandemic-related supply chain disruptions and competition for resources from other types of construction have pushed up prices significantly, by nearly 40 per cent since late 2019, according to the Reserve Bank of Australia.  

In recent times, construction costs had stabilised, growing at the slowest annual rate in 22 years.

Residential construction costs grew 1 per cent over the September quarter, in line with the pre-Covid decade average, according to CoreLogic’s latest Cordell Construction Cost Index (CCCI), released Tuesday (14 October).

On a state-by-state basis, the quarterly change in CCCI was highest in Queensland, recording the largest quarterly increase in construction costs (1.1 per cent), accelerating from the 0.3 per cent lift seen over the June quarter. New South Wales and Western Australia saw construction costs rise 1.0 per cent, in line with the national growth rate, while Victoria and South Australia tied for the smallest quarterly increase, both up 0.8 per cent over the quarter.

“At the same time, housing demand in Australia has been running above housing supply for the past two decades causing a dwelling shortage,” Mr Arraj said.

In 2024, it has been estimated that only 167,000 new homes will be completed, well below the demand of around 240,000 homes​. This gap has led to a national undersupply of approximately 200,000 dwellings.

“With costs finally moderating in the construction sector, I’d expect to see more residential construction projects proceed as their feasibility improves.”

CoreLogic Economist, Kaytlin Ezzy, said the data would likely put additional pressure on the Federal Government’s target of 1.2 million new homes.

“As a forward indicator, the recent re-acceleration in the CCCI is concerning for the new homes component of the CPI, as the two series are highly correlated.

“This may partially offset the impact of slowing rent growth on housing inflation”

"Additionally, the increase will be unwelcome news for builders, who are still working to repair profit margins.  Although the latest quarterly rise aligns with the pre-Covid decade average (1.0 per cent), overall construction costs have surged 29.5 per cent, putting significant pressure on the feasibility of many projects.

Building activity varies by state

The number of homes being completed varies widely among the states.

Victoria continues to build thousands more homes than any other state, with more than 60,000 home completions over the last 12 months – nearly 15,000 more homes than New South Wales. 

ABS data released today shows Victoria built 60,606 homes over the year – a 7.5 per cent increase year on year, while New South Wales built 46,573 homes – a 3.9 per cent decline year on year. 

In Queensland, the ABS building approvals figures show that demand for new housing is managing to overcome the headwinds to supply in some parts of the state – but the government targets set for Queensland remain out of reach.

The Queensland figures also show some positive signs, with detached houses (+13.2 per cent) and units (+30.7 per cent) performing strongly over the three month trend.

The 12-month total has risen above 34,000 dwellings (34,380) for the first time this year – but is still a long way short of the 49,000 needed to reach the state’s share of the annual National Housing Accord Target.

Master Builders CEO Paul Bidwell said it was crucial to minimise the amount of red tape confronting the industry.

“Re-examining the changes made to the National Construction Code 2022, particularly the new requirements for accessibility and energy efficiency, is just one lever that can be pulled to provide immediate relief.

“The goals of the inclusivity and sustainability are important, but they won’t be achieved if they drive up the cost of new housing.”

He said the energy efficiency changes can add as much as $18,000 to the cost of building a single-storey home, while the liveable house requirements can also hike up the cost anywhere between $2,000 and $5,000.

“That’s enough to make the difference between a new home being delivered or stalling in the planning stages – not great when demand is far outstripping supply.

“To be clear, we’re not calling for a blanket rollback to these requirements – just some very important technical adjustments that will make a huge difference in a contractor’s ability to deliver them in an affordable and efficient way.”