Construction sector pain ‘to last till 2025’

The construction industry can look forward to a difficult environment as developers and builders grapple with escalating costs, delays and financing issues, a senior economist said, and the pain will last until mid-decade.

BIS Oxford Economics senior economist Maree Kilroy said developers were facing weaker prices, higher borrowing costs and increased uncertainty, while pre-sales for apartments had weakened. 

ASIC’s latest insolvency statistics show 1,864 construction companies became insolvent to 19 March this year, a 77 per cent increase compared to the same period in 2022. Two recent collapses, of home builder Porter Davis and community buiding constructor Lloyd Group, have highlighted the sector’s vulnerability. 

“Developers are finding it difficult to get projects off the ground and we’re seeing a lot of insolvencies come through,” said Ms Kilroy.

In terms of building companies, escalating costs are placing pressure on fixed price contracts, while delays are pushing out payment milestones.

“They’re also facing financing issues which is impacting their profitability and cash flow,” she said.

“Builders are also seeing fewer new orders. There’s currently a big backlog of work which builders are getting through which is reflected in the official ABS data. However, once that backlog is gone, the pipeline for new orders is weak.”

This will be another headache for building companies on top of the difficulties they’re already facing. BIS Oxford Economics expects that small-to-medium construction companies will be the hardest hit in the current downturn.

“Small- to medium-sized companies have less cash flow and have greater difficulty in obtaining financing and [are therefore] the ones most at risk of falling over,” said Ms Kilroy.

Further insolvencies are expected to flow through the remainder of this year, particularly among the smaller to medium firms.

“We expect these headwinds for the sector to persist until mid-decade. This is not just a 2023 issue, it will reverberate into 2024 and 2025,” said Ms Kilroy.

Different stakeholders and companies will be hit at different stages of the construction cycle.

Ms Kilroy said the construction sector would not start to recover until costs begin to reduce and new orders increase again, and that would require the cash rate to start falling.

“A lot to these factors won’t become positive until mid-decade,” she said.

“While we’re forecasting property prices to begin picking up from next year, it will take time for that to feed through to demand for new homes and demand for pre-sales so that developers can get projects off the ground.”

Franklin Templeton director, fixed income, Andrew Canobi, said the rising number of insolvencies in the construction sector was likely a key factor in the RBA’s cash rate decision this week.

The RBA decided to keep the cash rate target on hold at 3.6 per cent for April.

“We feel the recent high-profile collapse of a large Victorian home builder, Porter Davis Homes, on the back of many construction firms struggling, alarmed the board,” said Mr Canobi.

“They will be increasingly worried that interest rate-sensitive parts of the economy like construction are starting to break.”

Master Builders Australia said interest rate rises coupled with rising inflation have have forced construction activity and new homes sales to slow sharply in the past few months.

The industry association said while the latest interest rate pause is a welcome reprieve, the impact of interest rate hikes or cuts takes time to flow through to the economy.

“The RBA has rightfully recognised the negative impacts of rapidly rising interest rates on accelerating rental prices and construction activity,” said Master Builders Australia chief executive Denita Wawn.

“There is now an opportunity for the government to step up with bold fiscal policy decisions to complete the job of bringing inflation back into line.”

“The government needs to take the necessary steps to ensure we are not overdependent on interest rates as the tool for controlling inflation. By doing so, we can help take some of the pressure off the shoulders of mortgage holders and business owners.”

The association said it would like to see the upcoming federal budget focus on policies that ensure spending is carefully targeted at boosting productivity for business and allowing for more favourable outcomes when it comes to the cost, quality and quantity of building and construction output.

“There is no silver bullet; this will take a concerted effort by all levels of government working in collaboration with industry,” said Ms Wawn.