Risks associated with home building

Risk Awareness and Management

For the home-owner, there are many risks associated with building a house as the project involves a large number of different people, products and services. Even if the whole process is totally hassle-free – and you would be truly lucky if it is – problems can still arise over the next five or 10 years because of poor construction practices or inferior materials.

Risk Variety

Certainly, the single most important issue to be aware of when building your house is RISK. As long as you know what to expect, you can take steps to avoid them, or at least to minimise the impact.

Cost is usually inversely proportionate to risk – the lower the cost, the higher the risk. But this does not mean that you should pick the contractor who submits the highest bid either!

Knowing the building specialist is no guarantee of reliability, quality or service. You’d need to select him based on merit.

There are four broad categories related to the risks you will face:

1. Abscondment/bankruptcy
2. Inferior end product
3. Negligence in servicing and warranties
4. Over-blown budget

So what is a home-owner to do?

A good guide is to look for an organisation which takes ownership and pride in its work, and insists on a certain standard even if it exceeds your budget. Typically in any industry, this would be a company which:

• Is proud of its track record
• Has a reputation to maintain
• Has direct interest in the outcome of all its projects in the short, medium and longer term
• Is 100 per cent focused on excelling in the trade
• Will deliver on its commitments
• Uses a tried-and-tested workflow/business model.

You are also advised to look for its dedication and investment profile specific to building houses, not just other structures. This is important as building a house involves many details that the contractor must have an aptitude and passion for – details which are essential to creating a cosy haven called home.

Whereas a reputable house builder can almost certainly build a factory of good standard, the converse is not automatically true. In a home, there is a greater need for aesthetics and functionality, and for them to seamlessly coexist.

If all else fails and you are unable to decide on your construction partner, this last acid test always works. Talk to previous customers and see how many are willing to vouch for their builder’s credibility, reliability and responsibility in delivering the house, and the followup service after the guarantee period.

You owe it to yourself to get a list of references and contact details so you can check out the builder(s) yourself. Remember, your sanctuary is an important investment, and you should involve yourself in any way you can – especially in selecting the team which will make your dream a reality.

Also refer to our article: “How to choose the right builder”

Abscondment / bankruptcy

1. ‘Rollover’ strategy

   Small construction companies often employ what we call a ‘rollover’ strategy – using the monies from a new project to finance an old one because of poor cash flow or an underbid project. Therefore, the existing project does not get the attention or resources it should be getting. When a project cost is unrealistic, this is quite often the strategy to survive. Eventually when the going gets too tough, there is always the risk that the contractor would abscond with whatever cash he has by simply abandoning the project.

2. Poor cash flow management

   One of the biggest causes of a contractor’s inability to complete a project is poor cash flow. Many start off well, largely because the initial 10 per cent down payment is a good sum to kick off any project. But contractors – like small businesses everywhere in any industry – have been known to succumb to the allure of a sudden large sum in the pocket, and therein lies the problem.The math can speak for itself. If a project costs $500,000, a 10 per cent down payment is $50,000 in cash. To the affluent, it may not seem much, but to a lot of people in this trade, it’s a lot of money. The amount can be used to place a 20 per cent down payment on a new Mercedes, and still leave behind a five-figure sum.

   This kind of personal spending – which happens frequently in the industry – is akin to spending money ahead of it being fully earned. If any unforeseen circumstances should arise during the course of the project, it will inevitably plunge into losses because part of the amount meant for the project has already been spent. Hence, what is commonly referred to as a ‘loss-making’ project by builders, is in reality loss making because part of the funds have already been diverted elsewhere. In a financially well-managed project, the only reason it could go into a loss is when either funds are diverted, or the company’s total overheads are too high relative to the size of the project.

   As mentioned in some of the earlier articles, while staff numbers are a measure of business activity, it is no way an indicator of profitability in this niche sector. In a labour-intensive industry, the total productivity coupled with tight labour and resource management while developing a critical mass in tiny Singapore is key to long-term survivability.

   Typically, rather than incurring heavy losses on a project, a contractor may just opt for abscondment or bankruptcy. Alternatively, he could look out for another project at another low price, so he can prolong his survival with the new project (and extended time). Sooner or later, this ‘rollover’ game will have to end, and the last project will be left unfinished. And the home-owner loses…in more ways than one.

3. Under-budgeted project

   We have heard horror stories of projects which stand unfinished for years because the money ran out. Some of these are under-budgeted for in the first place, so there are no excess funds to cater for contingencies like increasing material and/or unexpected costs that are work-related. Some of the smaller construction companies are also notorious for submitting rock-bottom quotes just to secure a project. And to a large extent, that is what the market demands! The builder is pricing according to what the market expects – low prices – but at the same time a high level of quality and competency. (My earlier articles have mentioned that in construction, this is a near sure-fire way of the project getting into trouble.)

   While a low-price-good-quality approach can be quickly sussed-out for an off-the-shelf consumer item, this method of construction is almost always a formula for disaster, and a source of frustration to both yourself and the whole building process. There are far too many ways of cutting corners without anyone knowing what and where, except the builder himself.

   The building industry is a highly complex one and involves many people. It will test the whole gamut of a contractor-proprietor’s business practices from financial discipline to accounting, organisational management and people skills. Unfortunately, it also paves the way for the company’s financial baggage to be transferred from its past and current projects to future ventures.

   In the context of this industry, baggage typically accumulates over time and can continue to develop; historical record is no measure of future performance (think blue-chip companies and how they too can fall from grace). The sheer number of sub-contractors and tradesmen working on a house project – and their respective loads of baggage – can inflate the many risks already faced by a home-owner.

