Construction

Friday, 4 December 2020

KordaMentha’s Behind Business podcast discusses the most pressing commercial, financial and operational issues facing business today.

In this episode of Behind Business, Paul Mirams and Ted Fitzgerald from KordaMentha’s Real Estate team,  join Sean Aylmer to discuss the history, present and the future of commercial construction in Australia.

 

Transcript

Sean Alymer:
Welcome to Behind Business, the podcast where KordaMentha experts discuss the most pressing issues facing business today. I'm your host, Sean Aylmer, an economist and journalist for 25 years. The voice of the fear and greed daily podcast. The construction sector, quite literally built the nation. It leaves an indelible footprint on our geography. It reflects society and leave signposts of our value, successes and failures.

Construction reveals the choices we've made in building our nation and where we want to go. It's incredibly colorful, full of characters in many Australians have made their fortunes investing in construction. The industry is also huge. It comprises everything from one person shops, through to multi-billion dollar companies. It involves millions of workers from high flying corporate executives, to accountants, lawyers, and thousands upon thousands of tradees across the nation. This morning on behind business. We're talking about commercial construction that includes high and medium density residential construction, commercial office buildings, and educational facilities.

To talk to us about the history of the present and the future of commercial construction in Australia, we have two experts from KordaMentha's real estate division. Executive director, Ted Fitzgerald joins us from the Melbourne office and partner Paul Mirams joins us from Sydney. Ted and Paul, welcome to both of you.

Ted Fitzgerald:
God day, Sean.

Paul Mirams:
Thanks, Sean.

Sean Alymer:
Ted, let's begin by getting a sense of the size of the construction industry in Australia. How big is it? How many employees, how many businesses, the dollars involved, that type of thing.

Ted Fitzgerald:
Yeah, thanks Sean. The construction industry generates some 360 billion in revenue per annum, which quotes around 9% of Australia's GDP. By way of construction work undertaken, it totals around 210 billion and its employees some 1.2 million people. And this is forecast to rise to around 1.3 million by 2022.

Sean Alymer:
9%. That would have to be one of the two or three largest sectors in the economy, I'd imagine?

Ted Fitzgerald:
That's rod. The industry has around 360,000 individual businesses and small businesses make up around 90% of those.

Sean Alymer:
Wow. So when you think about it, you often hear about the very big companies involved, but as you say, primarily, it is actually an SME sector?

Ted Fitzgerald:
Yeah, that's right. A small business employs 70% of the industry's employees and that's the highest of any industry sector. A common misconception of the building industries that builders build. In fact, head contractors, those we generally refer to as builders, sign the construction contract and have only about 10% of the employees on site. And sub contractors make up the balance. These are generally small businesses that specialize in parts of the construction project like plasterers, electricians, [inaudible 00:03:00], et cetera. The subcontractors are the ones that actually do the building, whereas the head contractors or builders just manage the process.

Sean Alymer:
Okay. And is it mostly private money that is spent on construction or is it the government spends

Ted Fitzgerald:
The industry is split probably 75% of the private sector and the balance of 25% made up by the public sector. The public sector is predominantly focused on infrastructure and makes up around 40% of the value of work undertaken in the infrastructure sector.

Sean Alymer:
And when you're talking about the sorts of projects that we're going to be talking about for the next 20 minutes, what are typically some of the sort of projects that these guys are doing?

Ted Fitzgerald:
Yeah, so the industry can be divided into three broad areas of activity, engineering, construction, or infrastructure. As we just touched on, building more roads, rail and mining, which is about 45% of the industry. The non-residential building sector, which includes offices, hotels, hospitals, education, makes up about a quarter of the industry. And then there's the residential sector, which we all know through houses, apartments and townhouses, which makes up the balance.

Sean Alymer:
Paul, bringing you in. Can we just take a couple of the issues that we continually hear about everyone used to laugh about when the skyline was full of cranes, it meant the construction sector was doing well. Is that still true?

Paul Mirams:
Oh, absolutely. And there are actual crane count barometers published regularly in Australia, which are seen as an indicator of economic activity. And generally speaking, those crane counts have been increasing for the last reasonable number of years.

Sean Alymer:
So worker safety, is that still as significant an issue for the sector, as it seems to have been for decades?

Paul Mirams:
Worker safety is an enormous issue in construction. Worker safety is both governed by the builders themselves, by the unions, by the other authorities floating around the industry. And there was a real focus on it, because it's pretty rare in this day and age that we have people who can go to work and actually be physically hurt and at risk in doing what they do on a day to day basis. You never want a situation where people don't come home.

