Drive or dive: Assessing the risks for developers and how those risks are managed

Construction projects don’t always go as planned and sometimes projects may fall behind or incur additional unforeseen costs. The construction industry has been through a particularly challenging period since the COVID pandemic began, with supply chain issues, state-enforced shutdowns, high material costs, labour shortages and weather events are some of the factors having the biggest impact on the sector.

In this article, we explore the biggest risks facing the sector in more detail and outline some of the mitigation strategies lenders should have in place to minimise, monitor and manage borrower default risk.

Key challenges facing builders

Builders have been doing it tough over the past couple of years. One of the biggest challenges for builders has been sourcing enough materials at affordable prices, as rising material costs have been compounded by supply chain issues. Strains on logistics and delays in delivery caused a bottleneck in 2020 and 2021 during the height of the pandemic and the industry continues to be affected.

The surge in building material costs has been reflected in the Australian Bureau of Statistics’ (ABS) recently released Producer Price Indices, which showed a 5% jump in the cost of concrete, cement, and sand in the December quarter. There were even bigger surges in the cost of cupboards and built-in furniture as plywood and glass prices climbed. The report showed that overall, prices increased by 2.2% in the December quarter. This brings the annual rise in residential building material costs to more than 14 per cent, a significant annual increase. However, the 2.2% rise over the quarter was lower than previous quarterly price increases, which could indicate the trend is slowing, and is a positive sign.

Price increases for house construction inputs

The increasing costs associated with the Australian property market have presented builders with cash flow challenges because many are locked into fixed-price contracts with clients. In the rapidly inflationary environment, builders are finding it particularly difficult to ensure profit is maintained.

Additionally, labour shortages and border closures in the property market, exacerbated by the pandemic, have resulted in a struggle to source adequate labour at affordable rates. This in turn has resulted in unfinished builds or significantly delayed builds, hurting profit margins. Although a labour shortage remains, CoreLogic points out that the property market outlook is optimistic, with the opening of borders and the arrival of skilled workers expected to eventually flow through to the construction industry.

Key challenges facing developers

In the current market, external risks and challenges are making it more difficult for property developers to achieve their expected return on investment. The pandemic presented a tough and unpredictable period for developers. With rising interest rates, volatile asset valuations and fears of housing market corrections, developers are now facing increasing cash flow challenges. In some instances, completed products are not being sold or have suffered from price deterioration, while in other instances, developers are facing the prospect of projects not being completed by the builder due to the issues outlined above.

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This article is issued by Trilogy Funds Management Limited ABN 59 080 383 679 AFSL 261425 (Trilogy Funds) as responsible entity for the Trilogy Monthly Income Trust ARSN 121 846 722.Trilogy Funds is not a licensed credit provider and does not make loans regulated by the National Credit Code. The source of Trilogy Funds’ loans may include managed investments schemes registered with ASIC, as well as other private lending arrangements with high net worth investors. Application for investment can only be made on the application form accompanying the Product Disclosure Statement (PDS) dated 30 September 2022 and by considering the Target Market Determination (TMD) dated 30 September 2022 for the Trilogy Monthly Income Trust ARSN 121 846 722 available at www.trilogyfunds.com.au. The PDS and the TMD contain full details of the terms and conditions of investment and should be read in full, particularly the risk section, prior to lodging any application or making a further investment. All investments, including those with Trilogy Funds, involve risk which can lead to no or lower than expected returns, or a loss of part or all of your capital. Trilogy Funds is licensed to provide only general financial product advice about its products and therefore recommends you seek personal advice on the suitability of this investment to your objectives, financial situation and needs from a licensed financial adviser. Investments with Trilogy Funds are not bank deposits and are not government guaranteed. Past performance is not a reliable indicator of future performance.