In an allegory for the wider problem of SME funding, recent research has revealed that the UK’s small construction firms are struggling to return to the profits they achieved before the recession, while large housebuilders have already recovered beyond their pre-crunch highs.
Small firms saw their profits drop to 0% during the recession — a very difficult period that immediately followed the profits of 12.2% they posted in 2006. They have since returned to a level of 7%, and clearly have a long way to go before their recovery is complete. On the other hand, the big building firms have gone from 11.2% before the crunch to 11.7% after, in other words surpassing pre-recession profit levels.
The financial crisis hit all housebuilders hard, but it’s clear that the large firms have bounced back while the small builders lag behind. Although overall average profitability for SME housebuilders has recovered, small firms’ margins are lagging significantly behind the levels enjoyed by the major operators because the smaller companies are sharply restricted in the scale of projects they can take on.
What does this mean for the UK housebuilding sector?
You might be wondering — “so what? If the large firms have recovered, the smaller companies should follow suit soon enough.” The problem is, smaller housebuilders used to account for a much larger chunk of the overall number of new build homes. In 2008, SME housebuilders built 44% of new homes in the UK. Now, that portion is down to 27%.
You’d be forgiven for assuming that this is down to a reallocation of market share — or put another way, the large companies are building what the small and medium-sized companies would have previously. But while this may be true up to a point, the total number of homes being built is nowhere near what it should be to achieve the UK Government’s ambitious targets — between 2011 and 2014 only 460,000 new homes were built, in contrast to the 974,000 required according to the National Housing Federation.
Why is this happening?
Small housebuilding companies are struggling — that much is clear. As well as highlighting a problem among a specific sector of UK SMEs, this draws attention to a wider issue facing all small and medium-sized companies — lack of access to lending. Smaller companies are still finding it very difficult to get the loans and finance they need, whether it’s for short-term cashflow gaps or longer-term growth plans, and that leaves them in a difficult position.
Access to funding is key to growth, and for housebuilders and construction firms specifically the problem is amplified because their industry involves trading on credit, reinvesting profits and using various forms of finance to bridge the gap. For example, a housebuilding firm taking on a new project will have to hire subcontractors, buy building materials, lease machinery and pay its staff, and all of these have to happen long before they’re paid for the whole job.
Add to this the fact that even fast housebuilding projects are likely to take many months, and the problems are obvious.
Repercussions along the whole supply chain
In this context, it’s no surprise that the smaller housebuilding companies now account for a smaller share of new-build homes in the UK. With profits much lower than before the recession, combined with financing issues, this effectively means they’re restricted in the scale of projects they can go after without risking their very existence by overtrading.
There is a serious knock-on effect from the housebuilders’ funding struggle too. If the small companies are less able to go after lucrative contracts, they’re not only less likely to catch up with the big firms in terms of profits, but there will also be consequences for the firms they work with; if the smaller housebuilding firms are struggling, it means all the suppliers and contractors they work with are affected in turn.
In this way, a funding problem for a specific subset of companies becomes a cashflow problem for the whole supply chain — and suddenly, the small housebuilders’ situation feels a lot like an example of what’s happening to SMEs all over the UK.
What can we do about it?
Alternative finance offers a critical second avenue to funding for construction firms that aren’t served by their banks — and with myriad options in the market there’s finance to suit a wide variety of construction businesses. With more and more types of equipment finance, invoice finance, supply chain funding, bridging loans and growth finance on the market, the SME end of the construction industry can catch up with the largest firms, who have put the recession firmly behind them and are making the most of extremely high demand for new homes.
Since overall levels of new build housing in the UK are far behind where they need to be to hit the Government’s (arguably) ambitious targets, if SME construction firms also realised the profit levels their larger counterparts currently are, this gap could be significantly narrowed.
Although awareness and understanding of alternative finance in the UK has improved hugely over the last few years, there’s still a lot of work to be done. But if things continue on their current trajectory, more of these struggling housebuilding firms could get the finance they need to invest in the increased manpower or equipment necessary to capitalise on new development opportunities.
There is another aspect of the small UK housebuilders problem that I haven’t yet covered — the role of the banks. While it’s easy to place blame at their door, capital requirements from global banking regulations which I’ve previously written about on this site mean they are still sharply restricted in the level of risk they can take. That situation is unlikely to change in the short term — if we can close the knowledge gap, alternative finance can go a long way to improving the situation and taking pressure off the banks.
For now, it’s clear that access to finance is a keenly felt problem for construction SMEs, which echoes the issues that small and medium sized companies all over the UK — and Europe — are facing when it comes to business finance.
In the housebuilding sector, as in many other industries, taking an ‘alternative’ approach could in fact make a lot of business sense.
Conrad Ford is Chief Executive of Funding Options, recently described by the Telegraph as “the matchmaking website for small businesses and lenders”. With the free Funding Options service, you can quickly search dozens of alternative business finance providers.