Sean Alymer:
Absolutely. And it's a fairly heavily unionized sector?

Paul Mirams:
Well, the unions are very involved, but generally at the top end of the market, unionization rates fall dramatically once you get into the middle lower tiers in a value respect. So if you're building office towers and road and rail, there is a significant union presence.

Sean Alymer:
So, Paul, you must have some great stories about working with unions.

Paul Mirams:
One of the most interesting stories of my last 20 years working in the industry was probably two or three years ago. We had a client whose builder had unfortunately gone into liquidation. We attended the site and at that stage that the site was probably 35% built. And whilst our client had paid builder in full as is very often the case, the builder hadn't paid his subcontractors. So we got to site to talk to those subcontractors that were unhappy. They'd not been paid, there's probably 10 of them in the room. And it's quite emotional when you haven't been paid. And we asked them to identify themselves about who they were, who they're working for. And there was one guy who was probably five foot six, bald with an ACDC t-shirt on, and he refused to say who he was. He just said, "Look, I'm just here to see what's happening."

And so we passed on the conversation and over time it turned out our small bald friend was actually a member of, one of the prominent bikie gangs, and they had quite a representation in parts of the subcontract industry. Now over the next two or three months, we actually worked extensively with the CFMAU and the bikies.

And they were focused, and I don't want to suggest that the CFMAU and the bikies are aligned in any way, shape or form, but they were so common in their interest. They were interested in having their people paid. They understood that whilst we'd paid the head contractor, that they saw it as simply, we understand that, but we want our people paid. These are working class people, they've got small businesses, it's critical. And so we eventually came to commercial arrangements with the CFMAU about getting their people back onsite. And that process was pretty painful for the developer, probably led to an overall delay of six months on the site to get a new builder on and maybe a cost increase of 35%. But the union were open. They were honest. They were clear about what they wanted.

Sean Alymer:
And the bikies as well?

Paul Mirams:
They were surprisingly good. It was a fascinating exposure, not something I want to do twice but worth doing once.

Sean Alymer:
So Tim, until this year, the construction sector had pretty much had achieved several years of continuous growth. Now a growing population, I'm sure is a big part of that and the need for more infrastructure comes along with that. Where, is the construction industry up to now at the end of 2020, not quite post pandemic, but certainly hopefully over the worst part of it.

Ted Fitzgerald:
Yeah. So COVID influences, I suppose, together with the state and federal government responses have certainly created some winners, but also some loses in the sector. I would say overall, the construction industry is anticipated to ride the COVID bump reasonably well. State and federal stimulus measures have substantially helped the sector. These include the cash rate reduction, job keeper, some property market measures like land tax relief and the home builder program. And also the infrastructure investments for shovel-ready projects, not to mention the temporary insolvency protection measures have all had a positive effect on the industry. The infrastructure, it's said to benefit greatly from these measures from both federal and state governments. Whilst the non-residential sector, businesses and institutions are deferring or delaying non essential CapEx. And we're already seeing this play out with building approvals in this sector, down 37% to the September quarter 2020.

Sean Alymer:
Okay. Paul, do you have any more to add to that?

Paul Mirams:
Yeah, Sean, look, I think the thing you have to realize about construction is it's actually not a driver of economic activity, it is a responder to economic activity. So construction is busy when the economy is busy. Because if you think about an office building. A construction company just doesn't turn up and build an office building for fun, it requires an owner of the land and an owner of the end office building to decide now is the time to build a new office building. And then the construction firm gets involved. So as I said, that they respond to economic activity. So as long as the things the government is doing, and the recovery from Corona is strong, the construction industry will do okay out of it. But if we do see an extended downturn, you would expect the construction industry to have a far more difficult time than it's had of recent years.

Sean Alymer:
What I always find interesting with the sector, you often read stories about a company going broke and Grocon recently, or some of its subsidiaries have gone into administration. I know KordaMentha is involved in that. They take big bets, construction companies because of the nature of the work that they're doing, are spending millions or tens of millions of dollars and agreeing to do that and hoping there's a reward at the end of it. Maybe starting with you, Ted. It just seems to me, it's an industry which you have to have risk takers in it.

