Construction companies go under…

… in a construction boom.

Insolvency expert, journalist and fireworks enthusiast, Damien Grant

It is a reasonable question that I have asked myself many times. We are in the middle of a construction boom, the likes of which we have probably never seen before (not since the 1930s anyway, which was a contrived building boom to drag us out of the Great Depression). So why are we seeing so many construction companies go into liquidation? Something has to be wrong here. Poor management is the reason most companies go into liquidation. Surely, in the middle of a construction boom, any construction company can make money. Can’t it?

It appears not. Damien Grant discusses the issue at NBR : quote.

In the past year we?ve seen Ebert, Corbel, Accent, Matrix Homes all fail, and these are just the failures that I?ve had some involvement with. Fletcher Building lost half a billion dollars and a host of smaller builders went under.

This boom in demand for hammer hands, plumbers and electricians does not result in new tradespeople appearing. A few wrinkled chippies may have been coached back on to the tools and some guest workers made their way to construction sites but the net effect of a surge in demand with constrained supply is an increase in cost.

According to Stats NZ, the cost of building a new house in Auckland has risen 37% in the past five years and this has caused the construction failures we?ve been witnessing.

An artificially low interest rate sent a false signal to the market and resulted in an oversupply of investment. This is now resulting in the inevitable liquidation of unsustainable positions. It is standard Austrian economic business cycle theory that predicts that, when the state controls the money supply, it will artificially lower interest rates for political gain. This will result in a false signal to the market, resulting in mal-investment as too many firms seek to use the cheap money to expand. Ultimately, the expansion leads to failure as there isn?t the underlying demand to meet the expanded supply.

Construction is useful because it is the most responsive to interest rates and the most sensitive to market pressures. We are living in an economy fuelled by cheap money.

Firms are expanding thanks to low interest rates in order to meet the consumer demand driven by households going into more debt than they would have if interest rates were rational.

Over the past decade household debt has continued to rise even as the cost of servicing this debt has fallen. At present households still retain a large capacity to borrow. Servicing costs are well below where they were in 2008 so there isn?t any reason to think we are about to fall off an economic cliff.

But the malaise in our building sector is a sign of an economy under increasing strain.

NBR End quote.

Working as an accountant in the private sector, I have always found that whenever the economy was starting to go into a decline, it was always the construction sector that was affected first. I never really knew why that was, unless construction was the area where, due to the amount of money involved, people would put off their decisions; but I had never thought of it as an issue regarding interest rates. Now it makes sense. When money is cheap businesses can borrow more, and construction companies need to borrow a lot more to fund material costs and possibly increased labour costs. The issue I have with Damien Grant’s theory here, however, is that the Reserve Bank is talking about reducing interest rates in 2019, and to date, interest rates have not increased, so that they cannot be blamed for business failures. Also, the demand for construction is high. Or is it? Have we reached saturation point already, with literally thousands more houses already under construction?

Being directly involved with company liquidations, Damien Grant would understand the issues here far better than I. One thing is clear though. The economy is showing signs of strain. Prepare yourselves for a harder year ahead.