[+] ‘Cash Flow is King’ in Delivery Risk Challenge

“Subcontractor defaults are still our biggest risk factor.” But so too is the risk of shovels never hitting dirt on site for Victorian builder Balmain &amp; Co’s Jessica Jones. Speaking at The Urban Developer’s recent webinar Navigating Construction Risk in Volatile Markets, the head of strategy and business development at the construction company articulated the challenges that have taken root in Australia’s construction industry. “Projects not getting off the ground is a huge risk,” Jones said. “Once we’re on the ground, although it’s eased there’s still risk around our subcontractors and labour shortages, there’s no denying that it’s still an issue.” Construction insolvencies over the past year have risen considerably. The Australian Investment and Securities Commission reported that 2498 construction companies entered administration in the year to May 2024, compared to 1020 in the year to May 2022—a rise of 144 per cent. Jones said the multi-residential builder was taking a cautious approach to subcontractor tendering. “We’re looking at who they’re working for, how many projects they’re undertaking and what kind of risk our subbies are taking on. It comes back to us anyway so we’re just being really cautious around that,” she said. ▲ Balmain &amp; Co's Jessica Jones said subcontractors remained the biggest risk for the construction firm. But there was a silver lining to the dark clouds hanging over construction, with cost escalations easing, according to Jones. “The risk that subbies were willing to take on, or their capability, and just the pricing we got was about 20 per cent different (to a few years ago). So for us to win a job, you don’t want to go with the lowest, but you need to win the job and if that subbie falls over, it’s game over,” Jones said. “That element has been taken away. We’ve recently seen that for a really well documented tender we might be getting seven or eight prices per trade and they’re all within 5 to 10 per cent.” Cost escalations easing Jones says there is now less risk in terms of taking on those escalations because the trade prices have levelled somewhat. “We’re seeing escalation be less of an issue because there’s more depth in that market … subbies are starting to get hungrier.” But on the developer side of the ledger, the waters are a bit murkier when it comes to construction risk. It’s not just about the builder, developers are also facing regulatory and planning changes and delays according to WINIM senior development manager Kip Laverack. ▲ WINIM has experienced construction risk exposure and Kip Laverack says the Sydney developer is constantly monitoring builder financial viability. The Sydney-based developer has been bitten in the post-Covid insolvency hangover—its Otto project was delayed after WA builder Pindan went into external administration in 2021. Laverack says things are not getting easier. “From a developer point of view, the risks we’ve had over the last few years are still the same today,” Laverack says. “It’s not just the builder-side though. We’ve got ongoing regulatory delays that we’re constantly dealing with, as well as dealing with the financial constraints of builders and consultants, and subcontractors, as well as ongoing compliance changes, such as the DBP (Design Building Practitioners Act). “It’s just exacerbating the risk that we’ve been talking about for the last two-and-a-half years.” Developers wear the risk IPEX chief executive Paul Reid says the proptech platform is seeing a “rolling of the dice” when it comes to builder selection, which doesn’t always work out well. “Insolvency risk is a big issue from the developer side and it’s a big part of what we do,” Reid says. “We ringfence developer-lender funds and make sure they get to the subbies and suppliers that are working on that project. ▲ IPEX chief executive Paul Reid says the proptech platform ringfences funds to ensure they flow to subcontractors and suppliers on projects. The builder-developer relationship is a two-year relationship and Reid says “it’s not just about where they are at the start of the project, it can be hard to monitor the relationship throughout”. “There’s obviously a desire there to make sure the builders are healthy during due diligence … but once you’re in a project there’s an ongoing risk that builders take on new projects [their] positions might change, and the concern is how do we make sure we’re protected throughout the duration of the project,” he says. “Ultimately it all becomes the developer’s problem if it all goes wrong.” WINIM’s Laverack says other costs had also impacted feasibilities. Design and planning costs are “almost two-fold” where they were at the start of Covid a few years ago according to Laverack. “The additional costs that we now put into quantitative analysis processes and compliance, architects peer-reviewing other architects, and certifiers certifying other certifiers, there’s just all those additional costs that you’re chucking on top of that,” he says. “And you also have the ongoing financial review of the builder as well.” ‘Cash flow is king’ Financiers are also taking a cautious view on construction risk and the ongoing financial landscape. ANZ state director of property and health for Queensland and West Australia David Byrne says in his 20 years in banking the sands have shifted dramatically from builders not wanting to talk to a developer’s bank, to builders embracing strong relationships with the banking sector. “At the moment across all markets, it’s all about delivery risk,” Byrne says. “Our first question to a new lender is always who are you and what have you done, but we’ve very quickly moved past that to who’s your builder and what have they done, what’s their position, can we see their financials. ▲ ANZ's David Byrne says banks are focused on the financial health of the builders on projects they fund. Byrne says “cash flow is king” in the health of a builder. “We understand that for a period of time this has not been a profitable game from a builder’s perspective, some went into this better capitalised than others,” he says. “Builders go broke through lack of cash flow rather than lack of balance sheet or lack of profitability. So we’re delving into not just the project that we’re funding but what else is this builder doing and who are they building for and what are their cash flows like. “It generally only takes one string pulled to sometimes undo the whole bow.” Risk sharing not viable And while risk-sharing was touted as a way of mitigating risk and preventing builders from hitting the canvas, Balmain &amp; Co’s Jessica Jones says it just hasn’t happened. “[Developers] think they’re passing the risk on to us, we think we are passing risk on to sub-contractors but ultimately no-one’s passing on any risk,” Jones says. “It’s all going to come back ultimately to the developer. “The notion of shared risk, although in theory is great, from what we’ve seen it hasn’t necessarily happened. From what we’ve seen it’s probably gone the other way since those really tough times. “A lot of our builds have been repeat clients and that’s what’s really held us strong through the last few turbulent years. “But there is some hesitation on sharing risk when it comes to putting pen to paper.” Jones says builders will price risk based on the level of information they have. “We will take risk on anything we can control. Where we are willing to take on and price risk is different We’ve been asked recently to take on latent conditions or program risk based on minimal drawings or minimal reports and that’s where it comes a bit unstuck. “The less information you give us the less risk we will take.” You are currently experiencing The Urban Developer Plus (TUD+), our premium membership for property professionals. Click here to learn more.

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