Risk, liquidity and change in the construction industry

Three broad developments in construction and property services will be elaborated over subsequent sections, but here it is important to identify them and the financial calculus that binds them.

First, commercial property has been integrated into global capital markets. Before 30 years, the major clients of commercial builders were governments, large corporations and insurance companies, who typically built-to-own or built-to-occupy or manage. But commercial property has become a global asset class, purchased by organisations like pension funds and hedge funds without any necessary direct connection to the industry. They want exposure to the financial performance of buildings – their rent, maintenance and their capital appreciation – but not necessarily direct ownership. Buildings are now built-to-distribute, often to become part of capital market vehicles like listed property trusts.

The second related development has occurred in the corporate organisational structure of construction work. Construction companies have been transformed from specialist regional builders into global property services firms who are now often involved in finance, development, construction and property services activities. Construction has become just one part of their business operations.

The third change has been in the construction labour process and the contractual relations organising it. While sub-contracting has long characterised the industry, we can now see this form of work diverging further from the conventional wage relation and evolving more intensively into forms including individual labour-only sub-contracting, labour hire and output-based labour remuneration (metre-age rates for plaster boarding, tiling etc.).

These three developments are closely linked, for they all feed into the related concepts of liquidity and risk. In broader social terms, we might describe this as a process of ‘globalisation’ and ‘financialisation’, but those terms, especially the latter, need to be fleshed out concretely in the context of the construction industry.

In the current era, a financial problem for the construction industry has been that its output is illiquid. Finance is tied up for long and often uncertain periods in the construction process, and the building itself is not quickly sold. In a world that prizes liquidity as a way to manage risk and optimise returns, the three changes identified above move the industry towards innovations that produce liquid, globally traded financial exposures to fixed assets (property trusts) and liquid exposures to workers (sub-contracting etc.). It is by the creation of two concurrent liquid exposures that the pricing and shifting of risk comes to the fore as the calculative agenda of both finance and work.

The remainder of this article draws out the significance of these three processes.

The cityscape becomes an asset class

From the 1980s, an increasing determinant of what buildings are erected, where they are built and the pricing of those developments could be found in the decisions made in global capital markets. Part of that process involved a reorientation of corporations and governments away from commissioning buildings to own and occupy or for financial institutions like life insurance companies to own as landlords. In its place has come the development of securitised investment vehicles like real estate investment trusts (REITs) to become the owners of property developments. Here, the objective shifts from the purpose and use of the building qua building to building as asset and its value compared with other asset values. With this financial innovation, investors can now buy into the pooled income streams derived from buildings without the need to own the bricks and mortar. The development of financial products to give a financial exposure to property has generated a new globalised liquidity to construction-related assets and helped make commercial property into an asset class for global investors.^{Footnote 2}

Financial institutions can generate fee income from providing financial services to the property sector, without the need for direct ownership or lending. In a recent global survey of the listed REIT market, it was reported that there are now 43 listed REITs in Australia with a market capitalisation of about US$100 billion, representing more than 8% of the global REIT market (European Public Real Estate Association (EPRA), 2015). As the then Property Council of Australia CEO, Peter Verwer, astutely noted more than a decade ago, with asset ownership increasingly separated from occupancy, the sorts of calculations about property have become more and more financialised:

Increasingly, property developers rely on global capital markets and financial innovation to raise funds for construction and deliver in return liquid financial assets backed by construction and property service contracts. This change has increased the competitive pressure on developers to attract mobile investment funds and convert illiquid built assets into internationally tradable financial instruments. The effect is that built assets, as a class of asset, enter into competition for the attraction of funding with other asset classes (like stocks and bonds) on a risk-return adjusted basis.

Government expenditure in construction has followed a similar path. As public sectors around the world have diminished their direct engagement financing and undertaking construction, preferring ‘contracting out’ of things like infrastructure, the public sector employment of construction workers has declined markedly and new opportunities have opened up for property developers and investors.

