COVID bounce back and the challenges in ’22

So long 2020. Adieu 2021. Welcome to 2022. Whilst we are no doubt happy to see the back of 2020 and 2021, that last statement is a problem. Saying 2022 sounds like “2020 Part 2”. I don’t think anyone wants another 2020. Without doubt, the last two years have been a challenge at every level. Uncertainty for the future. Lockdowns. Concern for loved ones at home and overseas. Fear of an unseen and intangible assailant, fuelled by hyperventilating government and media forecasts and rhetoric.

For building – particularly house building – this seems doubly so. For well over a decade the sector has struggled with growing pains. Housing demand has grown by around 16% per year since the Global Financial Crisis (GFC) of 2007/8. The Auckland growth rate is closer to 19% pa. Recently annual consents issued across New Zealand rose above 40,000 – a record not seen since the 1970s. Coping with this rate of growth is difficult. Eking out nearly a fifth more production each year from the same staff and investment without overstretching the company is a challenge. It seems like every developer is at full throttle. Every contractor we know is working all hours and struggling to get the skilled workers they need. Materials availability is a constant battle of moving goalposts. Suppliers introduce seemingly random price increases for no apparent reason.

On continuous repeat in the background is the rhetoric of successive governments. The industry is inefficient. Housing is too costly. Materials are a rort. Quality of construction is poor. Building takes too long. We need more land – land is the answer. And on and on. New initiatives to solve the problem? We’ve seen more and more. Anyone remember Special Housing Areas? Not to mention the historic “success” of KiwiBuild.

So, it all seems chaotic at present for sure. Not good. Deep breath. But it is worth taking the time out to take a look at the big picture and see where we are going.

Supply chain in crisis

The current supply chain crisis is both a national and international problem. New Zealand can’t supply itself with the materials it needs for construction. We produce some materials indigenously – for example treated, sawn and machined timber. But for many other products, such as insulation, fixtures and fittings, pipework, sealants etc, we rely on imports. The reason for this is that there is sufficient market scale to warrant the investment in production plant for the higher bulk demand items, but less so in other manufactured lines. Hence, we import.

Our international suppliers are similarly under stress. The USA has seen cut timber prices triple over the last year. Government policy there and globally has seen massive injections of capital into economies to offset the effects of COVID-19. New Zealand is no different. Populations have become cash rich and seek to protect their gains through capital investments. Housing investment is a primary mechanism. A housing boom has propagated around the world – and continued New Zealand’s decade long bull run. Consequently, less product is available to export to New Zealand and the premium to supply here has increased.

Concurrent with an explosion in building product demand, our supply lifeline has been constricted. The initial economic impact of COVID-19 in 2020 was significant. International shippers anticipated recession as demand collapsed. They reduced ships in service, retiring older hulls. Routes were rationalised and less profitable destinations (i.e. New Zealand) saw reduced service. Consequently, import shipping costs have increased significantly. A last feature of the supply chain problem is the effect that COVID-19 has had on our offshore suppliers. Workforces have been depleted through illness and hospitalisation in countries like China. Similarly, transportation workers have been hit by both illness as well as the imposition of vaccine mandates in some countries. Both production and transportation has been consequently impacted that feeds back to New Zealand as a spike in materials costs that we import.

The demand chain

New Zealand is in love with property investment. Buying. Renovating. Flicking on. Our future prosperity and pensions are inextricably linked to housing. Most financial investment consultants will recommend buying a rental property as a key element of a portfolio. With this in mind the sector as a whole has been heavily skewed into fulfilling this demand profile. The COVID-19 infusion of liquidity into the New Zealand market led to a sustained growth in demand for housing throughout the lockdown periods.

People spending more time at home took on renovation projects. Money not spent on overseas holidays and travel to work became redirected into property investment and renovation work. This combination has spiked materials demand and magnified the capacity constraints in the market.

