Defects Policy Requires Rectification

As long as there are new buildings there will be defects. The major structural defects problems besetting the construction industry has existed in the past, exists now and regardless of the actions of government and professionals will exist in the future. This is cold comfort for the hundreds of residents and owners that are in temporary accommodation due to the problems. 

Interestingly enough, the longer this issue has lasted the less column inches are devoted to those affected and the more focus is on the politicians and interest groups. Policy has been hijacked by politics and money – but that’s nothing new. Politicians want to be seen to be doing things and the interest groups want to control any money that may be thrown at any solution. Meanwhile, the people affected have their temporary accommodation paid for until this plays out. 

The problem is largely a failure of policy and partially a function of externalities created by constructing buildings. Politics and money alone won't solve the issue. Get the policy right and the benefits are substantial because not only are you going to be able to rectify the problems that presently exist but you will also be able to restore confidence to a sector that will underwrite future growth, jobs and investment. 

To build an appropriate policy response you need to understand the history. A simple google search shows that in 2001 this was as big an issue in Sydney as it is now. Before then windows were popping out on the street in Melbourne in the late 90’s and massive waterproofing issues occurring all around Australia. Building owners back then were looking at long term performance guarantees from contractors. It was simply too expensive to provide these guarantees and except for a few buildings they never really took hold. 

While it was a problem back then and has always been, this time there is a greater risk. Last year Sydney had the highest number of apartment completions ever (growing by 24%). Completions have been roaring ahead for half a decade. Whilst the overwhelming majority of developers are world class in this market there are a small minority who aren't. With record completions and stock there will be more major structural defects experienced. 

While it is totally unreasonable to expect there to be no defects in building, the starting premise for good policy is how do you design a policy that minimises risk and provides solutions to major structural defects rectification. This is not complex. New South Wales had a system in place called home owners warranty insurance. It provided an insurance solution to defects. In the early 2000’s the collapse of HIH led to a collapse of the scheme as insurers left the market. No insurance companies were willing to take a position in the market and the scheme was wound back and limited to properties less than 4 storeys with capped insurance of last resort. 

The simplest solution to the problem is to find a way to reintroduce home builders warranty insurance for apartment buildings (or something similar). Interestingly, there are ways that this could be done. The Baird Government introduced far reaching strata reforms in 2015. As part of these reforms developers/contractors are required to provide 2% of construction costs as a defect bond. That bond applies to the specific development and is designed to provide monies for the owners’ corporation to rectify defects. Any monies left over are returned to the developer.  

The proposed solution may not be popular in the short term but if the funds were pooled (i.e. could be used to rectify defects in buildings that were not constructed by the developer) then funds would be available to rectify the broader defects issue. Developers/builders would be right to complain because such a system enables a few poor and unethical developers/builders to free ride on the back of the majority of good ones.  To solve this problem, a system of accrediting developers/builders could be implemented whereby their financial bona fides, development history and capabilities are assessed based on their proposed development. A risk premium to the defects bond could be adjusted based on the review. Developers/builders with a good building history would pay less than the 2% in the medium term and the ones with a poor history would pay far more. 

This is the first step toward reintroducing an insurance product. The framework is there. Government may very well need to initially establish the market so claims history can be determined but there could be funds available to solve the defects issue by using the bond. Importantly, it could provide certainty to those effected and instill confidence of future investors. 

There are other issues that require attention as well for this to work. To stop builders walking away from their obligations, accreditation should also come with personal guarantees.  A taxi rank system should be introduced for certifiers and certifiers should be recognised by the relevant local council. Some changes to the earlier strata forms should be reconsidered such as the length of time a strata manager can be appointed by the developer. It should be reverted back to three years. But at the same time, strata managers should not be allowed to provide asset or facilities management services to give the owners corporations greater transparency. 

The bones of a policy solution are there. Sure, there will be some disgruntled interest groups. But at the moment most (except the developers who have been surprisingly quiet) are trying to cost and risk shift – any rational actor would do this. What we risk is a major compliance overload that can't stop defects but will bring with it an administrative dead weight loss that will jeopardise the viability of building apartments in NSW.  Everyone should all take a step back and look at the impacts on the industry, market, jobs and the broader economy. More importantly, they should remember there are people who are looking for a speedy resolution to their misfortune.