In Australia, the public sector share of total expenditure on construction declined by nearly half, from 36% of the total in 1987 to 20% in 2004 (ABS, 2004) (the period of rapid ‘privatisation’) and currently stands at 19%. Government retrenchment also extends to withdrawal from directly employing large numbers of construction workers and professionals, such as architects and engineers.

The financialisation of commercial property ownership has also changed the competitive dynamics of construction. Financialisation has effectively re-aligned competitive processes within the construction industry in favour of head contractors. With the rise of property as asset class, there has been less incentive for former large owner/occupants like governments and insurance companies to participate in the construction process either as builders or managing clients. Large private developers, both government and private, have divested themselves of most of their internal construction and engineering skills once required to directly supervise the construction process. They instead now focus much more on financial management. The Property Council’s Peter Verwer is worth citing again on this issue:

Moreover, as governments have looked to reduce the book value of public sector debt, by privatisation of physical assets, the borrowings undertaken to purchase those assets are increasingly funded by securitising their income streams. Infrastructure and infrastructure-like assets that promise the (relative) safety of government guarantees or service contracts and which generate stable revenues (like toll roads and telecommunications), but with higher yields than government bonds, have become particularly attractive in financial markets. Here, too, a global calculative discipline has emerged. As a report by the financial conglomerate Australian Mutual Provident (AMP) noted,

Builders become international property developers and financial services companies

Before 30 years, head contractor companies in commercial construction in Australia were largely specialist regionally based organisations. Multiplex, for instance, was a commercial head contracting company that grew to dominate this sector in the Western Australian capital city of Perth. Grollo Construction, likewise, was a dominant head contractor in the Victorian capital city of Melbourne. Both grew to become major national and then international players in the commercial construction industry. The business of head contractor used to be principally managing labour and sub-contractors on-site and ensuring the timely supply of buildings on a range of contractual terms. These companies typically undertook work commissioned by governments, large corporations and insurance companies (who usually bought and owned the buildings for direct occupancy or as an investment for long-term ownership), on a range of contractual terms, but often on a cost plus basis. Their IR models were often similarly regionally particular.

But a number of global and sectoral transformations changed the relations between property development and head contracting. In the 1980s, the contractual terms being offered to construction head contractors started to change. One senior construction manager interviewed noted that in contracts started shifting from cost plus to ones where the construction companies had to bear risks for things like weather, industrial unrest, force majeure, latent ground conditions and the like. Construction companies initially found this quite stressful, but over time they began to find ways to pass these risks down to sub-contractors. As the interviewee puts it, construction companies responded by finding better ways of assessing such risks and ‘monetising’ them.

Australian construction companies also began to expand globally. Multiplex famously nearly risked and lost it all when they built the new Wembley stadium in London, and other head contractors went abroad with initially mixed results. Since then, and along with Lend Lease, Leightons and Grocon, they established significant operations in Western Europe, Asia and the Americas.

As commercial buildings have become integrated into global finance in new ways, there has also been a growing fluidity in the institutional structure of finance, production and consumption of commercial real estate. A prominent example of this is that the earlier division between developer, head contractor, client and financier has been blurring.

In this period of flux, with property developers increasingly engaged in physical construction so as to provide a material platform on which to create securitised investment vehicles, the balance of power between client and the head contractor has tilted structurally towards head contractors.^{Footnote 3} In a highly contractual environment, technical knowledge about the qualities, capacities and applications of a building; the details of costs of producing them; and their likely revenue-generating capacity is effectively a form of financial power. Head contractors came to realise that in such an environment of property-as-asset-class, they could not only leverage that technical knowledge to increase the profitability of their construction activities, but they could also themselves become property developers.

When we look at modern construction companies, two things therefore stand out:

1. 1. Increasingly, what construction companies do off-site (and outside of supervising the actual work of putting up buildings) is as important to their success and thinking as what happens on-site.

2. 2. Construction companies today are as much about property development, investment banking and risk trading as constructing buildings.

