The unfolding fallout stems from a perfect storm of headwinds. Rising inflation (which is expected to peak at around 7 per cent this year, according to the Reserve Bank of Australia [RBA]), alongside the war on Ukraine and the global pandemic has all contributed to a skyrocketing in the cost of materials over the past year.

In fact, the latest data from CoreLogic’s quarterly Cordell Construction Cost Index (CCCI), found national residential construction costs increased 10 per cent over the 12 months to June 2022, which marked the “highest annual growth rate” outside of the introduction of the GST.

In addition, demand during the pandemic increased with government incentives such as the HomeBuilder scheme providing eligible owner-occupiers (including first home buyers) with a grant to build a new home, renovate or buy an off-the-plan home – which put additional pressure on supply constraints.

At the same time, Australia is facing a housing shortage, with many would-be travellers at home during the pandemic and new government schemes being rolled out in an attempt to drive supply and keep the economy going during the peak of the COVID pandemic.

Indeed, more than 137,000 people applied for the HomeBuilder grants alone, providing a boost to the construction industry. But, as quickly as the pace picked up, an already-fatigued skilled workforce left, leaving a workforce shortage that has been unable to meet the increased demand.

These have all created a “perfect storm” and put immense pressure on construction industries going forward.

It’s estimated that the “worst is yet to come” according to the Housing Industry Australia.

The chief economist of the housing industry body, Tim Reardon, said it’s a challenging time for the industry with a “doubling” in volume of homes under construction.

“We’ve seen no increase in the population of Australia over the past few years and a significant increase in demand for homes as people move to lower density,” he said, adding the time it takes to build a home has blown out from eight months to more than 12 months.

As supply struggles to meet housing demand, Mr Reardon said the Reserve Bank’s interest rate hikes will play a part in slowing down demand creating some balance.

“We can see that occurring already in other markets where rising rates are slowing demand for housing. And the same will transpire here,” Mr Reardon said.

The pace of building approvals has already begun to descend in Australia, with the Australian Bureau of Statistics (ABS) reporting a 23.4 per cent drop over the year from May 2022 and a 37.2 per cent drop in the construction of dwellings over the year.

Backlog of activity

While the industry is subject to cyclical events, senior economist Adelaide Timbrell at ANZ Research said the increase in demand, alongside company collapses and extreme weather events has also caused a backlog in activity.

“One of the things that is creating unstable pricing in the construction sector is just a huge backlog of activity, whether it’s in the residential sector after HomeBuilder or in the commercial sector as well,” Ms Timbrell said.

“The other big headwind is the weather – we’ve seen so much rain and flooding over the east coast this year, that has slowed down a lot of construction activity, which has meant that the sector was not able to operate as efficiently as they usually would.

“All of that has come together to really create some difficulties that we wouldn’t usually see, or at least we wouldn’t usually see all at the same time for that sector.”

The increased costs in materials are being felt across the industries from metal, structural steel, reinforcing, fixings and fencing, adding to rising prices across timber products.

Ms Timbrell said with price changes happening “really quickly” construction companies struggle to provide services at an agreed price.

Builders pass on costs

Speaking of the issue, broker Amy Small at Small Local Brokers has told The Adviser that builders seem to be increasingly getting “into trouble” because they are passing on the additional cost in materials to borrowers, by increasing their invoices.

She said new invoices had been issued to almost “every client”, and, in some cases were adding on up to $95,000 more than agreed.

“The builder has just asked the client to find that money halfway through the build because costs have blown out and the construction is trying to recoup those funds.

“A fixed build contract actually means nothing now,” Ms Small said.

“If anyone, anywhere in the world suddenly got an invoice for $70,000 they would maybe take a step back – that’s what we’re seeing from [families from] all walks of life.”

But lenders have been sympathetic to the issue. Regarding insolvencies, Ms Small said it was in the bank’s best interests to help borrowers who have lost their building contracts due to insolvencies – as was the case for one of her clients.

Ms Small said the lender “stepped in” and provided “wonderful support” to help her client find a new builder.

“I believe it’s in the bank’s best [interests] to support clients that are in this sort of predicament as well,” Ms Small said, adding that lenders were liable to losses as well.

While this client was supported, she said there were a lot of delays and costs caused during the process.

What the lenders are doing

Given the risk to lenders, head of lending at Trilogy Funds, Clinton Arentz, said they had “increased the emphasis” when reviewing building companies to ensure they are in “reasonable shape”.

Mr Arentz said the non-bank lender – which provides “tailored finance solutions” for construction lending – aims to minimise the potential for brokers and their clients to end up in tough situations.

“We’re fairly forensic in the way that we would look at a new loan application. That includes reviewing and sense checking all the supporting elements that make the project successful and one of the critical elements is construction delivery,” he said.

“Have they got experience in that particular industry or construction type? For example, there’s specialist childcare builders, NDIS builders, shopping centre builders, and industrial builders.

“But also, are they solvent and are they current with all of their other dealings? We’d even go so far as to look at their other current projects and see how they’re tracking on those jobs.”

As building costs change, checking a company’s creditworthiness is also important, he said.

“Brokers should be talking to their developer clients about how the building contract structure works as well to protect the borrower and the developers,” Mr Arentz said.

