Construction, and housing more broadly is at the epicentre of the economy. A report commissioned by the Property Council has estimated property is the country’s largest industry, worth more than $41 billion directly to the economy, equating to 15 percent of gross domestic product.
Construction does very well during the good times but under-performs during the tough times. The tentacles of the construction sector spread far and wide across the economy. Many manufacturing items flow into construction. It impacts transport and wholesaling. The construction sector is bigger in size than agriculture (excluding the manufacturing side) with many businesses directly or indirectly exposed to the construction sector. New Zealand is a proliferation of businesses linked to housing.
This procyclicality, or movement above and below the general economy reflects its sensitivity to the likes of interest rates. It is a sector that can turn quickly and has experienced numerous boom-bust cycles.
State of play
The construction sector has been on a roll, albeit amidst COVID lockdown twists and turns. Fletcher Building’s financial results highlight a business seeing solid demand.
The volume of construction activity is broadly 20 percent higher than it was five years ago. However finding staff is a key problem. Excess demand in combination with supply chain challenges has seen construction costs surge around 20 percent.
Anecdotes on the ground point to materials shortages easing of late – a good sign.
Xero’s days to pay data (a key cash flow gauge) shows little deterioration in payment terms across the economy or construction sector.
Demand for Africa
On the face of it the sector should be busy for at least another 18 months. There have been $32 billion of building consents issued in the past year, $20 billion of that for residential construction, and residential building consents issued has exceeded 50,000. The construction sector has capacity to build around 35,000 units. Enquiry levels and building consents for new houses (as distinct from townhouses) is fading quickly though.
There are many areas of structural support to the construction sector. We have huge infrastructure deficits. Major projects such as the hospital in Dunedin are massive locally. The government is spending a lot of money on housing, education, and hospitals.
There is good demand for quality buildings, ticking environmental requirements, well connected to transport and amenities, necessary to encourage staff back into the office. Out-of-favour office space will need to be refurbished and repositioned. Such pivots are welcome and will need financial support. Industrial property could benefit from outsourcing overseas shifting towards some local manufacturing production.
There are well documented structural issues in the sector. This led to the establishment of the Construction Sector Accord, designed to combat key issues including skill shortages, poor-quality builds, a lack of transparency around the scale and timing of central and local government projects, the pricing and taking of risk and a short-term cost focus.
New Zealand’s population growth has gone from 90,000 to 12,700. A 60,000-migration inflow is now a 12,400 outflow. That will hit housing demand. The population of the Auckland region has shrunk in the past year, whereas building consents and townhouse/multi-unit developments are surging.
Getting inflation down will not happen unless the construction cycle turns. It is a sector that needs to suffer for inflation to dissipate. Despite a huge pipeline of work – surging construction costs, difficulty accessing credit, and higher interest rates (capita costs) will see a higher-than-normal attrition rate on projects. The viability of projects is more difficult to stack up when costs spiral 20 percent and project pricing certainty becomes challenging.
Banks have turned off the lending tap, reducing risks at a time good business operators need support with many turning to non-bank lenders. Bank lending has become very vanilla whereas many non-banks appear to be more open to working with clients on making deals lendable.
Home borrowing has exceeded income and economic growth for the past five years whilst commercial borrowing has risen but not been on steroids, so we know where the more vulnerable parts of the market are.
What it means for me. Keep an eye on the M’s.
- Margins are the epicentre of business health. Inflation is bad for margins if costs cannot be recovered. We will see business failures due to margin compression.
- Manage debtors carefully and especially construction sector exposures. The money line for any business is the ability to meet demand – this includes staff, efficiency, managing cash flow and working capital demands.
- Focus on the microeconomics of your business. The macroeconomics of the likes of construction is not something you can influence.
- Manage relationships. Good ones endure, even during tough times.
- Make sure you keep in close contact with financial partners. They do not like surprises. Conversely, they might be able to help if opportunities present themselves, which they always do in the “under” stage of the economic cycle.
For more information about Apricity Invoice Finance or to find out how an invoice finance facility could help your business adapt to changing conditions by giving you access to the funds from your invoices as soon as they are issued visit apricityfinance.com or call 0800 277 424.