Construction companies become risk traders

As property development and finance merged in new ways, forms and spaces, opportunities emerged for head contractors to transform themselves into players in financial markets. In Australia, head contractors not only continued to manage building construction, but they also started to organise the financing, manage the financial risks of developing buildings and manage the property trusts that were becoming the ultimate owners of the buildings. Lend Lease signalled the direction of their future expansion in the early 2000s:

Apart from casting Lend Lease now as principally a property development firm, Desai identifies financial deal flow as driving the strategic thinking of the company. One indication of this shift is changing composition of its board of directors since the late-1990s. Figure 1 indicates that whereas from the late-1990s until the mid-2000s, directors with an engineering and general background made up more than 80% of the board; by 2013, there were more directors with a finance background than those with an engineering and general background.

Figure 1. Lend Lease – Professional backgrounds of board.

Source: Lend Lease (1999–2013) Annual Reports.

Board composition is one symptom of the financial changes explored here. The underlying process is the way the value chain of ‘construction’ companies is now being framed in terms of financial risk and asset management. For example, Figure 2 shows the evolution of Multiplex from a Perth construction company in 1962 to an institution featuring finance and investment. In 2007, Multiplex was bought by UK-based property services conglomerate Brookfield Asset Management. Similarly, in 2015 Leighton Holdings was formed into Construction, Infrastructure, Mining and Concessions (CIMC), after an investment partnership with funds managed by affiliates of the US-listed Apollo Global Management Corporation. These instances signal the growing role of asset liquidity and financial risk management within the construction industry.

Figure 2. The transformation of head contracting companies into property and financial services conglomerates – the case of Multiplex. ASX: Australian Stock Exchange.

Source: Multiplex Annual Reports, various years.

We can only surmise as to why this shift has been so dramatic in the construction industry and among head contracting firms from Australia. Perhaps, it was because the head contractors were at the intersection of so many points of contractual negotiation and risk management that their capacities for negotiating around and managing risk had forced them to transform their operations as a key to profitable head contracting (Reference MeadMead, 2007; Reference WoodWood, 2012).

Financialisation and labour in construction

This focus on financial risk management, and the capacity to design contracts which deliberately allocate financial risks along the value chain, has undoubtedly created a risk management culture in the way head contractors and large sub-contractors now manage construction sites. The growing role of finance in the industry, the deepening fragmentation of the labour process via pyramid sub-contracting and the task-based costing and payment systems all have implications for the nature of work contracts, work intensification and occupational health and safety (OHS) outcomes. The new capacity to measure risk is accompanied by a capacity to shift it, based on power inequality on construction sites:

The transformations of commercial property into an asset class and head contractors into part risk-trading investment bank have had a direct impact on work in the construction sector. Put simply, many risks previously borne by clients, head contractors and large sub-contractors as employers in construction have been systematically shifted across the construction value chain and especially onto labour. Work is, for instance, increasingly contracted on a task and output basis and increasingly also on an as needs (contingent) basis. There are now several more layers of sub-contracting: labour hire agencies supply more temporary labour and head contractors now typically employ hardly any people on-site. This change flows right down to the individual worker, who is now often working on individual contracts for service (as pseudo-small business operators), and required to manage the risks of rectification, continuity, injury, superannuation, public liability and their associated financial contracts.

Sub-contracting intensification has a deeper connection to developments in construction and the property services industry:

We can identify two broad ways in which risk shifting occurs in construction contracting:

1. 1. There are now more layers of sub-contracting. Head contractors now perform less of the construction work on-site and more of it is performed by specialist sub-contractors. The share of specialist sub-contracting in small-to-medium–sized firms in construction has grown from around half in the 1980s to over two-thirds by 2012 (ABS, 1984–1995, 1997, 2013).

2. 2. The intensification of work by risk shifting onto workers – less than half of all construction workers are in a conventional contract of employment (i.e. an employee who receives entitlements such as paid leave), making ‘non-standard’ forms of work the industry standard. The use of individual contracts and forms of de jure or de facto piece rates to arbitrage of regulatory differences is now also standard (although controversial). The growth of ‘sham contracting’, where a person is engaged on a contract for service when they are under the effective control of a firm, is widespread (Queensland Government, Finance and Administration Committee, 2016; Queensland Government, Ministerial Reference Group, 2011; Reference Rafferty, Wright and ChanRafferty et al., 2011).

