Danny is a co-founder and director of Debuilt Property and has a professional career spanning architecture, construction, project management, development and property finance. Debuilt provides a wide range of consulting services to investors, financiers and developers.
The collapse of Probuild Constructions took many in the property and business community by surprise. In the short time since Probuild appointed administrators much has been written about a ‘broken system’ and the disproportion passing of risk onto builders and ultimately sub-contractors.
The property and development industry is built (pardon the pun) on high leverage and low margin. Developers chase lowest cost (required to make the project stack up) and lenders require fixed (or maximum) price contracts. Builders competitively tender projects on extremely tight margins to win the work and then corral a team of independent businesses (subcontractors) onto a foreign location (building site) to conform to a bespoke design (reams of documentation), an intricate (tight) program; all whilst maintaining a lid on costs.
Our work for financiers and investors focuses on construction due diligence and project monitoring. It is not uncommon to see projects where the developer’s desire (or need) to squeeze price results in the appointment of a builder without the desired management systems, site team and quality assurance processes. The risks are exacerbated when a developer, after signing up the builder, pays insufficient attention to detailed monitoring, scrutinizing quality systems and subcontractor payments - and linking quality to quantum.
What is unnerving about the failure of Probuild, is that this was a quality Tier 1 builder that would have easily satisfied most developers and financiers. Whilst a credit assessment may have raised concerns, it would have been a tough decision not to appoint Probuild due to a fear that it could not complete.
The following article by James Thomson from the AFR provides valuable reading on this topic.
The collapse of builder Probuild shows how a broken system of contracting has built up in Australia, where too much risk is taken on for too little return.
If you want to understand the collapse of construction giant Probuild, just follow the money.
As Johannesburg-listed parent company, Wilson Bayly Holmes-Ovcon said in its statement announcing it had put Probuild and a group of related companies into administration, raising financial guarantees from lenders to secure new work has become increasingly difficult in recent times.
The construction sector’s system of risk allocation is badly broken. David Rowe
Peter Jeeves, national manager of construction at Lockton, the world’s largest privately-owned insurance brokerage, also says insurers have been pulling back from the construction sector for some time.
“We’ve seen the insurance market appetite and capacity for construction professional indemnity shrink significantly in the last three or four years leading to reduced competition, significantly higher premiums and restrictions in coverage,” he says.
And why has the construction industry’s financial plumbing clogged up? Because this is a sector with too much risk and not nearly enough reward.
Clearly Probuild has been caught in something of a perfect storm caused by the pandemic. As Australian Constructors Association chief executive Jon Davies explains, many of its current projects would be being built under fixed-price contracts signed well before the supply chain disruptions and explosion in labour costs caused by the pandemic.
“We’ve seen significant price escalation in the market and there’s no opportunity to recover that,” Davies says.
‘The system is broken’
Moreover, many contracts will require construction companies to pay liquidated damages if they can’t recover time lost to COVID-19-related delays.
But the problem here is much deeper than a pandemic profitability squeeze, according to Nicola Grayson, CEO of engineering industry lobby group Consult Australia. “The system is broken,” she says.
Whether it is in infrastructure or commercial building, Australia has fallen into a vicious cycle where project owners look to push all the risk in a project onto construction companies, typically through fixed price contracts. The construction firms, facing stiff competition, take on these contracts on extraordinarily slim margins. For example, Lendlease’s target EBITDA margin for its construction division in 2022 is between 2 per cent and 3 per cent.
This margin seems crazy when you consider the risk and complexity involved in a big project. But it’s even crazier when you consider the nature of these take-it-or-leave it contracts that give construction companies few avenues to recoup margin – except, as Grayson points out, by pushing the risk down the line onto project participants such as the engineering firms, which then find themselves taking on outsized risks.
Remarkably, there’s near universal agreement on the solutions: vastly improving scoping of projects, so risks can be properly assessed and priced; a recognition that project owners must share some risks; and a more collaborative approach from all parties.
Davies says it is starting to happen, with governments becoming more cognisant of the need to set contracts up with better risk sharing. He agrees with Grayson that model clients are also needed in the private sector; governments can play a role there too, through their involvement in public private partnerships.
But the construction sector also needs to recognise that the merry-go-round needs to stop.
“We need to shift our mindset away from ‘we’ll fix this problem because we’ll just get that next job that will either tide us over or give us the extra profitability we need’,” Davies says. “We’ve been doing that for too long, which is why the pressure has been building and building.”
Deloitte, which got Virgin flying again in 2020, is now in control of Probuild and intends to keep building sites open while it runs a rigorous and rapid sale process.
Grayson hopes Probuild’s collapse might see the small number of construction firms that have become more selective about taking on uneconomic problems grow. But she doubts the pain is over.
“This has been coming for some time. And, unfortunately, we’re going to see this again, unless some action is taken to balance out the risk allocation,” she says.
This article by James Thomson first appeared in the Australian Financial Review on 25 Feb 2022.