Over the last year inflation in construction projects has been zero and possibly negative in some areas – so what’s happening now and is there anything that will help the development community get back to business?
Activity you would have to say is patchy at best – there have been some recent improvements but there is still real pain in the development sector.
This is predominantly as a result of project financiers still having a tight grip on lending for development projects.
There have been some well documented cases around of good and viable projects, with strong unconditional sales in place that cannot get the required funding to commence. There have been a number of private equity groups and institutions funding (maybe bailing out) some developments which is encouraging but these remain few and far between.
Our level of enquiry for financiers development risk reporting dropped from around 10 to 20 projects per week back to zero for a while but has moved up on average to three or four projects per week – so there are signs of improvement on this front.
There are obviously a number of factors that contribute to price escalation and the major ones are activity based.
We will see another large swathe of school projects kick into action very soon that will run through to the end of 2011 and this will keep pricing up in the smaller to medium end of the construction market – especially in the $2 to $5 million smaller range and the $5 to $20 million medium range, and probably up to a maximum of $30 million in size, as larger contractors shrink back into smaller range markets.
At the large project end of town it is substantially more competitive, the more you spend the larger the discount you’re going to get – so basically the more you spend the cheaper per square metre to build – nice work if you can get it.
The Queensland Government’s construction cost inflation index predicts an increase of 2 per cent to June 2011 and a further 5 per cent to June 2012 – we would probably concur with the 2011 but are maybe a little bit less aggressive in the two year forecast with a view of between 3 and 4 per cent.
The much talked about devaluation of the Chinese Yuan will possibly have an effect on pricing depending on where it takes the Australian dollar, but some predictions, particularly one by Morgan Stanley, are that a significant movement in the Yuan may reduce the Australian dollar to as low as 77 to 78 cents against the US dollar by year end which would effect the price of many imported items like lifts, mechanical services, glass, kitchens, sanitary ware and lights. But what actual dollar increase in construction costs this causes, varies by project type and size and therefore remains to be seen.
So even a prolonged downturn in this sector hasn’t really seen a significant reduction in costs to build. There a number of issues that are clearly going to continue to make it tough to get developments to work going forward, including rising interest rates.
As an aside, but also relevant to overall cost of development, the most crazy thing about all this is the acknowledged shortage of stock in certain areas, especially residential stock, be it houses, suburban apartments or town houses.
As demand for these assets continues to rise, so too does the price of land suitable to develop.
So there is clearly a timing issue here, the sooner you can realise the value of the land by developing it the better, but not-withstanding the market need for development, it becomes a bit of a snakes and ladders game created by the inability to get funding.
On the upside a stronger and rising economy and equities market will assist with affordability, certainty and definitely with the desire for individuals and companies to invest.
This combined with a general upswing in confidence may assist in us in getting back to business sooner rather than later.