[+] Profit Margin Uncertainty Causes Seismic Construction Shifts

The construction industry has a reputation as the Wild West, but operating in such a high-stake, low-margin environment after years of turmoil is proving almost impossible. Bidding on projects with expected negative margins and absorbing price fluctuations in fixed-price contract environments, on top of labour shortages, rising interest rates, inflation and terrible weather, have all affected the industry. Even the biggest builders, such as Hutchinson, with an 80 per cent pre-tax profit drop this year , has shown loss-making projects are the norm. Rexine Jones is the chief financial officer at commercial construction firm Hansen Yuncken, builders of major projects including the Rooty Hill Sydney Coliseum Theatre. “Your financial performance in construction and development requires entrepreneurial spirit,” she says. “The construction industry needs a reset. We’re not racing to the bottom anymore, we shouldn’t be bidding at negative margins, we need to come up with a new idea of what a ‘good’ outcome looks like.” Where are builder profit margins now? Australian Constructors Association chief executive Jon Davies says that the situation is becoming critical at the top end. “The latest data from Equifax suggests that subcontractors, smaller builders and civil contractors are maintaining pre-tax margins above 3 per cent,” Davies says. “By contrast, larger builders are achieving pre-tax margins below 1 per cent. “Under normal pre-pandemic conditions, these businesses were in the 3 to 4 per cent range. Note this is the median score—so many of these builders are carrying losses. “The profit margins of large builders strongly suggests that a sizeable minority—if not majority—of large building projects during the past two years have been loss-making.” ▲ Rexine Jones is chief information and chief financial officer at Hansen Yuncken, builders of the $100-million Sydney Coliseum Theatre. Estimates of course vary between sectors and individual builders, but the Reserve Bank of Australia announced last month that construction company insolvencies now account for close to 30 per cent of all insolvencies . Due diligence in identifying builders is key to avoiding an insolvency situation, according to Paul Reid, head of strategy and operations at industry payment platform IPEX. “Some builders are only continuing to trade by operating under a ‘ponzi’ type method of cash management; ‘buying’ new ‘donor’ projects and using early progress payments to complete existing contractual obligations,” he says. “We’ve seen multiple builders go under shortly after being awarded a new contract, suggesting manipulation of the due diligence or tender assessment processes. “Not only does this behaviour place any new project and all associated subcontractors/suppliers at risk, it’s also hurting other builders. “Low ball bids from distressed or potentially already insolvent builders are significant contributors to the race to the bottom, driving margins down for all builders.” Sector by sector Altus Group cost and project management president for Asia Pacific Niall McSweeney says that this landscape is causing builders to move away from certain sectors. “With the transfer of risk and liabilities associated with residential, it’s becoming a little bit of a poisoned chalice,” he says. “Either builders are not willing to take those projects on, or getting bonds released is a big issue for them, and with all the compliance required for it, they just aren’t willing to do it. “Participation rates are an issue especially in residential, but of course the golden child at the minute is industrial, which is going gangbusters. “Margins on that side of things are fairly steady, but major developers and funds already have a good panel of contractors and they know what they’re getting into.” ▲ The Sydney Coliseum delivered by Hansen Yuncken has been described as Western Sydney's answer to the Opera House. Cushman &amp; Wakefield head of project development services for Australia and New Zealand Mitch Wilson says that projects in niche markets such as renewables, data centres and some industrial builds will typically have higher margins. “In the commercial real estate space, the current downturn in the cycle means fewer projects are coming to market,” Wilson says. “For offices, the post-Covid landscape has meant fewer employees coming to the office, which has led to a reassessment of real estate expenditure and for many companies, the reduction of space continues to drive decisions from a cost-base perspective. “This reduction has seen many office spaces put into hibernation or put to market to sub-lease, reducing the number of fitouts that builders are competing for.” The need for change Regardless of sector, builders are feeling the pressure from above as well as below. “In managing their margins, builders are as usual trying to push it down, which means squeezing subcontractors,” McSweeney says. But this can put the pressure on relationships and, in a worst-case scenario, mean replacement subcontractors starting from scratch. “Then that’s your margin compromised on your project from one failure, or one threatened failure,” McSweeney says. The issue is extra or potential costs not being factored in, he says. “Consider the cost of defect remediation—that’s running anywhere from 3 to 