Over the last few weeks and months we’ve had a lot of people reach out to us because they’re concerned about builders going bankrupt, and how their investments might be affected by current market conditions.
To address these concerns, in this article we’ll explain:
- What Lion Property Group’s relationship to the building industry is;
- Why builders are going bankrupt; and
- How we’re preventing a builder bankruptcy from impacting projects.
Lion Property Group is not a builder.
Let’s start with the big one: Lion Property Group is not a builder. Lion Property Group is a property developer—we hire builders to work on our projects. The market conditions that are causing builders to face bankruptcy do not apply to us. Are there knock-on effects of builders going bankrupt that affect us? Yes, but to a much less severe extent (as we will explain later).
Why are builders going bankrupt?
The simplest answer is a lack of cash flow, which in itself is caused by two factors.
The first is the rising cost of materials. In the building industry, it’s quite common for building contracts to be set at a fixed price. The builder will scope up the works, provide a quote, and after some negotiation, a fixed price will be agreed upon.
The problem builders are facing now is that they are contractually obligated to complete builds at a price that doesn’t cover the rising costs of materials. If timber is now twice as expensive as it used to be, the builder has to eat that cost—the build price is fixed.
This is made even worse by the second factor: suppliers are now requiring up-front payments. Prior to shortages, it was commonplace for builders to purchase their supplies on credit and pay the vendor after they had been paid. This meant builders could operate with a comparably small amount of cash flow relative to the volume of supplies they were purchasing.
Imagine you have an incredibly limited supply of timber to sell. Who do you sell to?
- Builder A can give you 10% now and pay the rest later; or
- Builder B will give you the full amount right now.
It’s a no-brainer: you sell to Builder B. It’s the better deal for the vendor.
So the current situation is that builders have to pay more for supplies than they were expecting, and they have to pay upfront, which is something that many of them are not capable of doing.
How is Lion preventing this from affecting projects?
The simplest way to stop this from happening is to check for it before it becomes a risk. When we’re thinking about engaging a builder, one of the things we do is check their balance books and cashflow to make sure they are in a stable financial position. We won’t engage with a builder if they’re not stable.
But sometimes unforeseen things happen, and this is where we need to find a balance. We like having long-term business partners. We like having partners who will go the extra mile for us, and we’ll go the extra mile for them in return. We think it’s a better way of doing business.
But ultimately, it’s not our responsibility to manage a builder’s cashflow. If they get themselves into a predicament, it’s not our job to save them.
Will we lend a helping hand? Of course. We’re understanding of the fact that supply costs are rising and that these expenses may need to be passed onto us. We will negotiate with lenders to release funds early to help a builder’s cash flow. We may even contribute our own capital, where possible.
But if it’s not enough and a builder goes bankrupt, then we hire a new one. It’s far from the ideal outcome. It will cause delays. But it’s happened to us before, and that project still went on to provide a 42% return to investors.
Won’t rising material prices impact the profitability of projects?
In our experience, no. The rising costs of materials get passed along to the final purchaser. As long as you’re able to handle the increased costs up-front, you’ll make it back at the end.
We have a project in Brisbane which is selling stock at the moment. We were originally expecting prices of $650,000. Just a couple of weeks ago, we sold one for more than $800,000.
When the entire industry is affected, that means that prices for everyone are going up.
Any other questions?
Schedule a call with our Head of Capital to have your questions answered.