Local government grappling with construction sector challenges

Local government grappling with construction sector challenges

New Zealand’s volatile construction industry is causing headaches for councils and government departments around the country with the recent failures of the likes of Arrow International and Ebert Construction, and Fletcher Building's well publicised woes, making headlines.

And Auckland Council chief economist David Norman says recent reports of similar problems in the Wellington construction industry are merely a reflection of demand side pressures in the industry.

“It’s the same in Auckland,” Norman says. “People look at the construction sector and see that it has been booming and say ‘how could a company go bust?’. But in any form of vertical construction where you see these huge increases in demand it becomes hard for businesses to accurately price their contracts.”

Norman says in the construction industry contracts can sometimes be agreed on years in advance, but they may not take into account inflationary pressures in the industry.

“We’re also seeing a lot of cash flow issues as well, so it has been a big challenge.”

Capital's construction problems 

Last month the Wellington City Council had to sign off extra funding for the seismic strengthening and upgrade of the Wellington Town Hall in the face of rising costs.

A council report on the project claims New Zealand’s volatile construction industry is partly to blame. It says tight margins and rapidly rising costs have led to a number of well publicised construction industry failures in recent times. It states:

“The receivership of Mainzeal, Eberts, Orange H and withdrawal from the vertical market by Fletcher Construction has resulted in remaining main contractors and subcontractors not being prepared to accept risk that they cannot quantify.

“As a result of the volume of work across New Zealand, main contractors and subtrades are experiencing labour shortages. Sub-trades are selective and a lack of competitive pricing tension drives up cost.”

Norman says the Wellington City Council report’s findings are a good summary of the problems the industry is facing, even if it has traditionally been the Auckland and Canterbury regions that have had to deal with such issues.

More sector problems on the horizon

After the recent voluntary administration of Arrow International, economist Cameron Bagrie stated that more building and construction firms were destined to fail. 

"You are going to see more failures within that sector, we haven't seen the last of it. What you have at the moment is a nasty combination where the sector is basically maxed out capacity wise, access to credit is becoming an issue because the banks are looking at everything closer, and costs keep moving up," Bagrie said.

Auckland Council director of infrastructure and environmental services Barry Potter says while the council still uses fixed priced contracts, there are other options. He refers to the contracting model being used to build the infrastructure for the America’s Cup in 2021.

Potter says the Auckland Council and its development arm Panuku have contracted Downer, McConnell Dowell, Beca and Tonkin and Taylor to do the work needed, from the initial design and architecture through to the construction.

“Under that arrangement we’re working collaboratively and the risks are shared by the whole group and all the players are working on a pain share, gain share basis. And there are incentives to meet the KPIs (Key Performance Indicators),” he says. “We went into it with this sort of arrangement because the timeframes are very tight to deliver it on time.”

He says the Auckland Council and CRL Limited are looking at using a similar type of contracting model for the next stage of the City Rail Link (CRL) project.

But the project hasn’t been without controversy. Rumours in the last couple of months suggest the revised estimates for the project had increased by $500 million and that there were now concerns the cost overrun could top $1 billion. Auckland Council, CRL Limited and Transport Minister Phil Twyford have all refused to confirm or deny the reports. 

While in November it was announced that RCR Infrastructure (NZ), which was in a joint venture with WSP Opus, was still completing the $7.5 million contract to design the railway when it went into voluntary administration. The company is the New Zealand subsidiary of Australian company RCR Tomlinson which went into liquidation in 2018.

Need for overseas input

But Potter says major public infrastructure projects often require overseas expertise.

He says when the council needs to carry out civil construction work there is a number of local companies that are capable of doing the work.

“But when you get very large projects you are playing on an international market and you want international players to be part of your team. So you have to make sure your project is attractive to them.”

He says they often bring expertise and experience needed.

“What you might think is a big project in New Zealand terms, in an Australasian context isn’t. But it’s important that these big projects are attractive to big players.”

But whether it’s fixed price contracting, or different types of agreements, things are changing in the construction world and if Bagrie’s comments are anything to go by Arrow International certainly won’t be the last big player in the market to go bust.

Last month Arrow International announced it had gone into voluntary administration after a court decision over a leaky building left it insolvent.

The company was involved in a number of major construction projects in Auckland, including a $28 million, 18-level apartment project in Airedale Street which was due to be completed next month. It was also working on a $40 million, 21-level student accommodation block on a site in Beach Road bordering Anzac Avenue. The project was due to be completed in mid-2019. In a statement released last month to announce the company was going into voluntary administration Arrow International referred to the turmoil in the industry.

“In recent times the construction industry has become challenging and there is a disproportionate level of risk carried by contractors. We have managed through tough trading conditions which have stressed the entire sector but this unexpected result has affected solvency to the point that we could not sustain trading as we have been.”

We welcome your help to improve our coverage of this issue. Any examples or experiences to relate? Any links to other news, data or research to shed more light on this? Any insight or views on what might happen next or what should happen next? Any errors to correct?

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I happen to know David Norman , and he is an astute, hard-working and very likeable fellow , but he needs to send some home truths to his bosses, who seem to reside on some other planet .

Like the costs of a resource consent for a tiny 65m2 minor dwelling where council fees are between $70,000 and $90,000 which is almost MORE THAN THE COST OF THE BUILDING ITSELF , thus practically doubling the cost .