Ted Fitzgerald:
That's right. But what we're dealing with at the bigger end of town are lodge contracts, and Paul can touch on this further. A lot of these large contracts are half a billion dollar contracts. And the industry operates on skinny margins, three to 5%, quite common for the larger end of town. And in order to drive a profit, they are large contracts. So you're seeing still large amounts of profit being generated from these contracts. Notwithstanding the letting gains through subcontractors that the builders are getting at the moment because subbies are struggling for work in certain sectors and are willing to price work a bit cheaper.

Sean Alymer:
Okay, Paul?

Paul Mirams:
As often happens in industries that are very busy, there has actually been growth in the number of builders and the size of builders and that means growth in competition between builders. And what landowners have been able to do is they've been able to push risk that's traditionally associated with the owner to the builder. So builders have been increasingly taking greater risk in order to secure building contracts. So as Ted said, whilst the margins appear low, they still make significant money. But the risk profile they are taking has been increasing in recent years. In many respects, that position is supported by the legal practitioners who once they achieve a legal outcome once, try to push it through all of their contracts. It's supported by the banks, who wants to see risk passed down. They perceive fixed price and time contracts are risk mitigant to their lending. And in fact, you can argue that pushing risk into the building game increases risk for lenders. But the industry over the last few years has evolved to push risks to builders and the builders have accepted that. It's a two way street.

Ted Fitzgerald:
Yeah, that's right. But it's the builder's position to push that down the chain. And that's what we see in the construction industry is this pyramid like structure of the industry that passes risk down the line. The brunt is often felt bus out contractors as a consequence of that pyramid structure of the industry, where there's often not a direct contractual relationship between the businesses or subbies performing the bulk of the work being undertaken on a project and the head contractor who's being paid by the client. The structure just places, considerable pressure on businesses down the contractual chain.

Paul Mirams:
I had a site in Sydney, a fairly major site in Sydney where the builder took the risk of services being supplied to the site. Now, service provision, so electricity, water, et cetera, is not generally a risk profile factor for a builder. It's the owner's risk. You give the [inaudible 00:13:26] to the builder in a position where they can build it. But in this case, the builder, as a point of difference said, "We will take that risk into our construction timetable and our cost." And it turned out for technical reasons, they couldn't get one of those services to site. And that has led to an extensive delay on that side of more than 12 months. And therefore that builder now is in a position where it's going to suffer liquidated damages because they have delayed the project. That wasn't a risk they should have taken, at least in my mind, but it is a risk they took. They took the commercial position, they could manage it and ultimately they were wrong and will pay the price for it. But that is a risk that traditionally would not have sat with a builder.

Ted Fitzgerald:
But Paul, we say this all too often in construction projects, where a principal has chosen the cheapest builder. It's not often the best case to choose the cheapest builder. And they often take unbalanced contract risk positions, which quite often, will cause distress through the project as the builders under price the build. And they're on the wrong foot from the get-go.

Sean Alymer:
As in they're trying to cut corners?

Ted Fitzgerald:
That's right.

Sean Alymer:
So Ted, where are we up to right now? Are you seeing many construction businesses in distress or more than normal, or has the government help kind of inoculated them somewhat? What's the state of play right now?

Ted Fitzgerald:
There definitely has. And that's the case across all industry sectors. The construction industry has historically been disproportionately represented in corporate insolvencies. As we touched on earlier, the industry represents about 9% of the national GDP, but represents some 23 to 25% of all external administrations.

So it is disproportionately represented. Given those stimulus measures, as you mentioned, plus the temporary insolvency protection measures, construction industry insolvencies are down some 65%. Any given year would see some 2000 to two and a half thousand construction insolvencies. But this year we're on track to only see around 600 to 700. What will be interesting is once the stimulus measures and the insolvency protections are wound early next year, I think we might say certainly an uptick in construction sector insolvencies. And it's also early in a year is a hard time for a builder and a subcontractor, given workdays are limited due to the public holiday season and cash flows do dry up during this period.

Sean Alymer:
I think that's incredible that you described of how few insolvencies there are relative to what they normally would be. Does this mean you guys are likely to be busy in 2021, '22?

Paul Mirams:
There is clearly an evolving view that the recession might not be as severe as was expected. And that's countered with a view that there is a built up wave of small business, particularly that won't survive this process. But because of the things the government has put in place, we're not seeing that wave of insolvency occur. It's genuinely hard to know where it's going to land. There are always unintended consequences. The construction industry nationally was deemed to be critical. And so it kept working through the Corona issues in pretty much the whole of the nation. Having said that, the additional things that builders needed to do, social distancing, safety and the like, due to Corona has meant that a very large number of builders are late and have had cost overruns. And in most of those situations, their contracts never envisaged a world where Corona would lead those things to occur.

