Why are building companies like Porter Davis failing? That is being asked by the public but more importantly by new home buyers. The potential causes that lead construction companies to go out of business are both internal and external. Potential consumers may need to consider more than finishes and aesthetics. Building companies may need to address future economic issues more aggressively.
Capital & Cash Flow
Companies like Porter Davis are capital-intensive businesses where large amounts of capital are invested in fixed assets like tools, heavy equipment, and vehicles. During the period post Covid, the holding costs have been increasing at an accelerated rate. Many building companies have needed to borrow more during this time to keep up with the increases.
Some building companies have become over-leveraged, or have tied up working capital and cash in ongoing projects. The constant need to catch up with price increases can make some companies vulnerable to collapse. Overinvesting in fixed assets that are underutilized can also be a reason for firms to need their cash reserves and deplete all available capital.
Cash flow management is critical in all companies and poor administration will hasten collapse. Ensuring that a company is billing for projects, being paid within time frames, keeping accounts payable and receivable in check and properly managing project budgets is essential. Cash flow can be a huge problem for construction companies because they rely on other businesses and consumers that are also impacted by the current downturn. The domino effect of poor and slow cash flow in the building industry is now critical.
Fixed priced contracts
Under a fixed price contract, the builder agrees to bear any costs above the fixed price, except for those costs incurred because of variations requested by the client or matters outside the control of the builder, such as a fire, war, strike, or natural disaster. Porter Davis clients entered fixed-priced contracts that clearly didn’t anticipate 10 interest rate hikes, supply shortages and cost of living increases.
Under a fixed price contract, a new build consumer is not able to reduce the amount paid if the price of materials decreases and the builder is not entitled to pass cost increases to the owner. Continuing to perform under fixed price contracts when the external market is not stable can become unprofitable to the point of collapse.
During stable economic periods, builders can anticipate and sell the cost variations. Consumers accept contract prices because the price is within a palatable margin. If a builder was to anticipate a 30% /40% increase it would be prohibitive for buyers and builders. As no one predicts economic doom accurately builders and consumers have to decide for themselves what prediction they believe.
The courts are not likely to intervene and support builders and it can equally difficult for consumers. For builders, it can be argued that future material price increases are foreseeable and should have been contemplated when the contract was quoted. For purchasers, courts are unable to extract monies from failed companies. Whilst many increases are predictable economic downturns are not. Unfortunately, both consumers and builders are collateral damage when economies falter.
Economics is not an exact science. Further, people’s needs never perfectly align with external market forces. When making large financial real estate decisions consider the external pressures of your purchase. When building consider:
- what you are looking to accomplish – choose the most important imperatives – you may not get everything you want from one builder;
- do due diligence – ensure you’re buying the right block of land at the right price without hidden problems;
- ask the builder to present solutions to your concerns – this may include what happens if the economy changes;
- consider the builders’ strengths and weaknesses along with prices and specifications;
- contract signing – ensure there is full transparency in what you are entering into and
- building – ensure all service levels are met and your project is on schedule.