I hate to think what hoops developers have to go through to get a highrise apartment block consented

An additional water connection costing $20,000 for the 65m2 minor dwelling ( when the existing house has one already

A total lack of commercial urgency in processing applications by Council who seem to think money grows on trees , and delays that cost a fortune in holding costs for developers ............ and it should be noted that holding costs dont only include interim interest , but also affect the viability of projects as wage rates and building material inflation eats into any projected gross profit margin .

Frankly , the system is broken , and we need to re-visit the way we do things

Those costs don't sound credible. DCs should be 20-30K max, especially as council has 'discounts' on smaller dwellings.
Could you please expand on what those costs ($70K - $90K) are made up of.

Fritz whilst those costs do seem high, remember that a lot of stuff has to be done to get resource consent.

Some plans (often quite detailed nowadays), geotech reports and a host of other reports (acoustic etc.)

Then planner's time, resource consent fees. I can see $50k easy.

He said 'council fees'.
I'm not the biggest supporter of Auckland Council, but 'fair dinkum' as the Aussies say...
I'd like to hear from Boatman as to what those 70-90K of 'council fees' are made up of.
It's one thing to be critical of council, it's another to come up with nonsense.
So, Boatman, please tell us why that is not nonsense.

Boatman if you are out there I am keen to hear your breakdown of the 70-90k council fees

Ok, I’m assuming your claims are nonsense.
Credibility downgrade.

Nz is having a big gap in construction capacity and capability and should seriously consider outsourcing many projects to China.

Haha :)

If NZ outsources to China, China will one day own NZ...

Can we interview someone who's not 'an economist'?

Because pretty much none of them understand the problem.

LOL ;)

Disagree. Economists understand the problems better than the overwhelming majority of other people.

The real issue is that the overwhelming majority of people don't understand economists. It's a well known fault of all branches of science/research. Those who know the most find it difficult to, or are completely unwilling to, explain things in simple terms which many objectors can reconcile.

I'm not sure about that.

University economics teaching isn't an education: it's a £9,000 lobotomy
https://www.theguardian.com/commentisfree/2014/may/09/university-economi...

Your justification is on the basis of a Guardian op-ed.
I think this just re-iterates my point.

OK will the Financial Times do?

Crash and learn: should we change the way we teach economics?

A growing student rebellion is challenging the decades-old academic consensus

https://www.ft.com/content/0dc9b416-8573-11e6-8897-2359a58ac7a5

That's fine if they want to challenge it. Economic thought should be 100% democratized.

But they have to understand it first. In which case your 9k lobotomy is required.
There is no point is protesting something you don't understand. Which is almost 100% of the time with those bemoaning economists.

In this case the economist has no idea what he is talking about. Fletchers is the only one that had massive cost overruns (about $450m just for the Convention Centre). The rest have been hit with civil claims that exceed the capital in the company, that's nothing to do with pricing contracts.

Read Balls-elevation

They don't make it very easy for us mere mortals. In a recent publication on this website David Norman wrote several paragraphs about the importance of compactness and tying urban growth into existing structures. Then someone pointed out that the paragraphs written by David Norman were completely irrelevant to what David Norman was writing about.

I think that someone pointed out that the paragraphs you wrote were completely missing the point of what DN was writing about.

How long have you been working at the council k_s?

David Norman is not some kind of Crystal ball economist , he is up to speed on all issues of fact affecting the economics of our city.

He is certainly not prone to making wild or frivolous observations or predictions.

Not that long ago I invited David Chaston to a presentation by David Norman at the professional body to which I am affiliated . David Chaston had not previously met Norman.

The gist of the presentation was the issue of Housing and property in general in Auckland , although other relevant topics were covered.

Norman was frank and open about the city's problems.Norman looks at the facts, analyzes hard statistics , and then probes them when they don't make immediate sense , he then outlines them succinctly and was happy to field questions the issues and the findings of his research .

He is one of those rare breeds of economists who is able to articulate his views, supported by empirical evidence.

We should be thankful to have someone like him working for the City.

As to the issue of mis-pricing of contracts , there is sufficient evidence to support the view that pricing models are not working , smaller contractors are going to the wall with alarming regularity, and larger contractors also dont seem to have accurate costing models available to them .

That aside , we also have a dire shortage of truly competent, experienced Quantity Surveyors who know and understand the dynamics of the NZ construction sector as it is at present .

If he doesn't know about energy and entropy, then he will be of increasingly little use.

http://energyskeptic.com/2016/lambert-hall-energy-eroi-and-quality-of-life/

That paper (and some treatise on entropy) should be mandatory learning for economics students. As should be a study of our current point on the trajectory. Local Government is all about using fossil energy, as is 'private development'. Both are running into a lowering physics lid. Neither understand that this is happening.

...And teach them what from that paper?
The importance of the understanding of the difference between correlation and causation?

Yes - and underwriting and triage

What do you mean by underwriting and triage?

I'm pretty sure undergrad students learn about resource scarcity and intertemporal optimisation.

I have the feeling that this all isn't going to end very well. When your inputs are too expensive and your systems are unresponsive, you have a problem my friend.

Both land costs and construction costs are simply too high. Given that, it becomes very hard to deliver housing to the market at a price point people can afford.
Both need to fall at least 20% for things to start stacking up.
Will they? Not sure of that.

If house prices fell 20%, you would run into a whole other stack of problems completely unrelated to the ability to provide what the customer can afford.

And they were significantly cheaper before massive outflows of money from China drove them up in the last few years. Question will be whether those costs can be sustained now that China has been clamping down even harder on capital outflows via the shadow banking sector (see the effect that limits on the regular sector have had since 2016).