Like a snake swallowing a large animal. That is how Antony Blackshaw, chief executive of Australia’s eighth-largest home builder Henley Homes, has described the past three years in the housing construction sector.

First came the upheaval and chaos of the pandemic itself. Then the feast and famine caused by the federal HomeBuilder grant, which triggered a surge in demand for new houses followed by a slump when the stimulus measure ended.

Henly Homes chief executive Antony Blackshaw.Credit: Eamon Gallagher

As the construction industry set about building that huge number of homes, it was hit with cost pressures linked to soaring prices for raw materials such as wood, cement, steel and glass, compounded by global supply chain nightmares.

Having locked in tens of thousands of fixed-price contracts in the race to capitalise on the $25,000 federal grant, builders confronted large losses.

And now – just as those pressures are starting to dissipate – the industry has to stomach the most aggressive interest rate tightening cycle for decades, that has decimated confidence and the forward pipeline.

“People talk about the pandemic being a one-in-100 year event,” Blackshaw says. “But for us, it’s been like three one-in-100 year events in a row.”

On March 31, the building industry was left reeling after one of Australia’s largest and most respected residential builders, Porter Davis Homes, collapsed, leaving about 1700 unfinished homes in Victoria and Queensland.

Families and tradies now face an agonising wait as the company’s liquidator begins a complex salvage operation.

Other companies are also feeling the pinch. ASX-listed home builder Simonds Group and Melbourne builder Dennis Family Homes shed 10 per cent of their staff this week in response to falling sales volumes, rising costs, trade shortages and market downturn. Economists and housing industry experts are warning more pain is in store.

Porter Davis’ implosion is a remarkable case study in how the economic law of supply and demand can break down – a company has gone bust despite huge demand for its product.

It also highlights how government attempts to stimulate the economy can have unforeseen consequences.

The question of how bad the situation might get for the construction sector – and by extension the national economy – remains a vexed one. State and federal policymakers, already struggling to manage historic levels of public debt, are now watching on anxiously.

Porter Davis had approached the Victorian government for a bailout. But on Thursday, Premier Daniel Andrews argued it would not be right to use public money to prop up an unviable company.

“Where a bank refuses to prop up a business, that’s exactly the place where I don’t think we should be stepping in,” Andrews said. “To go without an administration, to go straight to a liquidation phase, tells you that the fundamentals of that business were not strong.”

Even so, the ramifications of further failures could be profound.

Construction is directly responsible for about 7 per cent of Australia’s GDP (in volume terms) and 9.5 per cent of total employment. But its importance to the national economy goes well beyond that, particularly given the psychological role it plays underpinning consumer and business confidence.

Economist Saul Eslake says trouble in the construction industry often provides the first warning that boom conditions are coming to an end.

He says sharp downturns in housing construction were features of the initial stages of the recessions in the early 1980s and 1990s, in both cases preceded by periods of historically high interest rates.

“The construction sector is often the canary in the coal mine because it is so interest rate sensitive and construction activity, more than anything else that I can think of, is usually undertaken with borrowed money,” Eslake says.

“We’re almost certainly about to have a significant slowing in the economy. It would be amazing given how quickly interest rates have risen if we didn’t.”

The construction industry occupies a unique place in the broader economy.

Brad Walters from credit-monitoring firm Equifax says every dollar spent on building and construction results in three dollars being spent across the broader economy, which explains why governments have repeatedly targeted it with stimulus dollars when things go bad.

“This is traditionally why this sector has been quite supportive economically. When it does well, the economy does well,” Walters says.

Is the flipside then true too? If the construction industry is suffering will that have an outsized negative impact?

Walters says Australia has a strong banking system, low unemployment rates, high export prices and household savings.

“But in an environment where we’ve got population growth, housing and rental affordability concerns, and we need more [housing] stock, the fact that the construction sector is under pressure is really concerning.”

The signs for the industry have been worrying for months now despite a national shortage of houses.

As far back as May last year, when news emerged that another home-building giant, Metricon, was potentially in strife, economists and construction industry experts predicted a “major correction” for the construction sector.

That correction is now clearly under way. According to Australian Bureau of Statistics figures, the number of dwelling projects approved by councils rose from 13,000 in June 2020, to a peak of more than 23,000 in March 2021, the second-last month of the federal HomeBuilder scheme.

