Following our commercial property costs reports of September and December 2021 (available on request), our intention was to issue a further update by the end of Q1 2022. However, the ongoing developments are such that we considered it may be helpful to share some further insight and guidance in this interim update.
The state of the market
Strong inflation in the building sector is due to the trinity of Covid, Brexit and a long term shortage of skilled labour. Added to this is the large volume of work that builders are facing as postponed contracts catch up with new work.
Most recently (and we haven’t seen the full effects yet), energy price increases and fuel shortages have added to the cost of doing almost everything.
According to The Insolvency Service, construction insolvencies have increased dramatically in recent months (18.6% on the quarter at Q3 2021 and 80% on the year). Over 92% of these insolvencies correspond to voluntary liquidations resulting in this type of insolvency increasing by almost 130% on the year. Over 59% of these insolvencies were from plumbing and electrical businesses.
It is thought by industry experts that the number of construction insolvencies in 2022 could be higher than in 2021 and that many of these insolvencies are likely to have an impact on the delivery of projects.
The construction industry is all about cash flow. Builders have to pay for labour and materials before receiving payment for the finished work and this can mean several months of outgoings before revenue comes in. In more ‘normal’ times, this can be managed by trade accounts for materials and bank facilities. As costs increase, the value of the gap between outgoing and income widens and if the time period also increases, bank arrangements become stretched to the point where the bank won’t increase or may even withdraw facilities. This triggers the majority of failures.
At the moment, where materials are in short supply or require an element of pre-ordering, merchants are requiring deposits or payment with orders, increasing the builder’s financial commitment and the period between paying out and being paid.
What does all this mean for insurance repairs?
Tenders for major repair projects can present a risk that the winning contractor could become insolvent before work is completed. It could be that the lowest price is submitted by a contractor that needs work on their books, which may not be financially viable. At the same time, contractors may submit higher than normal prices because of material cost uncertainty. This could result in a much wider range of costs than we would normally expect and trying to select the optimum balance of value and low risk becomes a vital consideration to the total cost of the claim. The best price may not be the lowest, especially where there may be ongoing consequential losses such as BI or loss of rent.
Contractors may ask for interim or even ‘up front’ or deposit payments to cover material purchases as mentioned above. While this helps the builder manage their cashflow and reduces the risk of them failing, it shifts the risk to the end-user. If the builder fails, any money
paid for work not completed could be lost. Being aware of the potential financial security risks of a builder is becoming even more important. Discussions need to be held with the customer and their advisers to ensure the risks and responsibilities around such issues are mitigated and clearly understood.
Whilst introducing network contractors can help to mitigate the risks, this can bring its own challenges. No builders on networks are exempt from the cost pressures and although due diligence has been done, it needs to be completely up to date as the situation is changing regularly. It doesn’t take much (a few late payments from a client, a job to go a bit wrong, etc.) for a contractor to tip over into becoming insolvent. Contractors will often work for more than one network and if any network is struggling with an aged debt issue with their suppliers, it can affect the contractor.
We mentioned in a previous update of the risk of construction resources transferring to other industries. If someone has been an employee of a failed contractor, will they be tempted to find work somewhere ‘safer’? This could further reduce the resource pool.
On the positive side, out of this comes opportunity. The construction industry, at the level we are involved in, is very traditional and the business models are not complex. Often, it is a good tradesman setting up as self-employed and then evolving into a larger business. There could be opportunities for entrepreneurs to enter the market with different and more efficient business models. There is potential for well-run businesses to enter the market in the current conditions.
For further information please contact Nick Turner on 07736 892148 or n.turner@woodgate-clark.co.uk
