Henry Oliver asked John Tookey, AUT’s deputy head of the School of Engineering, Computer & Mathematical Science, to explain how Ebert Construction is going bust just as New Zealand’s building industry is supposed to be ramping up.
This morning, construction company Ebert Construction went into receivership, leaving workers on several major projects across the country locked out of construction sites, separated from their tools and wondering whether they’d ever be paid. John Fisk, a partner at PWC and one of three receivers, told the Herald he thought the shortfall would be “about $40m.”
Ebert’s current contracts included Auckland’s Union Green apartments, the nearly-completed Library Lane apartments at Albany, a mental health unit at Middlemore Hospital, the new Indian High Commission in Wellington, a fire station in Upper Hutt, Synlait plants in Canterbury and Pokeno, and an air-drying factory in Gore.
Earlier this year, Fletcher Building announced it had lost $660 million for the 2018 financial year. Now this. In the middle of New Zealand’s biggest construction boom in decades, how is this happening?
What’s happening out there?
John Tookey: It’s very straightforward. It’s called risk. Risk is everything. Cost is a risk, time is a risk, quality is a risk, everything is a risk. What’s happened is the business has taken on board lots of stuff out of their comfort zone. You’ll see in the media how Ebert builds Bunnings Warehouses and stuff like that. That’s fine. Then all of a sudden somebody says we’re gonna start building some housing because there’s lots of coin to be made there, right? The problem is that the trades are different. The way the structures are built are different. It’s away from their comfort zone.
Also, when you load up your company with lots of different locations, you load up your risk factors and stretch your financial ability to sustain your cash flow. So what’s happened in this instance is the various different projects have been taken on board in different locations, they’ve loaded up the risk and now they’ve become financially stressed and they can’t cover the working capital. So even though they’ve got a full order book, they can’t keep the cash flow.
We all familiar New Zealand’s insatiable need for housing. We’re hearing about how much money is being made on property. And then Ebert isn’t the first construction company to go down recently. Why is it so hard for these companies in the middle of a construction boom?
The cost of construction is high and it will remain high because the skillsets are limited. The amount of investment in new technology in the building industry is very small. As a result, the cost of production has never made a significant downward trip. Productivity in the building industry has flatlined for many many years because the process of construction has not been automated in any meaningful sense.
In contrast, the cost of constructing a car is the cheapest it’s ever been in history. Because the technology of production has forced down unit costs very very low, which has been passed on to the consumer. That’s what happens when you’ve got mass-production, mass-construction, mass-manufacturing. Unit prices go down.
The receiver has said that it’s due to “poorly performing projects”. What does that mean?
They’ve committed to build at a certain price. Let’s say they’re building a block of flats.
Well, Ebert is building Union Green in Auckland.
They say, we’re going to build these flats at this cost per square metre and they’re going to be sold at this price. The total project is, say, three years in duration and in that time, the cost of fit-out contractors – the people who set the kitchens, the people who do the gib stopping and the timber framing, all of the processes – go up for labour. And they can’t raise their prices. And to get everything builds, the builder has to commit to the new prices subcontractors are charging. So, all of a sudden they’re getting squeezed on both ends. So the margins are gone.
But that’s not new, right? Is the market too competitive? Are they under-bidding?
They’ve committed themselves to one business model at one end of the spectrum and as they’ve made their initial assumptions at initial tender prices, things have changed. So when you are making assumptions about how things are going to do in two or three years, all you have to be out is one or two percent, and all of a sudden your margins disappear.
Kiwibuild is coming. In Auckland, there are unbuilt apartments for sale all over the city. Who’s going to build them?
Very good question! The thing is, the government is blissfully waltzing along making promises with regard to Kiwibuild, but the industry is capacity constrained. The government doesn’t build things, private industry builds things. And the private industry we have is very stretched. So when the government sits there and says they’ll build 100,00 new homes, that’s great. But last year we built just under 7,000 homes. The government want to increase the production of new homes by 10,000 a year. So we’re going to have to more than double the size of the building industry. Is that likely? How does industry cope with increased demand? It has to have big orders in place and it has to have promissory cash flows. You see what happens when people start making commitments to build things over an extended period of time in a dynamic environment when prices go up? You end up running out of money.
At the moment, the government isn’t committing to build. Where are the big orders? A 5,000 home order to a contractor for example. So how does a contractor invest, bearing in mind there’s no announcement of who’s going to be building these things?
This is where we sit.
So what’s the solution?
There’s no easy solution. You need a multifaceted solution. you need to invest in additional capacity by announcing large contracts with finite completion dates and fixed costs. So you pick your winners first. Then you invest extensively in training schemes for skills development because we’re skills constrained. And you do it all as soon as possible. And by the way, to build ourselves out of this situation it’s going to take five to ten years.
The problem with the lag-effect of what we’re doing is we’re sitting around making policies and hoping that the market fixes itself on the basis of the policies that we’re creating. We’re basically saying, ‘look at the opportunity over there if you invest this money’ and then we’re terrified because companies don’t invest until they’ve got contracts signed and deadlines fixed. But it’s really hard to justify investment ahead of a contract.
Margins are super tight and risk is anathema to companies. Everybody wants to give the contractor the risk and the contractor carrying an enormous amount of risk only needs one or two projects to go sideways and all of a sudden it puts the rest of the portfolio in problems. Look at what happened to Fletchers – they did exactly the same thing.
Winning business is easy, you just bid very low and you win the business. Making it pay is hard. That paradox is something the building industry is in extreme stress over right now. It’s easy to get business, it’s very hard to ensure it’s going to happen, particularly when all of your trades haven’t got very sharp pencils because they’ve got more business than they know what to do with. They’re capacity constrained. All of the supply chains, all of the materials, all of the engineering companies – they’re capacity constrained. The demand is very very high so people don’t have to try too hard to get jobs. Try getting a simple renovation project done with a local builder, it’s incredibly difficult because everybody’s busy.
If your strategy is to gain business, it’s easy – you reduce your tender price. But by reducing your tender price, you increase your risk profile. That process of winning business means that whoever ends up building your project doesn’t have a sharp pencil because down their chain, their subcontractors and their subcontractors’ subcontractors and their subcontractors’ subcontractors’ subcontractors, they’re all super busy too. All of a sudden you a have scenario where you’re tendered based on subcontracts. But if your subcontractors pull out of the contract you’ve got to go and tender again in a tight market.
What does it mean for the locked-out workers?
Unless they’ve got their tools with them they’re going to be struggling to get their tools back. Any of the creditors are only likely to receive cents on the dollars they’re owed. And very often they’ll find that their retentions are forfeited. So there’s going to be a whole bunch of legal strife and it would not be surprising to see some collateral damage of companies going into liquidation – subcontractors who are owed substantial money from Ebert.
If workers get locked out of the site they won’t be allowed on site to get their tools because in the past subcontractors have damaged a work in progress. And sometimes if they don’t feel like they’re going to get their full dollar value back, they’ll steal stuff in order to make good.
Is that common?
Put it this way: it happens. They’ll get their stuff back but it’s a long winded exercise.
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