 

Inferior end product

Building entails multiple value chains of work. One value chain is made up of a main contractor, main sub-contractor, other trade sub-contractor, sub-sub trade sub-contractor, work team leader, and actual workers. Because control becomes diluted by the number and length of these value chains, the home-owner faces a higher risk of an inferior end product.

1. Down-side of privatisation

   The modern business guru may dictate privatisation for cost efficiency and quality – that is, works should be sub-contracted. In fact, many main contractors in the house building segment don’t even have their own workers because everything – from supervisors to foreign workers and tradesmen – is sub-contracted out. This is a very lean, cost-effective, and short-term way to survive in a very small domestic market like Singapore. But for the home-owner, it is the highest type of risk profile you can possibly face.

   The extended value chain in a sub-contracting position most often means that the lowest rung in the chain gets the smallest worm, at possibly the lowest price. When the specific work done by the sub-contractor is completed, quite often he will ask for full payment because that is the deal – low price, but 100 per cent payment upon completion. So if a problem does arise, he will demand additional money to fix it. More often than not, the main contractor will refuse to fork out the extra cash because he needs to protect his own margin. The result? – the home-owner gets stuck with poor finishing and even worse accountability.

   In our experience in housing construction, sub-contracting is often the biggest reason for quality-related risks. This situation is often unavoidable because it is not practical for one building firm to be an expert in everything throughout the value chain. Aluminium works for example, require space, capital investment and technical knowledge; plumbing, electrical and tiling works require knowledge and skill for proper completion.

2. Addressing the risks

   By selecting the correct builder, many of the risks associated with sub-contracting can be reduced.

   If a company has a critical mass of projects, it can form dedicated work teams specialising in the full range of sub-trades. Each multi-skilled team is then trained to achieve the company’s benchmarked level of quality and consistency.

   With in-house teams, should post-construction problems arise, the same team will be responsible for reviewing and rectifying them. Their individual knowledge and experience grow, there is accountability, and the home-owner is assured of a quality product.

   A good construction company updates and documents its experiences and learnings from every project so that it is constantly evolving. This push to raise the bar on professionalism must come from the top, and usually comprises five steps:

   • Procurement as a point of control
   • Documentation for future reference
   • Inspection for verification
   • Testing for efficacy, and if despite all that is undertaken, and things still fail, then
   • Proper rectification as proof of responsibility.

   Unfortunately, very few construction companies show such dedication these days. As an industry, there is little incentive to improve – competition is stiff, margins are down, and it is tempting to cut corners to boost earnings.

   Unlike other industries such as transport, where over-competition is frowned upon by the authorities as it results in deteriorating quality, construction does not have such safe-guards for the public. Home-owners are often the losers if they choose the wrong builders.

3. Brokers / Agents

   Over the years, many ‘contact’ agents in search of ‘real’ builders have approached us. They include property agents, contractors, sweet talkers, estate/project managers and renovation contractors. In the private, landed property segment, some of these agents are seeking commissions of up to 40 per cent, though the average hovers around 10 per cent.

   Are there such margins in home building? Yes, if you get unscrupulous builders, where an aluminium system can differ in price by 250 per cent! If price is a major criterion in your quest for a new home, we’d suggest you re-consider – because there are too many unknowns, especially those you cannot see or have no knowledge of. For example, how do you tell if the person you are liasing with is a real builder? He may speak the same lingo because he’s had years of practice…as a middleman, with no real or practical knowledge of what is needed to build a quality home

   At Meridian Homes®, we work directly with the home-owner/decision maker. By removing the invisible layer of intermediaries or sub-contractors, we are also drastically reducing the risk of problems. Additionally, you get industry-leading specifications, end product and decent workmanship.

Negligence in servicing and warranties

The private residences/landed property segment is notorious for its fussy home-owners, and the current standard contract perpetuates such behaviour by over-protecting customers. Whilst it is true that bad contractors have given the industry a bad name, there are also many home-owners who are unreasonable in their demands and expectations.

Following the SIA contract, a 2.5 per cent balance will be outstanding when a project is physically completed. Most builders would have factored in this remaining percentage as being unclaimable in the overall budget. Since there is no longer an incentive to provide after-delivery services or honour warranties, some contractors choose to ignore such commitment.

For a new home-owner shopping for an ideal partner in building, a repeat client says a lot about the contractor’s deliverables – from start to finish, and beyond. A good guide is how well the builder provides after-delivery service and honours warranties.

Overblown budget

In order to present an acceptably low total cost to clinch the project, the contractor may have omitted certain items, or quoted for low-end products. A layperson or new home-owner may not be aware of these ‘strategies’. Even if the lists have been itemised, not many people are able to tell what is missing. So unless it has been specifically disclaimed, the home-owner must be prepared for risks such as additional or ballooning costs during the building process.

The danger of an overblown budget can be mitigated – do not fix the budget first, and then look for a contractor who can provide the products and services you desire within this budget. A builder with rudimentary knowledge and a great hunger for the project can easily put together a written contract to build your brand new house for as little as $300,000. You can then expect him to inform you – frequently – of the additions which are essential, and must be paid for throughout the building process. The home-owner often feels trapped, but may not be in the position to say no if the alternative is to break the contract. (Some have done so and gone on to appoint another contractor.)

But don’t take our word for it – because chances are, you have friends, or friends of friends, who can inundate you with harrowing tales of being held ransom by contractors, or new homes which literally fall apart after a short time.

Believe us when we say that the low initial costs will multiply over the longer term – through maintenance and replacement expenses. The building industry is fond of its own insider joke – ‘either pay upfront or pay in instalments, via repair bills’.