“You can get a pretty good feel for whether the builders are in reasonable shape and whether they’ve got the right experience, from those initial investigations.”

The head of lending at Trilogy Funds said he had seen a lot more “cost escalation provisions” coming into the building industry and also builder and developer partnerships.

“Developers and builders are teaming up in what’s called ‘early contractor involvements’. The builder gets in early and is involved in the design and approvals, [and] it’s a more collaborative type of approach to completing the project,” Mr Arentz said.

He explained that independent checks such as quantity surveyors to break down the cost of the project and ensure they are in line with industry standards, are important.

“The quality of consulting reports is everything. Anything outside the standard parameters is a warning sign either way – whether they are under-priced or overpriced,” Mr Arentz said.

He said if the builder runs into financial difficulty the borrower needs to be able to carry through the work with the support of the lender to get the project complete.

While construction lenders can bring in specialist skills where it sees fit, ultimately the borrower must have sufficient funds and contingencies in place to mitigate some of these expected delays a development project can create.

“If they don’t have an appropriate project plan, appropriate building contracts and sufficient contingencies to manage market changes, then perhaps they shouldn’t be in the project – it’s an unfortunate reality check that lenders sometimes need to give the developer,” he said.

It’s certainly a reality that rings true for broker Karen Le Comte, at Smartline in Cleveland, Queensland, who said borrowers need to have “contingency funds of at least 10 per cent” to feel comfortable in being able to complete their build.

Ms Le Comte had recently assisted a young couple to increase their finances after a variation of $33,000 was slapped on them by the builder.

While the actual costs were closer to $55,000, Ms Le Comte said the builder provided some solace by absorbing some loss and planning to continue the project, but the process presented challenges.

“We’ve had to start from the beginning, which means new documentation, new application, new valuation and reassessment,” Ms Le Comte said.

“They needed to sign an agreement to say that they’re accepting that variation and we’ll be able to pay the difference.

“At the same time, that pool builder increased the cost by $5,000.”

The Commonwealth Bank of Australia had been helpful to ensure the borrowers could increase their loan, but the new loan structure had changed increasing repayments to include principal and interest, she said.

“The Commonwealth Bank has accepted that increase and will allow us to base the new loan on the new valuation. So that’s put them in a stronger loan to value ratio than what they were originally when we submitted their loan,” Ms Le Comte said.

The new agreement has meant the drawn loan amount was refinanced to a principal and interest loan, rather than interest only adding significant costs, Ms Le Comte said.

Despite some concerns from the added costs, it was far better than the alternative scenario.

“If it didn’t move forward with the increase in the build costs, you’re at a standstill and you have to sell an unfinished home,” she said.

“They’re not going to get anywhere near the value of what that property is worth because it’s not finished.

“I hope I don’t end up with anyone that’s in that boat.”

However, with a number of subdivisions and developments outstanding, Ms Le Comte anticipates another wave of collapses are yet to come.

“I’m looking at this stage, probably in August or September, we’re going to have another round of issues because we haven’t actually settled on these [land and house] blocks yet,” Ms Le Comte said.

Indeed the cost of inflation is being felt in the pockets of the borrower, the lender, and the builder, with insurance expected to foot some bill. 

“If these builders don’t get the increase to cover their costs, well then they’re going bust – and that’s where the builders insurance is having to step in and I wonder how much money they’ve got there,” Ms Le Comte said.

“It’s a double edged sword because the bank is going to lose out as well because they’ve got a property that is not complete, so it’s potentially devalued their security position.”

First home buyers hit hard

The situation is particularly challenging for first home buyers who accessed the government’s First Home Loan Deposit Scheme, as it does not allow the borrower to increase the loan amount unless they are released from the guarantee, Ms Le Comte explained.

She said the only option is to get a new valuation that has “hopefully increased” enough to avoid lenders’ mortgage insurance that was exempt as part of the government guarantee.

“A lot of the [first home buyers] are only in the market because they were able to get the first time buyers grant, the HomeBuilder grant and then your first home buyer loan deposit scheme,” Ms Le Comte said.

“So that first time buyer that started this journey 12 months 18 months ago who was just so excited they were getting in the home market – it’s turning into a nightmare for them very quickly.”

The impact on brokers

As brokers’ workloads are already stretched, Ms Le Comte said the added processing has also taken a toll.

“We want to help our clients but we have a business to run as well. We’ve already had to do a lot of these loans two or three times because they kept expiring, because it’s taken so long for land to register.

“In some cases, it could be two, three, four times that we’re doing an application to get that person the end result of living in their own home – and we don’t charge a service fee for that.

“It’s a hell of an expense on us as brokers,” Ms Comte said, adding clawbacks were inevitable.

“If you’ve got brokers out there that have written a tonne of construction loans – they’re going to start going through this and they will, that’s going to put a lot of pressure on businesses as well.”

While the industry is expected to bear more challenging times this year, as inflation begins to level out and demand eases, many anticipate there will be easier times ahead for the sector.

In the meantime, it’s imperative that brokers are preparing clients who are looking to build for unexpected cost increases, blowouts in turnarounds, and ongoing delays. By providing ongoing and clear communication – as well as ongoing engagement with the lender – it is hoped that the construction crisis will only be short-lived. Time will tell.