But they can still thrive even when work dries up.
In this opinion piece Westpac Economist Paul Clark warns a downturn in the building industry is on the horizon and offers six ways builders can get through it.
The construction sector has been running hot for the past two years, with activity levels and consents at record highs. That, however, is unlikely to last.
Operating and borrowing costs have risen, while sale prices for existing homes have tumbled across the country. With prospective buyers of new builds becoming increasingly nervous, and property developers more cautious about bringing new projects to market, Westpac is predicting a drop in building work of around 15 per cent by 2025.
In boom times, builders are often so busy working in their business that they don’t spend any time working on their businesses. They often get away with it when work is plentiful, but once the investment cycle turns and demand dries up, they’re scrambling to survive.
And the investment cycle always turns: residential building activity is notoriously cyclical, massively overshooting when the economy is on the up and undershooting when things turn sour. Since the early 1990s, there have been five big upturns and four downturns, so to survive in this industry builders need to be prepared for both.
With another downturn on the horizon, what can Kiwi building companies do right now to help them survive and thrive in the years ahead? Following are six ways we think can help them ride out the tough times:
Protect margins
To achieve better profitability and cashflow it’s vital to understand costs and revenues. Builders should know exactly what their outgoings and incomings are and monitor them closely.
In any downturn, it’s critical to preserve profit margins. That sometimes means making tough decisions when it comes to cost-cutting. Laying off staff in leaner times is common in the industry, and builders might also consider:
• selling underutilised equipment
• plugging profit leaks (such as underquoting on jobs)
• shutting down poorly performing lines of business
• looking for quick efficiency gains, like using inexpensive tablets for onsite management
To boost revenue, ideally builders should focus on the jobs with the largest profit margins, and insulate themselves against the rising cost of building materials by embracing the move to variable price contracts, rather than fixed pricing.
Diversify
Some projects are less affected by an economic downturn. Think about renovations, government or council work, or retirement village projects. Can a business diversify into downturn resistant projects or go after some of the abundant work that’s on offer from agencies like Kainga Ora?
Builders might also think about offering complementary services such as, for example, plumbing and drainage services to support construction project clients.
Keep the cash flowing
Lack of cash is perhaps the number one reason why New Zealand construction firms fail. Anecdotally, we’ve been told that 50 per cent of builders with five employees or fewer face ongoing cashflow difficulties at any point in time – and it hits the big players, too.
Keep a very close eye on cashflow and maintain a solid cash fund to always meet outgoings.
Change thinking to weed out inefficiencies
Inefficiency is baked into the construction sector – we have weak productivity growth and too much waste. Projects regularly run over time and over budget. To tackle inefficiency within a building firm, it might be best to let go of ‘that’s the way we’ve always done it’ and move to new systems.
Here are a few examples of inefficiencies that may need weeding out:
• adversarial project relationships and poor coordination on a project.
• poor communication, leading to misunderstandings and unrealistic customer expectations on timeframes, budgets, and finished designs.
• short supply on materials and labour.
Upskill on digital technology
It’s not necessary to spend a fortune on digital technology yet, but there is a need to know what’s coming and how it works. Although home-building in Aotearoa is a low-tech sector that lags behind in innovation and adoption, some companies are using digital technologies.
Plan for constant change
Some businesses thrive in a downturn. The leaders of these firms actively plan and allow for constant change. They go beyond just managing for survival and instead take fast, bold, and strategic action to ensure their prosperity.
They respond quickly to changes in their operating environment. They target projects that leverage off their core strengths and deliver maximum profitability. They have a sharpened focus on cutting costs and paying down debt, while making sure they have ongoing access to credit. They work toward long-term success, setting a deliberate course toward value creation, higher performance, and sustainable growth.
By setting up firms to thrive by being financially fit, structurally prepared, and focusing on its strengths will enable them to not only ride out the downturn, but stand ready to maximise gains when the market rebounds.
This article contains general commentary, and market colour. The article does not constitute investment advice. We recommend that you seek your own independent legal or financial advice before proceeding with any investment decision. This article has been prepared without taking account of your objectives, financial situation or needs. The report on which this article is based, as well as a full disclaimer, can be found here: Research-Papers_Residential-building_bulletin_03Feb23.pdf (westpac.co.nz)