So their ability to pass those costs on to the land owner is at best marginal. And so we're going to see a situation where there will be developers and builders that come to a mutual agreement about sharing those costs. But there are clearly going to be cases where developers take this opportunity to go well, that was your risk, bad luck to the builder. And so the response to Corona from governments has been positive. It's kept builders working. The unintended consequence is it's increased the cost of the builder's work, and they may not be able to actually recover that cost.

Sean Alymer:
Do you think there are other things that will flow out of COVID-19 that will impact the sector for years and years?

Paul Mirams:
There are a couple of things that I think the government should be thinking about. We think the government will be over-represented in the contracting party. It will drive more than average workflow for builders for the next few years, as it spends money to get the economy out of a hole. That gives it the opportunity to shape some material discussions. But the first one of those is the five day workweek. So the construction industry in Australia, almost as a whole, works six days a week. There isn't another industry in the country that does that. There's not another industry in the country that would accept that. If anything, Corona has led Australians to ask themselves, "Are we working too much? Can we work from home more often." They're not options that are available to the building industry. So what does working six days a week in an uncertain environment, and construction is inherently uncertain because your job certainty lasts for as long as the project. Construction has almost doubled the suicide rate of any of the average Australian worker.

The answer to that is to get people home, to interact with their families, to have better work-life balance. And that is a five day working week, which every other Australian takes as a right. And the construction industry has the opposite of that. It also clearly means that women are massively underrepresented in the workforce. You cannot look after a family when you and your husband are working six days a week. So there are clear structural reasons why the five day working week has to be addressed. It has started in New South Wales. The CFMAU is onboard. There are government backed projects running in this state where they're going to look at the evidence about efficiency, about mental health for workers and the benefits will stack up that five days a week makes enormous sense. The second thing the Australian government's state and national should be looking at is Australian owned businesses should be doing the balance of work.

Most large infrastructure builders, and the government spends enormous money there, are not Australian owned businesses. The government should be asking itself the question, "We're trying to support the economy. Why are we handing out massive contracts to businesses that are not domiciled in this country?" And the third is the government has a leading role in getting the balance of risking contracts for major contracts right. And historically, we have a very large litigation piece that has happened in New South Wales, around the development of the light rail through the CBD. You can argue that's a balance of risk in the contract issue, and that's repeated time and time again around the country. It's time the government did what government should do, which is stand up for the people and not let commercial forces drive poor outcomes.

Sean Alymer:
I have never ever thought about that. That is really interesting Paul. If there is a builder out there worried about what's going to happen in the next six, 12, two years, what should they be doing? Paul?

Paul Mirams:
One of the trends we see in builders when they have financial issues is they ask professionals for help far too late. If by the time you ask for help, you can't pay your creditors, your late paying the tax office, there's just not that much that can be done. Our advice to businesses is, have great management information systems. When they identify stress in your business, get help early, ask for professional advice and accept that advice. The time for intervention is not when it's too late, there's nothing that can be done. So, that's our overarching message, not just to the construction industry, but to so many businesses. Accept that the skill base of restructuring your business and finding business outcomes is a skill base. You have a skill base in building things. We don't have that. We have a skill base in finding solutions to your financial challenges, ask for help early and take the advice.

Sean Alymer:
That's a good place to leave it. Ted, Paul, thank you very much.

Paul Mirams:
Pleasure, Sean.

Ted Fitzgerald:
Thanks Sean.

Sean Alymer:
I've been talking to KordaMentha Executive Director, Ted Fitzgerald and Partner, Paul Mirams. It's clear a healthy construction sector is good for the economy. It's a big employer, involves many, many small and medium sized businesses and some large businesses and as many flow on effects to the rest of the community. Certainly 2020 has provided the sector with challenges. Government has certainly helped, but the resilience of commercial property has also shone through.

Work safety in the sector is critical. So too are external factors like population growth and technology and design, and because the sums of money involved are so big, big firms are often trying to take big bets on single projects. In fact, commercial property is a high risk business. COVID-19 provides an opportunity for reform in the sector going forward, potentially including the number of days worked each week in the sector. For operators, understand where the next job is coming from and keep an eye on costs, revenue, cashflow, and contracts. It's critical. If you're worried about any of these factors, ask an expert, get some help. Being cautious can save massive headaches in the future. I'm Sean Aylmer and that was Behind Business.