Inflation will financially destroy many debt-heavy developers and builders
Australia’s developers and home builders, especially those substantially in debt, should be keeping a careful watch on inflation both here and overseas. Building costs are rising faster than inflation and already a growing number of business failures in this sector in Australia have condemned projects worth hundreds of millions of dollars to uncertain futures.
The latest Credit Watch’s Business Risk Report reveals the construction industry’s arrears at 12.41% is the highest of any in Australia, there has already been a 38% increase in insolvencies in the sector compared to last year, and the number of court actions involving construction companies in the last quarter of last year was 58% higher than at the same time in 2020.
Towards the end of last year Australia’s annual inflation rate was running at 3%, the first time in seven years it’s been at a level of concern for the Reserve Bank of Australia (RBA) – which nonetheless this month, at its first meeting for 2022, decided to leave the cash rate at the record low of 0.1% where it’s been since November.
There hasn’t been a rate increase since 2010, but there now seems likely to be one much sooner than RBA governor Philip Lowe has been suggesting there would be. For months he’s been saying it was unlikely to be any rate increases until next year, and possibly not until 2024.
However, Macks Advisory understands AMP Capital chief economist Shane Oliver has told The Urban Developer he expects there’ll be cash rate increases in two tranches between August and September this year of up to 0.5% and that “within a year or two we could be back to interest rates we saw prior to the pandemic, and if inflation remains a problem, we could see even higher interest rates.”
Some economists are predicting there could be a rate increase as soon as next month.
Meanwhile the RBA has stopped printing money and decided its bond buying program should shut down on 10 February. Clearly it is under pressure to tighten lending conditions as the Federal Government’s gross debt is expected to hit $1 trillion before then the end of the next financial year -- which would push the interest rate on such a debt to more than $18b a year.
Backgrounding the current situation
The pandemic has reversed an earlier trend towards lower inflation and lower interest rates. It has supercharged a demand for goods while at the same time constraining supply, a situation exacerbated by global supply chain issues.
Primarily because of aggressive government economic stimulus, home values surged 22% nationally last year, and economists are forecasting house prices will rise about another 6% this year – mainly in the first six months.
This is in line with predictions by the big four banks, but there’s widespread consensus a marginal increase in interest rates won’t precipitate an overnight crash in property prices. Rather it’s expected they will decline gradually.
Meanwhile, we believe developers highly geared during the pandemic, should keep sharp eyes not only on domestic inflationary trends but also expected international rate hikes, particularly in
countries like Canada and the UK that are major suppliers to Australia’s builders. It’s reported the US money market has already priced four rate increases into its trading for this year.
Thus, undoubtedly consumer prices will be raised here and will erode builders’ margins – a worsening scenario as tightening finance reduces demand and decreases the astounding number of new building projects and renovations recently fuelled by close to interest-free borrowing.
Backgrounding the immediate future
The extent to which international borders can be opened for immigration of foreign workers will be crucial to Australia’s economy this year.
For instance, migrants would underpin demand for housing and prevent a too-serious decline that would significantly worsen things for builders – although the dynamics of this scenario could be complicated by faster-than-expected development costs, higher interest rates and an unforeseen volatility in the property market.
But irrespective of that, Macks Advisory senses there is heightening community expectation that something positive needs to be done about the nation’s slowest rate of population growth in 100 years.
Economists are saying they expect plane loads of international students and skilled migrants landing in Australia to so push down pressure on wage costs and inflation, that accordingly the RBA may well be able to resist rate rises until next year and possibly 2024.
Knowing that obvious price increases and cost-of-living issues will be election issues, Treasurer Josh Frydenberg has told the media he hopes voters will look at these matters in perspective, that they will appreciate Australia’s economy is strong, remarkably resilient, subject to lower inflation growth than in Germany, Canada, and the UK, and only half America’s rate of inflation.
Builders overtaken by events
Many developers and builders are in financial trouble through no fault of their own. They cannot have been expected to foresee a pandemic that would result in supply chain delays that have slowed the pace of home building by 30%. They had no way of knowing that global supply chain disruption would increase the cost of home building supplies by an average of 8% in the nation’s capital cities.
Deloitte Access Economics director Chris Richardson says a wicked combination of global inflationary pressure, labour supply gaps caused by state border closures, delays in global supply chains and pandemic lockdowns in key manufacturing hubs, has created situations where businesses, even in a strong sector like the building industry, “will go bust – and these are usually businesses that operate fixed price contracts on low margins”.
Many current building contracts had committed to prices before work started, which means many projects now under way, because of rising prices, are doomed to make a loss.
When this article was being written Macks Advisory was aware of 85 building companies across Australia that had in recent months gone either into administration or liquidation. More than a quarter of all insolvencies nationally are occurring in the construction sector’
ABD Group had stopped work on a $140m project to build 300 units in Spotswood, Victoria, as well as a 25-level residential tower in Footscray, and a subsidiary had suspended work on as 53-unit project at Kew – and these are only examples of comparable, or even larger projects left in limbo in NSW and Queensland.
And we’re sure readers don’t need reminding of the adage that “what happens with accommodation prices and with real estate generally in the most populous states, inevitably happens, to a proportional extent, in SA” – which is a bit of a worry given that at least 10 and probably more buildings of more than 20 levels are under construction, have been approved for construction, or have been given planning approval in Adelaide’s CBD.
