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30 Sep 2021

Fixed price builds not possible with building materials shortage

Builders adding escalation clauses to contracts to protect against skyrocketing prices

Fixed priced house builds are fast becoming a thing of the past with builders unable to correctly or accurately estimate costs and timeframes due to the unpredictable nature of building material prices and availability issues.

When the cost and availability of basic materials needed to build varies hugely week to week, it’s become almost impossible for builders to offer a fixed price house build without risking serious damage to their businesses.

Banks are seeing a huge increase in escalation clauses in the contracts they work with. While it is an understandable inclusion to protect homebuilders it may have a knock-on effect to the homeowners in more than just final cost. With banks preferring to approve loans on fixed price jobs, this inability to provide may cause mortgage acquisition to become even harder for borrowers. 

Matthew Hardcastle with Williams Corp is the country’s fifth largest developer and has 1200 homes booked to build, though generally protected by their size and position in the market, says that they are not immune to this increasingly dire situation.

"So, what's going to happen is the construction industry is going to stop fixed-price contracts, or do less of them ... or [say] 'I'll give you a fixed price on the labour, but I won't give you a fixed price on the materials’… and then what's going to happen is banks are going to refuse to lend to these people.”

Bruce Patten, a mortgage broker, says what's occurring could have a "huge impact" and that "banks generally won't allow anything to be done on anything other than a fixed-price contract, unless you've got at least 35 per cent deposit … and the majority of people, not just first home buyers ... aren't putting in a third of the purchase price."

Why are fixed price builds affected by the materials shortage?

It is a combination of factors that mean builders costs and material prices can change from one day to another. If the estimate is calculated and a mortgage approved at one price (with no escalation clauses), but when the builder comes to actually purchase the required materials only to find that they’ve doubled – they could not only lose their profit but actually go in to debt to complete the build.

"We've had three price increases just on bricks this year. It feels like every second day, you get a new email about price increases,” says Hardcastle.

The supply chain is so congested, and accentuated by the import restrictions thanks to the pandemic, some builders are having to down tools because the materials simply aren’t available.

Mike Blackburn from the CBS construction co-op in Canterbury reports that the pressure on their members is intense - “they simply don't have the building materials to carry on working."

Supply and Demand Disconnect in Kiwi Construction

Demand for house builds was already high, with construction consents causing a 4.5% inflation annually to construction costs as of June. Subsequent lockdowns and ongoing international supply chain issues have intensified the inflation.

"I've never seen cost inflation like this," Hardcastle said.

With the disconnect between the high demand for new homes and supply of materials getting harder and more expensive, builders and homeowners alike are suffering the consequences. Quoting a fixed price for a new home is a longstanding norm in New Zealand, but now the unpredictability of material availability and cost is making this an enormous challenge.

How much can these material increases actually cost?

Patten says that fixed price quotes are still happening but escalation clauses are becoming more common. Additionally, the increases in price are not negligible, one such increase that he reports seeing came in at $25,000 higher than the original purchase price.

Paulette Trotter, a thirty-year veteran of the finance industry, describes the current situation in the industry as she’s never seen it before.

"I've definitely seen a few things in the last couple of months I've never seen before," she said.

"I've seen in a couple of instances where clients have signed fixed-price contracts last year, and the builders have come back going, 'It's changed. You owe me another $65,000'…I've got them to take legal advice, but there's nothing they can do. They've had to pay the money."

What comes next for construction in NZ?

Some industry leaders are warning builders against offering fixed price quotes no matter the pressure from clients as it could cripple them in the long run.

One potential solution, suggested by Stephen Voyle, is to approach the separate parts of a build and offer fixed pricing for early work or the first half of the project when material costs can be more reliably estimated. This advice from him as a principal at Context Architects is in line with advice from Master Builders chief executive David Kelly who tells builders to “be very, very wary" because “you don't know what's going to happen.”

Unfortunately, builders don’t see this problem going away any time soon. The industry is expecting the building material choke to continue and that many firms will continue struggling with the changes to contracting.

Through the complexity that is added by these clauses and the additional risks that building now entails - "it is going to add significant complexity that most people won't be able to deal with," Patten said.

He went on to say that despite having record numbers of building consents right now, that he believes that there will soon be “record amounts of projects not going ahead.”

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