Crisis in Kiwi Construction

In 2009, your editor spent two weeks in Dakar, Senegal.

The capital city sits on the Cap-Vert peninsula along the western coast of Africa. Its strategic position as the westernmost city in mainland Africa propelled its growth as the slave trade across the Atlantic grew.

These days, Dakar is a bustling urban city with markets, music and well over a million people.

But one of my clearest memories is of the rooftops in the city. They’re different from anything you’d see in the developed world.

Houses and villas in the city develop slowly. Developers pause projects until more money comes in. While the projects are stopped, the buildings often sit abandoned and incomplete. The Senegalese call these the ‘not-yet houses’.

If you were to look across the rooftops today, you’d see a maze of concrete walls with steel rebar protruding out.

It’s evidence of an imbalance between cash flow and growing needs.

And soon, we could be seeing something similar across our own cities.

 

Trouble in paradise

Ebert. Hawkins. Fletchers.

Why are Kiwi construction firms dropping like flies?

An imbalance between cash flow and growing needs.

It’s a pandemic sweeping the nation…and one that could severely disrupt New Zealand’s growth in the next few years.

What might start in construction could eventually affect the entire Kiwi economy.

Construction activity reveals how the broad economy is growing…the level of investment…expectations for the future.

It’s one of the earliest signals of a boom or bust. That’s why the ‘Building Activity Indicator’ is one of the most-relied-upon indices that economists follow.

So, when building is up, you can expect growth. When it’s down, expect a contraction.

That’s generally how it works. But as seen in Dakar, it’s not always the case. Sometimes there can be plenty of building in development, but an imbalance can throw it off.

In New Zealand’s case, today’s imbalance comes from poor planning.

And it’s taken the form of a nationwide Ponzi scheme.

It starts with a bidding war. When a new project hits the market, prime builders bid on it by making an offer of how much they’ll charge to do it. Their estimates are calculated by their historical cost of goods and labour adjusted for future price increases.

The problem is that they forget ‘past performance is no guarantee of future results.’

Instead of giving themselves a healthy margin, builders bid based on razor-thin price fluctuations.

While that may win them the contract, it puts them in a tight spot if material prices change.

And that’s what’s happened. [openx slug=inpost]

Over the past few years, a sharp lift in building activity has squeezed domestic construction resources. That has ramped up prices for both labour and materials.

Infometrics predicted that the local market would experience an average price increase of 5.2% per year. That’s far beyond the rate of inflation.

For most builders, that’s not a big problem. They simply pass those increased costs onto their buyer.

But in New Zealand, the competitive nature of the industry has led many builders to offer ‘fixed price build contracts’. That means that the building costs are predetermined at the point of contract. So, if prices rise, the builders shoulder the burden.

For buyers, it’s a great deal. They know exactly what they’re going to pay. They’ll often pay a slight premium to get this sort of contract.

For builders, it can be a gamble. You’re hoping that your estimates for materials and labour stay accurate throughout the whole life of the project.

You can imagine how quickly it can all fall apart.

First, you’d start paying your suppliers and subcontractors later and later. Eventually, you’d go delinquent on your payments. If you’re lucky, you can write an IOU.

Then you’d start borrowing to keep up with the bills. You might even use some of your future cash flow to pay for present needs…hoping that it would sort itself out over time.

At some point, you’ll run out of money. Underestimating costs in the past has caught up to haunt you.

So you go under. Then your subcontractors and suppliers go under. Then their other clients go under.

It’s a house of cards waiting to be toppled.

And it’s just begun here at home. The cards at the top — Ebert, Hawkins and Fletchers — are collapsing.

Building sites are locked down. Contractors locked out. Red across the board.

That is, unless the government bails them out…and that’s probably what will happen.

Yesterday morning, government ministers met with construction firms to discuss the crisis and what can be done.

Infrastructure Minister Shane Jones stated that the government ‘needed to do whatever it could to ensure the sector could survive and thrive.’

Registered Master Builders chief executive David Kelly added:

This industry is strategically important to New Zealand: it is important to our economy, it is important to our social fabric.

If you start from that point of view you have quite a different mindset around the whole procurement approach.

To your editor, this sounds a lot like New Zealand’s building industry is ‘too big to fail’.

And who’s going to pay for the builders’ mistakes? You are.

Frankly, we don’t see this situation clearing itself up. Either the state places the cards back on top…or the industry resets. And if it does, don’t be surprised to see the effects spread across the entire economy.

You can bet we’ll be keeping a careful eye on this situation.

Best,
Taylor Kee

Daily Wealth

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Taylor Kee is the lead Editor at Money Morning NZ. With a background in the financial publishing industry, Taylor knows how simple, yet difficult investing can be. He has worked with a range of assets classes, and with some of the world’s most thought-provoking financial writers, including Bill Bonner, Dan Denning, Doug Casey, and more. But he’s found his niche in macroeconomics and the excitement of technology investments. And Taylor is looking forward to the opportunity to share his thoughts on where New Zealand’s economy is going next and the opportunities it presents. Taylor shares these ideas with Money Morning NZ readers each day.


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