Why is the cost of construction skyrocketing in Australia?
Constructions costs for new buildings are not just ‘increasing’ Australia, they are growing exponentially. Why is this and what does it mean for long term investors? Does it affect some types of properties more than others? These are all important questions that every investor needs to keep in mind.
In Australia, the government and society promote the idea of ‘the great Australian dream’. This ‘dream’ can be found in many other countries as well. For example, we have the ‘great American dream’, and Singapore’s founding Prime Minister, Lee Kuan Yew, was quoted many times about his “primary pre-occupation” of “100% home ownership for Singaporeans”.
Compounding this has been the ‘great spreading out’ from the CBD and non-landed properties to the outer areas into larger homes. Thus, there is always a continuous and strong demand for not just residential developments, but also commercial development and infrastructure creation such as roads, bridges, etc. Major undertakings such as these require a great deal of inputs (such as materials, skilled labour, permits, etc). Plus, competing them (especially post-covid, where governments are spending big to stimulate the economy) has led to great competition for these inputs and price rises. As a result, has led to demand side price rises.
Unusually, and simultaneously, in Australia (plus in other parts of our interconnected world) we have had supply chain delays. These interruptions have been caused by lockdowns, government delays in approvals, soaring energy costs for transport & production of materials, lack of skilled staff, natural disasters (e.g., floods & bushfires which by some estimates wiped out 25% of the plantation timber stocks in NSW), wars, etc. Unfortunately, this has resulted in supply side price rises.
The total effect of the ‘supply-side’ & ‘demand-side’ price inflation has been particularly hard on building companies in Australia. During Covid, the Australian government allowed businesses to trade in a protected way (as normally, it’s illegal for any business to trade insolvently & it makes the directors of the business personally liable for any outstanding debts if they do). However, during Covid businesses were not able to forecast their future and potential cashflows. Therefore, they were allowed to continue trading (in the hopes of trading their way back to profit after Covid and retaining as many of their staff as possible). Unfortunately, the Government’s ‘safe harbour’ came to an end, and nearly 4000 business declared bankruptcy, of which approximately 20% were building and construction businesses. The media in Australia has been constantly showing building companies (both big and small) going bankrupt.
This high level of bankruptcy in the building & construction industry is primarily because of the business model that most builders use. Usually, a builder signs a ‘fixed price contract’ with a buyer to build a home on their plot of land. The builder, based on their experience, would price the construction at a high enough amount to cover any increase in inputs (e.g., materials, labour, permits, etc.) plus a profit margin. Larger commercial builders (usually for projects over AU$1 million dollars), can agree to a ‘cost plus’ contract (sometimes referred to as a ‘rise and fall contract’), where they simply make a margin over the costs (which are transparent between the client & builder). One of the peak building bodies in Australia, the Housing Institute of Australia (HIA) is calling on governments to allow builders to pass on additional costs to the buyer and moving from ‘fixed price’ contracts to ‘cost plus’ style contracts for building projects under AU$1million in the residential space.
Let’s highlight how hard builders’ profit margins are being squeezed. According to the Australian Bureau of Statistics (ABS), overall building materials have risen 12% in 2021 (the strongest since 1981) and are expected to be substantially higher in 2022. Also, one of the peak bodies for residential construction, the Master Builders Association (MBA), released figures showing timber prices had risen by 39%, and steel by 37%. Additionally, with strong inflation & higher interest rates in the US & Europe, many building material producers are preferring to sell into those markets instead of Australia.
Many residential builders have simply handed back or cancelled contracts (as they would have incurred losses by completing them). Worse still, some have gone bankrupt part way through building a home. In the first case, getting a re-quote from another builder would simply result in a higher build contract price, which is not ideal, but it is workable. However, the second scenario can be financially disastrous for the owner because getting another builder to complete (and take all the legal compliance responsibilities) is both difficult and costly. Plus, the owner would be simultaneously fighting the builder’s insurance for some compensation, all the while paying holding costs such as interest. Therefore, it is critical to use not just a reputable builder, but also one that has the strength to withstand financial pressures, efficient processes to lower costs and an almost ‘fulltime’ workforce of tradespeople.
In fact, even in this abnormal environment, Tick homes (Resimax Group’s volume builder), is actually increasing the number of homes it is building. And due to the financial backing of its diversified parent Resimax Group (which has just had equity stakes acquired by a tier 1 international bank – Japan’s Nomura and the 3rd largest insurer in the world – Allianz), is honouring and completing all build contracts and not asking clients for any additional amounts.
So usually, when a landed bungalow ‘rises’ in value over the long term, it’s actually the land that appreciates whereas the bungalow/building depreciates. However, at the moment, with the cost to complete a bungalow/building rising so fast, it means that the bungalow is ALSO appreciating (i.e., the ‘replacement cost’ of the bungalow is going up). Unlike older, existing homes in built out areas, newly built homes are usually in new estates, and due to inflation, every new bungalow being built will be more expensive than the ones already there (plus the land plots are usually escalating at the same time). This will force faster capital growth than usual. In addition, under the new ‘hybrid work’ model (where people want a bigger home with an extra bedroom (or two) in an environment with great amenities), they will seek out and pay a premium to live in masterplanned estates that offer them the home they want in the environment they want. These are the types of homes that Tick specialises in, and areas that Resimax Group develops in to masterplanned communities.
Disclaimer: This article is for general information purposes only and should not be taken as advice. Always seek professional advice from suitably qualified professionals familiar with your situation and goals.
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Steven Molnar is Head of Research and Education for Resimax group. With over 25 years in property and finance in Australia and internationally, he brings a unique perspective to each interview with interesting guests and property insights. Resimax group is one of Australia’s largest private property developers, Resimax Group Investor is headquartered in Kuala Lumpur MY.