Intensified sub-contracting

These changes in corporate organisation and the logic of construction management mean that key skills of senior management now lie not just in engineering and building but in finance and financial risk management (Reference Ranesh, Zillante and ChilesheRanesh et al., 2012). Head contractors began increasingly to deploy those capacities in novel ways. One was to profit from their advantage in risk calculation and its relocation in order to ‘arbitrage’ their position against both clients and sub-contractors. Using the language of financial risk to explain the process, here is how a former senior manager at one of the leading construction companies put it:

This statement identifies sub-contractors as a key target for arbitrage within the building process: mid-tier sub-contractors must regularly confront very competitive tendering and re-tendering that often pre-determines shifting risk even further down the contracting hierarchy (Reference Perraudin, Petit and ThevenotPerraudin et al., 2014). The only way to secure a mid-tier sub-contract is often to transfer costs and risks to ‘lower’ contractors. Head contractors’ use of intensive contracting to shift risk extends also to off-site service providers like architects and engineers, generating adversarial contractual relations (Reference Loosemore, Dainty and LingardLoosemore et al., 2003: 4). One professional engineering association noted their experience of contractual risk shifting in commercial construction:

The peak body for professionals in the construction consulting industry in Australia has made a similar point about the power asymmetry inherent in the monopsonistic and financialised construction contracting system:

Intensification and fragmentation of work

Before 30 years, head contractors engaged a part of the on-site workforce directly and had a small number of sub-contracting packages on any build.^{Footnote 4} Today, head contractors employ very few on-site workers and instead manage a range of sub-contracting packages, which are often then re-contracted downwards. Workers are now often engaged on contracts and paid for work based on task and output, rather than time basis. This risk shifting across the value chain is manifesting in evidence of work intensification and more demanding work (Reference McDermott, Henne and HayesMcDermott et al., 2017; Reference Mayhew and QuinlanMayhew and Quinlan, 1998; Reference ThompsonThompson, 2003).

High levels of sub-contracting in the industry might be seen as a technical solution to the complex task of assembling and coordinating the range of specialist trades required in undertaking a construction project. Whatever the other merits, multiple levels of sub-contracting have widened the gap between the project manager and workers on the ground. Just as the construction industry has identified risk as a factor to be allocated in contracting, site governance arrangements can influence how and by whom those risks are absorbed in practice.

These contracts also often specifically allocate many risks previously borne by head and sub-contractors (as employers) onto labour (the requirement to self-insure around income security, workers compensation, superannuation, public liability etc.). These contracts are also arranged through a web of corporate entities, which effectively exposes workers to the risks of head or large sub-contractor insolvency.^{Footnote 5} They also shift attributes of the employment relationship between several parties (as in labour-hire arrangements). Such contracts also often re-define workers from a status as employees to de facto small businesses (self-employed, labour-only sub-contactors). Despite the fact that many people are working in virtually the same labour process as wage workers, their contractual status, while often varied, generally contrives them legally to be a separate, arm’s length business, or at least at arm’s length from the head contractor.

A contributing factor to the growth of self-employment and an indicator of risk shifting through sub-contracting in the construction industry is the growth of ‘sham contracting’. This is where a worker, who otherwise meets all the criteria to be classified as an employee, is operating as a sub-contractor. One of the key features that distinguishes a sham contractor from a genuine contractor is that 80% or more of their income is derived from one client, and they do not have control over what, where and how they work. As one account noted,

While the construction industry is the largest sector for independent contracting, according to one of Australia’s leading labour law academics, this process is becoming standard practice in labour markets:

This process can be seen in legal sense as disguise or in financial terms as a form of regulatory arbitrage: using legal re-framings to shift risks (and hence costs) without a substantive change in role, to the benefit of the head contractor. Head contractors now have the incentive and opportunity to drive risks down the contracting pyramid, with direct implications for labour, but not only labour. In cases where labour is organised or powerful, and can resist these pressures, it is often mid- and lower-tier sub-contractors that are squeezed. Indeed, one of Australia’s leading building management academics refers to this as an