6 per cent of total costs. Either you’ve priced that in or that’s your margin eroded, just by going back to fix things.” ▲ Cushman &amp; Wakefield head of project development services Mitch Wilson and Altus Group president of cost and project management Niall Sweeney. Wilson says that builders are going through a consolidation period. “We are seeing reduced headcount delivering the same workload across the building industry,” he says. “Businesses are also focusing on opportunities for Early Contractor engagements, which reduces the need to bid on projects on an open tender basis. “Fully documented designs allow builders the ability to price in less risk while still delivering a price point that is aligned with client expectations. “Cost-plus contracts with predetermined margins are also proving more attractive to builders in the current environment. “Identifying clients that prioritise quality over price and negotiating payment terms that are no more than 30 days are also key to maintaining business cash flow for builders. “Efficiencies can also be found by implementing technology that reduces employee hours spent on administrative tasks.” Using data to manage expectations The construction industry is notoriously technology shy, especially at the smaller end, but Hansen Yuncken has committed to bringing its supply chain along for the data-driven ride. “Ensuring you’ve got this common data environment, where you’re connected and you know the scope is set and you’ve covered the gaps if something goes astray [is key],” says Rexine Jones. “That’s where things like AutoDesk tools help, connecting data through the bookends of a project and allowing a space to contain that information, so we can look at where things have clashed and how to coordinate better. “If I could save five minutes of every engineer’s time, and if we have 200 engineers, that’s a lot of time available collectively to better manage risks and opportunities.” ▲ Hansen Yuncken converted the Main Works Offer for the $106-million Meadowbank TAFE after an extensive ECI planning phase. Hansen Yuncken took this approach with the Sydney Coliseum, completed in 2020. “There were no straight walls, it was about maneuvering our way through, we had every issue you typically have in a project,” Jones says. “Keith Urban was coming in to do a show, the building had to be built, and in the middle, the client wanted to bring the Australian Ballet in. “We’d already commenced construction, but the middle part of the main theatre had to be changed to accommodate what was possible for the building, you’re changing the inherent function of the building when you’re midway through construction and have that immovable date. “With AutoDesk, we had the key to sequencing how to get to the end point and see the risks in advance, effectively to see around corners.” The future of construction While major players such as Hansen Yuncken might have access to technology to manage its margins which is being more slowly adopted elsewhere, there are some fundamental structural issues in the industry that need to be addressed, says Jon Davies of the Australian Constructors Association. “We have long advocated against fixed-price contracts,” he says. “They are the main reason for the problems facing the industry. They are completely inappropriate to construction because the level of uncertainty makes it impossible to price a project with any accuracy. “We need a more sophisticated approach to contracting that provides an initial cost estimate, but sets up mechanisms to fairly and reasonably deal with risks as they inevitably arise through the construction process.” Many builders have turned their backs on fixed-price contracts as a result, he says. “Many calculate it is better to forgo revenue than be put out of business. “To their credit, many developers are coming to terms with this reality. A key barrier to making progress towards a more sustainable industry are actually the financiers who still insist on archaic fixed-price contracts.” ▲ Hansen Yuncken also completed the $55-million Thomas Dixon Centre redevelopment. From a practical day-to-day standpoint, McSweeney says that in addition to investing in software such as EstateMaster, there are things developers and builders can do to manage profit margins. “Continually monitoring what you’re doing, making sure you keep an eye on cashflow, looking out for warning signs and margin compression directly relates to a builder’s ability to survive adverse events, whether it be a pandemic, weather events such as bushfires or price fluctuations,” he says. “Getting the right advice, verifying the impact of costs and cost changes and what it does to feasibility, they key to protecting yourself.” Jones says now is time for the construction industry to evolve. “We come from a rise-and-fall environment but the more a company can show its governance structure and manage technology and conform with processes and be diligent about its delegations, the more you can create a bigger space, a space to be entrepreneurial and find the opportunities you need.” You are currently experiencing The Urban Developer Plus (TUD+), our premium membership for property professionals. 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[+] Profit Margin Uncertainty Causes Seismic Construction Shifts

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