Construction nightmares: How builder bankruptcies are costing Aussie homeowners millions

If there is an industry in Australia that needs confidence right now, it’s the residential construction sector. Yet, at a time of unprecedented need to build, construction companies are collapsing like houses of cards, leaving consumers with lost deposits and half-finished homes.

For consumers, embarking on building or renovating a home represents a large financial commitment.

However, when compared to other major investments that Australians will make in their lifetime, protection for their funds is limited.

Indeed, builders can – and do – spend consumer deposits in any way that they please.

Something’s broken in the residential construction sector

Australia needs to build new homes. Driving demand is both high immigration, with 2023 seeing net migration of 518,000 immigrants, coupled with an ongoing trend for fewer habitants per home.

On the supply side, building commencements are in decline, with 2024 data for new dwelling commencements at 10-year lows. Overall, the ratio of new population to new dwelling approval is the worst since data began to be recorded in 1984.

Despite this urgent need to build, residential construction companies are going into liquidation at an alarming rate. According to ASIC data, in the 2023-2024 financial year, 2,832 construction companies went into insolvency in Australia, representing the greatest proportion of company collapses and a problem that is trending worse, not better. These are not small or newly established companies, either.

Several industry-revered names have gone under, including Clough Group, Probuild, and Porter Davis Homes.

COVID disruptions, including skilled labour shortages and rising raw material costs, are often blamed for the high level of insolvencies. As the economy begins to settle down, the building industry doesn’t appear to be following suit.

Warning signs have been unheeded, with a 2022 review by the Reserve Bank of Australia identifying financial pressures across the sector. This same report predicted that insolvency levels would increase – exactly what has transpired since – and potential for financial stress of these insolvencies to spread to consumers and the wider construction supply chain.

Going ‘under the hood,’ Australia’s homebuilding industry is characterised by low profit margins and fixed-price contracts, meaning that there is little headroom or mechanism for builders to absorb pressures such as rises in material costs and labour shortages.

This means that many homebuilders have been operating at negative cashflows, where suppliers don’t get paid, and projects are left unfinished.

Consumers left ‘carrying the can’

When a residential homebuilder goes bust, consumers become unsecured creditors and are at the bottom of the food chain after a lengthy insolvency process.

For many consumers, the great Australian dream of building or renovating a home has turned into a nightmare. News is replete with stories of lost consumer deposits and half-finished homes.

The only available remedy is builder’s insurance, with most states – Tasmania being an exception – legislating that builders take out insurance that covers an insolvency event.

However, such protection has bounds: claims cannot be initiated until five weeks after insolvency, policy limits vary between states, and in some cases, are limited to 20% of the value of the build. In the case of Porter Davis Homes, this insurance wasn’t taken out in the first place, leaving consumers completely in the lurch.

The fallout does not stop at consumers; subcontractors also join consumers on the unsecured creditor’s lists. Often, small or family-run businesses become unsecured creditors needing to cover the cost of their materials and staff if they want to continue to trade.

Why your home deposit may not be protected like other investments

Embarking on building or renovating a home is one of the largest investments an Australian will make.

Unlike other large investments, such as superannuation, banking deposits, or payments to professional services firms, the construction sector has little regulation regarding how consumer funds are utilised and protected.

Regulations protect consumer funds across financial services in the event that one of these institutions collapses. Consider consumer payments for legal services; here, consumer funds must be held in a client account and only used for their intended purpose.

When a homeowner places a deposit with a builder, this money can be spent for any purpose. In some cases, there have been stories of builders on luxurious holidays at the same time as homes go unfinished. More often, given the cash flow pressures across the industry, consumer deposits from one project are used to complete prior commitments.

It seems nonsensical that consumer deposits can be used for purposes outside their intended use. However, builder accounts are opaque, and it is very hard to know where the money goes. There is little incentive or need for homebuilders to spend money on the project for which it is intended.

One remedy for homebuilders’ tight cash flows is to delay payments to suppliers. Another remedy is to take on more projects because these new deposits will increase cash flow in the short term. This means that troubled builders put more consumers at risk, thus becoming a classic Ponzi scheme – until it falls over.

A solution: protecting consumer deposits

Against a backdrop of stories of consumers being left in the lurch, it is hard to see confidence returning unless the industry takes a new approach.

Financial services firms already provide a template for ring-fencing consumer funds and ensuring that money is spent for its intended purpose.

Extending this protection to the residential construction sector would require setting up project accounts, where consumer funds reside until they are drawn down by builders and subcontractors and the work is completed to standard.

In the event that the builder goes bust, this money remains in place to pay subcontractors and continue the build. A side benefit of this approach is that it may improve the robustness of the construction industry, providing homebuilders with a motive to ensure that each project stands on sound financial footing.

Dr Brad Hastings is an Insights Associate at the UNSW Business Insights Institute, which delivers economic and business insights, research, and methods to government and business. Using a program-based approach consisting of Knowledge Hubs and Research Labs, the Institute helps industry partners solve complex challenges by linking them to academics and providing them with access to novel research insights.