Tips on how to avoid insolvency as a property developer in the construction industry

 

The drop in mining investment has paved the way for a construction spree fuelled by low interest rates, overseas investment and record numbers of international students. And developers both large and small are taking full advantage.

In June 2016, CoreLogic RP Data estimated that 44,500 units would be completed in Brisbane within two years. Other estimates came to around half that number, predicting that some projects would struggle to get finance.

But according to Citi’s report released in mid-2016, there’s already a glut of properties that are either struggling to settle or not selling at all. And while the supply is dropping to meet falling demand and stagnating rents, it may already be too late.

Problems for property developers

With an excess of high-rise construction (particularly in Melbourne, Parramatta, Brisbane and Perth), and new building approvals declining by 15% since their peak in August 2016, developers face project management issues such as:

  • the builder/head contractor staying solvent until the end of the build
  • the value of the apartments at practical completion, and whether the buyer can settle
  • the bank’s willingness to support them throughout the project and after practical completion.

Are you facing similar issues?

What you can do

If you’re worried about your project:

  • Ensure your buildings have wide appeal. Do they cater to a broad range of demographics (given our ageing population)? Owner-occupiers or investors? Will they appeal to international students? Will a lower quality fitout rule out owner-occupiers and create problems obtaining finance and/or sales? If you have any doubts, talk to your architect.
  • Get your finances locked in early. If you’re struggling to secure finance for your project, or your financier pulls out, you may have to turn to financiers that charge higher interest rates. This will not only increase your overall costs, but could also lead to a cost blowout if you’re unexpectedly delayed. Some of the potential pitfalls include:
    • unpredictable council approval times
    • increased builder insolvencies
    • increased settlement risk.

Opting for a small loss now could avoid a big loss later leading to liquidation and potentially bankruptcy.

  • Be diligent with your recordkeeping. For developers who are always looking at ‘the big picture’, recordkeeping is often just an afterthought. But having a bookkeeper or accountant managing your numbers will:
    • help you make informed decisions
    • allow for more accurate cash flow forecasting
    • help you monitor the ongoing viability of your project.
  • Don’t let a lack of cash flow sink the project. Ensure you have a realistic cash flow forecast that helps you identify cash shortages early.
  • Have backup financial sources. Consider selling your land bank ahead of time to ensure you have the necessary funds to complete your current projects.

If you’re worried about cash flow:

  • Keep your Australian Taxation Office (ATO) and other statutory paperwork up to date so you can claim your GST credits and satisfy any ATO queries.
  • Look at selling your surplus land bank ahead of time so you have funds available for existing projects if needed.
  • If you hold surplus apartment stock and you’re struggling to pay your builder as your project reaches or nears practical completion, consider offering them an apartment in lieu of payment. While not ideal, the outcome may be better than the alternative.

If you’re worried about your builder

  • Do due diligence on your builder. There have been instances of builders underbidding to win work, often to drive rapid growth. The lower contract price may then be recouped from the developer through a “death by variations”. The best decision might not be getting the builder with the cheapest tender price, but getting the builder for the cheapest price who can do the job for that price.
  • Get your contract right from the outset, in particular ensuring it addresses:

1. Payment pre-conditions and payment suspension rights (though these won’t work against BCIPA claims).

2. Rights to take over the works if progress is delayed or to directly pay subcontractors (and set-off those payments against any money owed to the builder).

3. What security you’re taking for performance of the works (cash retentions, surety bonds or bank guarantees).

4. Making sure your rights of set-off are broad and allow estimated costs to be set-off (not just costs which have been incurred).

5. With reference to the PPSA, your right to use and hold a subcontractor’s equipment and/or materials after an insolvency event (particularly if that piece of equipment is key to completing the works).

  • Ask your builder for fortnightly or monthly management accounts, aged receivables, aged payables and bank balances.
  • Monitor your project for “red flags” including slowdown in progress of the works, requests for upfront payments and plant and personnel not attending site (or leaving unexpectedly).
  • Talk to subcontractors to see if there are any payment issues with the builder. (The legitimacy of statutory declarations confirming subcontractor payments has recently been brought into question.)
  • If you have any concerns about your builder’s solvency, raise these with the builder and consider whether you can support them through their difficulties (ideally with the assistance of a turnaround or insolvency professional) or alternatively if subcontractors need to be engaged directly.
  • If you fear the worst, start talking to potential replacement builders early to minimise the impact of the builder’s insolvency on your project.
  • Ensure the claim certifier carefully inspects all completed work, and notifies you of any issues in the quality of the work being performed. (If the subcontractors are experiencing payment issues, they may be cutting corners to limit their potential exposure if the builder goes into liquidation.)

We sincerely hope you never have to deal with these issues. But with the recent scourge of builder and developer failures, you need to be proactive to ensure the success of your project. Here are some suggestions of what to do if things turn sour.

  • If your builder has breached your contract, consider seeking legal advice as to what your best and most appropriate course of action is. Ensuring your ability to deduct the costs of having others complete the works can be critical to minimising your exposure to a failing builder.
  • Be wary of the builder lodging caveats over the remaining properties in your development regarding progress claims—a right that stems from equitable charging clauses in building contracts.
  • Be prepared for the subcontractors’ charges.
  • Be ready for potential body corporate claims to be made against the developer and the builder if subsequent defects arise. Check with your insurance broker that your policies cover the various issues which may arise from a builder going under.

If you have any questions, or you’re concerned about your builder’s solvency or the viability of your project, get in touch with us to further discuss your options.

Posted on 25-04-17 in Business insolvency.