Builder tier system

What is a builder tier and how has the industry determined the tier of a builder?

There is a lot of conjecture about who, when and why the construction industry commenced referencing builders in terms of a builder tier system. We have discussed this with various industry professionals who have contrasting views. Some suggest the reference system has come from the banking and finance industry where aggregated construction risk across the loan portfolio is considered, when builder risk of individual loan applications is assessed. Conversely, some believe that it’s come from within the construction industry, namely builders to illustrate their superiority in terms of size, experience and capability against their peers.

Regardless of its origins, it’s safe to say that a builder tier approach is used by stakeholders in the industry:

• Financiers: in refence to their loan submissions and credit approval process, namely, “we will only approve a tier 2 builder for a project of this size and complexity”
• Quantity Surveyors and project managers: in reporting to a developer or financier on the experience and capability of the proposed builder
• Builders: to compare themselves and often differentiate themselves from a competitor
• Subcontractors: to emphasise their experience or capability in relation to the builders they work for
• Developers and purchasers: to differentiate their project on quality and price “this was built by a tier 2 builder”, to highlight a higher standard and better long term value compared to competing projects
• Government organisations: generally, use financial metrics to determine tender compliance
• Employees and insurers: in relation to workplace Occupational Health and Safety (“OHS”) systems

The difficulty, in practice, is that there is no industry adopted benchmarking model to consistently allocate builders into their respective tiers. There is limited debate about what makes a tier 1 builder, but a lot of conjecture around determining whether a builder is tier 2 or 3. Furthermore, how many tiers should builders be broken down into, 5 or 10?

Publicly available information to assist with this assessment is limited. We hope that this article provides some insights and suggestions to improve a very useful way of differentiating between groupings of capability within the construction industry.

Why is a builder tier important?

Stakeholders rely on builders to deliver reliable built for purpose facilities and homes that are constructed without material defects. These stakeholders include landowners, homeowners, investors, developers and subcontractors that undertake work and are directed by these builders, through to financiers and government authorities. Each stakeholder places reliance on the builder they contract with or purchase a property from. A well-defined and managed tier system that can be consistently applied would provide these stakeholders with greater transparency and understanding of the capability, experience and (to a lesser degree financial standing) of a builder. This would assist stakeholders in making informed contract or purchasing decisions.

There has been a lot of recent negative publicity concerning:

• Combustible cladding materials across Australia
• Structural defects in high-rise projects (e.g. Opal Tower, Mascot Towers)
• OHS issues at the Lachlan’s Line at Macquarie Park

Generally speaking, higher density projects are more complicated and carry greater risk in design, construction and OHS. Some of the builders involved in the above cases would be ranked in higher tiers, demonstrating that risks can remain notwithstanding the size and tier of the builder. However, with higher tier builders, we would expect that higher emphasis is placed on such things which will be reflected in investment in systems, processes and procedures that would minimise the frequency of such events, providing stakeholders with some assurance that the builder has the capacity to identify and manage such issues and rectify them when they occur.

Who should determine and administer the tier system?

In some industries, there is a governing or regulatory body that monitors or approves the level of commitment or risk that a supplier or service provider can undertake to protect end consumers. Examples of this include the banking system, contracting in Queensland through the QBCC, which licenses builders for different size projects based on financial capacity and, to a lesser degree, the accounting profession, with their reference to the “tier 1” or “Big 4” accounting firms.

We would recommend as part of the NSW Government’s review of the industry that it considers incorporating a documented tier system into the builder’s licencing regime. The tier system could be developed using industry feedback and engagement from key stakeholder groups. Each builder would establish their tier classification as part of the application and renewal process of a license.

Currently, a Service NSW search of Dept of Fair Trading licence information reveals no information about how a builder ranks against its peers. The information available is broad natured, can be out of sync with other government registers (i.e. ASIC), may lag in other respects (warnings could be out of date) limiting its usefulness.

Alternatively, Local Government oversight would be a possibility. Other alternatives would be MBA/HIA. However, a National approach would be desirable.

What factors should apply to determining the tier?

Key factors to consider:

• Capability and expertise (on project size and across construction sectors)
• History of the builder
• Financial capacity and access to capital
• Company and management structure
• Reporting obligations, are they a private company, public company or a listed company?
• Systems and processes
• Their geographical spread across Australia
• Their turnover and the number of projects they undertake

How may tiers should there be?

We believe that there should be 5 tiers, 1 being the largest and 5 being the smallest. Tier 5 would be reserved for a range of smaller builders undertaking anything from smaller medium density projects, individual houses or commercial builders and renovation works.

Builder tier matrix based on our Newpoint’s builder financial reviews

Newpoint undertakes third party financial reviews on builders for developers, financier and government organisations. Based on our experienced, we have created the following matrix of a tier system:

If you would like further information about this article or would like to learn more about how Newpoint Advisory operates, please contact us.