Approvals crashed to about 12,000 in January this year and are all but certain to sink further after the most aggressive interest rate tightening cycle for three decades continues to wash through the economy.

Lending has also collapsed. The number of home loans issued by banks and their smaller rivals to build or buy a newly built home more than doubled from 5837 in June 2020 to peak at 12,809 in February 2021, before collapsing to just 4267 by February this year.

Between July 1 and March 19 there were 1494 construction industry insolvencies, according to figures from the Australian Securities and Investments Commission, almost double the 787 recorded for the same nine-month period last financial year.

Craig Shepard, a partner at insolvency specialist KordaMentha, says construction companies accounted for about 30 per cent of insolvencies in Australia this financial year to date.

He says while parts of the commercial construction sector were booming, volume home builders were in trouble because they worked on very skinny margins and fixed-price contracts.

“It’s an unfortunate perfect storm, COVID had a material impact thinning out the balance sheet of these builders. They don’t have the funds to absorb the costs, and they cannot pass them on to fixed-price purchasers,” Shepard says.

He predicts the next 12 months will result in more insolvencies among volume home builders and the subcontractors who work for them.

“There will definitely be a contagion impact … hopefully not too dramatic, not too broad, but it will have consequences,” Shepard says. “We’ve been contacted by a number of suppliers and subcontractors saying, ‘What do I need to do to manage my cash flow?’”

The big question is what happens next. Economist Chris Richardson says the sector is experiencing “a lot of pain” that will worsen before it improves. But he does not believe the situation is dire.

“We are seeing what we often see – that is that builders are going bust so far, not so much because of interest rates but more because they bet wrong on what would happen to cost,” Richardson says. “That will calm down before interest rates calm down.”

Population growth is one of the big forces providing a sense of comfort for some in the sector.

In a recent report, the National Housing Finance and Investment Corporation, the body charged with boosting the supply of housing, warned the Reserve Bank’s sudden and unexpected interest rate tightening cycle had cut the supply of new homes.

It also predicted a recovery from about the middle of this decade. This would still leave a shortage of 106,300 houses over the five years to 2027.

The trick will be getting there for companies under pressure in the here and now.

Australia’s largest privately owned construction company Hutchinson Builders says areas of the construction sector are suffering significant financial pressures.

“There is massive haemorrhaging in our industry,” says team leader Bernie Nolan. “The reality is most building companies are operating on 1 and 2 per cent profit margins.”

Nolan warns more construction companies are likely to collapse over the next 12 months.

“The industry is deeply worried about the zombie companies that have made their way through COVID with government support,” he says. “People rely on cash flow to keep themselves afloat but at some point in time they work out that there’s not enough in the bucket to pay everyone.”

Nolan says volume home builders have been the hardest hit, but the commercial sector had also been affected.

Many construction firms struggled to find subcontractors due to tradies working on big government infrastructure projects such as the Metro Tunnel, North East Link and Victoria’s Big Build.

“That’s a massive problem because it’s taken trades away, which means that your ability to get things built quickly is reduced enormously,” Nolan says.

The labour shortage was on top of massive price increases for materials, exacerbated by Russia’s war in Ukraine.

“I know a number of companies that are buying sand quarries now so they can guarantee they can supply their own concrete,” Nolan says. “And when quarries go into private hands, it’s just going to push the price up higher because there’s going to be less quarries for suppliers to purchase from.”

Matthew Kandelaars, chief executive of the Victorian branch of the Urban Development Institute of Australia, says it will take time to work through the challenges of the past few years.

He agrees with the forecasts predicting the medium-term fundamentals for the industry are positive, with the need for new houses as strong as ever.

“It is an incredibly challenging time for all of us,” Kandelaars says. “The cost of labour and materials has been increasing exponentially over the past couple of years, there have been huge cost increases across the board and that has flowed through to the industry.”

For now, Blackshaw says the large animal is still being digested by the snake.

He thinks some of the more alarmist predictions are misplaced, and suggests the sector will begin shrugging off its woes from the middle of the year.

And after 10 consecutive interest rate increases, the Reserve Bank’s decision to leave its official cash rate on hold this month was a good sign.

“The industry is well and truly through the worst of it,” Blackshaw says. “We have been building through profitable contracts for a while. We just need a period of calm and understanding. What we are seeing now is just a hiccup.”

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