Technology

The houses we build today are largely the same as those we built a century ago in New Zealand. Any builder from 1900 would recognise most construction technology in use today. Admittedly they may look a bit sideways at wireless routers and BIM models. The effect of exploding demand for housing has been to see traditional construction stretched to the limit. At full capacity it is hard to invest in new technology and swap over to new techniques ‘mid-stream’. Construction technology in New Zealand has really not substantially advanced. Perversely investment in technology and growth is not favoured as many builders do not wish to overextend themselves and potentially suffer in any future downturn. Paradoxically this position is likely to be vindicated in the event of a downturn in the market which will likely impact those companies that have invested are more leveraged as a result.

Production capacity

For years we have seen rationalisation taking place in the New Zealand construction materials production sector. Multi-site companies consolidate onto single sites. Australia/ New Zealand enterprises retreat to the other side of The Ditch. Over recent years we have seen many instances of old timber and steel mills being closed, but not so many times when new infrastructure has been opened.

Investment takes place to streamline production and minimise less efficient ‘surplus capacity’. As a result, it is hard to reverse this trend and rapidly scale up production to meet inflated demand. Companies respond by working longer hours at consolidated locations. Double shifts drive time and a half pay. Labour and product costs escalate. Unsatisfied demand is addressed through increased waiting time or directly from imports. Alternatively, companies need to invest in long term capacity growth that may be at risk in the event that there is an economic downturn. In short, we have a finite capacity to provide materials to the sector and a limited taste for the additional risk associated with capacity investment.

Skills availability

We have been dependent for many years on skilled immigrant labour coming into New Zealand. Our ability to fulfil the labour demands of the industry is limited to the total number of Kiwis keen to start a career in construction. Sadly, that number is not expanding at a dramatic rate and demographics are against it. Even if it did ramp up, the lag between a student leaving school and entering the workforce varies from 12-48 months depending on skills, through trade training or university. Recently the government announced that border reopening will be accompanied by prioritisation of short skills such as engineering and construction. In the short term we may see some relief around costs of tradies, but the underlying shortage will remain a problem for years to come. Where next?

There will be a bounce back effect in the economy as borders reopen. The likely influx of returning Kiwis, tourists and international students will see some of hard-hit sectors of the economy start to reanimate. Increased economic activity follows the flow of people. This will likely generate an uptick in construction demand – balanced in part by immigrant skilled labour entering the industry.

However, we are likely to continue to see constraints around indigenous production capacity and supply chain. Fundamentally the cuts initiated at the start of COVID-19 restrictions are slow to reverse. Workers move on, skills are lost, companies reorientate their business models. It takes much longer to rebuild what was reflexively cut out in 2020. A wider concern are the ‘big picture’ global problems impacting money markets internationally and consequently the construction markets in New Zealand. President Biden’s spending plans in the USA have driven a 40-year inflation high. The Federal Reserve is raising interest rates which will impact all economies to a greater or lesser extent. The collapse of Evergrand property in China has now gone quiet during the Winter Olympics – the long-term impact in lending and Chinese investor behaviour is yet to be determined. US/Russia posturing on the border with Ukraine could easily lead to conflict. US/Chinese posturing in the South China Sea could lead to a different conflict. Any of these flash points could precipitate a substantial turn in New Zealand markets. Certainly, none of those issues look good for long term financial risk taking. Paying down debt is preferable to borrowing. Things could go very wrong very quickly. Inflation hit a 30 year high in New Zealand in the last month – just as interest rates and loan-to-value ratios (LVRs) are increasing. New Zealand Housing could turn on the proverbial dime in terms of sentiment.

Long story short, some of the problems we have faced over the last few years are likely to continue for the foreseeable future. The indicators for a lessening of labour shortages are good. However, the potential impact of isolation protocols of COVID-19 ‘close contacts’ under the government’s traffic light scheme could create staffing headaches to say the least. Currently investment signals are problematic. Elevated interest rates and inflationary pressures are an inevitable consequence of the COVID-19 response. The good news is that the bounce back will happen. It could be subject to some impediments in progress, but it will happen. On balance, the best advice that can be given is to proceed with caution.

John Tookey is Professor of Construction Management at the Auckland University of Technology (AUT). He maintains a wide teaching and research portfolio around project management, construction logistics, supply chain management and procurement. Consequently, Professor Tookey is a regular commentator in various broadcast media including radio, TV and press addressing construction engineering and housing issues in New Zealand.