Cost increases and labour shortages threaten growth opportunities in construction boom
2021 saw a growing mismatch between demand and supply pressures in the sector. Government stimulus, increased household savings and low interest rates fuelled strong residential demand, whilst record levels of government infrastructure investment added more major projects to the pipeline.
In the face of this increased demand, contractors are being confronted with a shortage of skilled labour resulting in unforeseen delays and supply side pressures that are driving up the cost of raw materials. The combined effect saw house construction costs hit record highs in December 2021, having risen 12% in the previous 12 months (Source: ABS). Several mid-tier residential contractors fell into insolvency last year, with most citing supply chain delays and inability to pass on costs due to fixed price contracts as the key reasons for failure.
Our overarching view is that risk management and the credit quality of your counterparties has never been more important. As we look to 2022, we anticipate continued volatility as well as various opportunities in different subsets of the market:
Commercial: Demand will remain subdued across sub-sectors including retail and office, albeit continued strong demand in industrial.
Infrastructure: Growth-hungry contractors may easily overcommit resources with insufficient capital and/or resources to deliver on awarded projects. Risk management will be key. On the client side, understanding the credit quality of the engaged contractor will be critical.
Residential: Economists are predicting interest rate rises and a possible reduction in house prices which will change the dynamics of the market. The recent trend of rising construction costs being absorbed through increased valuations will shift, as supply-side cost pressures continue but valuations flatline.
Against this backdrop of volatility, contractors can increase their resilience by:
- focusing on profitability and not top line growth;
- tighter working capital management; and
- assessing counterparties – at all stages in the value chain, contractors must ensure their business is partnering with customers, financiers and subcontractors who are stable, resilient, and can stand behind the commercial aspects of the project they are financially responsible for.