Building booms — transitioning to a normal market while keeping your shirt on

Mike Fox

EasyBuild director and Building Today columnist Mike Fox outlines some practical and effective steps that may help building companies avoid financial ruin, and enable them to maintain their original margins and a successful, sustainable business during stressful times and heavy workloads — and other strategies that will assist in the coming predicted industry downturn.

It is often naively said that builders make a fortune in the boom times.

Well, if that is the case, why are so many builders going broke when building activity is at its highest level for years, especially in the Wellington, Canterbury and Auckland regions?

The answer is not simple, but with hindsight it is clear and consistent. Builders find it easy to make sales in boom times. The problems come when they set about trying to complete their projects only to find that they are fiercely competing for sub-trades and labour that are in short supply, and will often not honour their original quotes or rates.

Add to this recent hyperinflation, rising interest rates, Credit Contracts and Consumer Finance impacts, a complete plasterboard meltdown and other material shortages.

Combine all of these and you have a perfect storm of potential business failure and abject misery for home owners.

In boom times the builder becomes the meat in the sandwich between highly-expectant home owners and often poor performing and demanding sub-trades and suppliers, who become mercenary as they pick and choose who they wish to work for.

I was talking to a contact the other day who confirmed to me that one accountancy firm they were dealing with had six of their building clients in liquidation — a very sobering and timely warning shot for the rest of the builders in the market.

So, what can be done to avoid a similar fate?

The following steps may help you avoid financial ruin, and enable you to maintain your original margins and a successful sustainable business.

• First, do your homework on clients carefully, especially if they have built with others before or are looking for yet another new builder as such.

Most clients are wonderful to work for. However, others can be a nightmare, or serial confrontational junkies. Avoid them at all costs.

Remember, you are not obliged to work for anyone, and are completely within your rights to decline a job. It could be the best call you make, so trust your instincts.

• Set your client’s expectations correctly from the beginning. In boom times, everything takes longer and tends to be more expensive.

Having a frank discussion about the reality of the market conditions and the impact of those on the build could save you from having a nasty dispute or a disgruntled client.

• Make sure you have proper contracts which clearly identify what you are providing. Do not agree to fixed price contracts.

If you fully discuss the reasons with your client, they and their banks will be more accepting. Failing that, in overheated markets it is your right to refuse this condition.

• Do not get locked into unrealistic delivery time frames or liquidated damages clauses. Let someone else get beaten up busting a gut only to get financially penalised for falling short in market conditions that are outside of your control.

• Allow a contingency over and above the normal to cover unforeseen budget overruns. Many builders are reporting cost slippage, due to increasing costs as high as $12,000 to $20,000 per house.

• Deal with reputable sub-trades and have them wherever possible fix their prices and contracts prior to your commitment to the client.

Easier said than done, but your survival may depend upon it. As the market cools there will be a much-needed change in supplier and sub-trade attitude to service and price.

• Keep your payment terms current. It is often a fatal mistake to fall for the lure of extended credit or use your suppliers and sub-trades as an unofficial and unwilling overdraft facility.

The builder who operates in this area plays a foolhardy game, let alone the naive suppliers and sub-trades who allow it to happen.

Professional builders pay their accounts current so that they can keep a watchful eye on actual cashflow, and deal with problems as they occur, not when it is too late.

• It is a mistake to let clients take possession of an unfinished project or hold a retention in their own bank account, even when faced with extenuating circumstances.

The result will be that the home will be difficult to finish around the clients, any financial retention that may have been held will be contested as goodwill diminishes, and you, as the builder, will tarnish your reputation and bank balance.

• Manage growth carefully. Many good builders have failed when expanding their business too quickly and/or spreading themselves over too wide a geographical area.

The transition from a “hands on” builder to managing staff and multiple sites in many locations requires a totally different skill set and strong systems, and large amounts of working capital are needed.

Get good accounting advice and produce monthly management accounts that highlight the fundamentals of your business.

It can be as simple as knowing your break-even monthly turnover and cash flow projections for the next three to six months. Timely information enables timely decisions about resources for your business.

• Don’t forward commit to large numbers of sections in the belief that you will on-sell before you have to pay.

There will be a number of builders now facing financial ruin as settlement date comes around. They are up for the settling with no means of doing so, with the likely scenario that the sites are now worth less than what they have to pay — a terrible place to be.

• Have a long memory. Anyone who leaves you in the lurch cannot expect favourable treatment when things tighten up. Nothing is surer that things will change and the tables will turn.

The building landscape will be significantly different come 2023. There are many younger builders and sub-trades that have not experienced a downturn. All of a sudden, they will learn that providing a fair price and service are the very ingredients of staying in business — or having nothing to do.

Reward those who stick by you with the loyalty they deserve, with ongoing work and prompt payment.

• Have a dedicated maintenance team who are efficient and reactive, and that are separate from the crews who complete the homes.

This will enable you to keep on top of your maintenance obligations, as failure to do this will severely affect your reputation and ability to get referral business.

The number one thing that annoys a client more than anything is when those small things are not taken care of after the build has been completed.

• It is better to do less work at higher margins than lots of work at low margins. The quality of your work increases, your income increases, work levels are more manageable, callbacks diminish, stress reduces, and lifestyle and family time increases.

Being the biggest builder in town will quite possibly make you the busiest but not necessary the most successful, wealthiest or happiest.

Be driven by results not your ego. Also remember that the gestation period for projects can be six to twelve months, so if your phone is not ringing now you will be quiet when your current work runs out in six months. Be proactive about your future projects.

I often remember talking to a builder who said he was stressed out with all the issues he was facing. He had grown his business from 20 homes per year to approximately 40, and was now making less money. He was ready to give it all away.

I asked him when he had had his best years, and he said at the 20-house level mark. My suggestion to him was why don’t you increase prices and see what happens?

It was like the lights went on — he could not get back to his office quick enough to make changes.

Nine months later I had a call to say his profitability had increased significantly, and the number of houses they were now building was in the 25 houses per year region.

They were turning over a similar amount of money, with less hassles and a better finished product.

The houses they were not getting to build were for clients who were very price-conscious and would only buy on price alone.

This outcome leaves you to concentrate on producing a good product for appreciative clients at sustainable margins.

So, in summary, here was a builder who solved most of his problems by reviewing his prices, reducing his workload, and focusing on clients who really wanted to build with him for his reputation.

Seems ironic — but why don’t you try it!

• This article contains the author’s opinion only, and is not necessarily the opinion of the Registered Master Builders Association, its chief executive or staff.

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