Welcome to Talking Property, our CBRE podcast series where our team of experts, clients, and industry specialists share insights into the way we live, work, and invest through the lens of commercial real estate. Hosting this episode is Sameer Chopra, CBRE's Pacific Head of Research.
SC:
Today, we'll talk about construction costs, which are one of the top-of-mind issues for our industry after significant price escalations in the past 24 months. Recall the outlook for construction costs was a key theme for our 2023 Pacific Market Outlook report. We took the non-consensus view that construction costs could face deflationary pressure, so to talk us through their views on what to expect this year, I'm joined by Matt Bourne, the newly appointed CEO of construction company, Roberts Co, and Tiffany Emmett, she's the Senior Economist at Turner & Townsend. Thanks for joining me today.
TE:
Thanks, Sameer. Thanks for having us.
MB:
Thanks, Sameer. Pleasure to be here.
SC:
Great. Maybe I'll turn to you first, Matt, and Tiffany, please join in as well. 2022 saw double digit type increases in construction costs nationally, and based on sort of early trends in 2023 for this year, do you expect we'll get that similar double digits, single digits, or could we even get flattish construction costs?
MB:
Yeah, thanks Sameer. Look, I think it's certainly an interesting time we're in from what everyone's been through with the volatility of the last few years and especially the last 12 months where a lot of people have been caught out and you've seen the effect of that. Really what we're seeing at the moment is probably really a mixture of single digits and potentially flat. So, it's quite an interesting discussion where there's still some, what I call, uncontrollable spikes, and risks in the market with some international supply chains. It's very hard to put your finger on it and forecast correctly. But there's also some potentially, I'm not saying going backwards at all, but potentially levelling in some areas and look, I was even involved in some tender reviews for some projects in Sydney and Melbourne before they sort of go in. I was quite surprised to see a bit of levelling in the Reo price starting to come through and a recommendation even from our team, dare I say it, but that we might not put some escalation on that because we expect potentially a fall in that area, but we haven't seen that fall yet. And the validity of the pricing from the suppliers is still 24 hours or thereabouts. So, it's still hard to lock them down long term.
And that's when you get a clash with, you know, the contracts that we're entering into that take sometimes a while to solidify and to actually move ahead. So, we're really seeing a bit of a mix. I'd say definitely not double digits. We can confidently say that from our point of view, from what we're seeing. We are expecting single digits, some flat, but still some spikes in some areas such as where you've got a high energy usage. Gyprock for example, they've had I think two sort of 30% increases in supply in the last six months. And really the subcontract market can't forecast that. And so, we believe it's to do with manufacturing and the gas prices in the supply chain and so forth, really pushing that up. So really trying to put your finger on that. We can forecast labour increases, you know, EBAs are getting resolved now, so we can probably reasonably forecast where that will be the next few years. But the supply costs where you've got a high energy usage is where we're getting some spikes. And then of course you get the world events that we've all been through that you just can't control. if there was an escalation further in Ukraine, further lockdown in China, another shipping company decides to get a ship stuck in a canal and make money out of that, which I won't go on about. Or another escalation of sort of world tension, I think that's the risk that we can't control and we're looking to speak to clients about at the moment.
TE:
And just to add on Matt's point, that's certainly what we are seeing as well at the moment. Building material costs for a lot of them have actually started to stabilise. Part of what I do is look at statistics and the ABS and looking at those price indicators. And we are actually seeing that quite a lot of prices are stabilising and in some instances falling. So things like reinforcement, structural, steel, glass, electrical materials, all of those sorts of components that can be sourced internationally or come through global supply chains. We're actually seeing that a lot of prices are starting to now come down. So, I think that is a positive indicator in terms of the level of growth that we're likely to see over the course of the year. Over the last couple of years, a big driver of what's increased prices has been around building material costs. So, if we're going to see some stabilisation with those material costs, then we are likely not going to see the same level of growth or escalation that we have over the last couple of years. As Matt said, the challenges, where we are seeing prices continue to rise is around labour costs. So, there's a big shortage of workers right around construction markets in Australia at the moment, and labour costs are starting to rise quite sharply, particularly on construction projects and also in preliminary costs. So, things like overheads, insurance, basically anything that's got to do with CPI or is flagged to CPI, that's where we're starting to see prices really start to increase and I think we'll continue to see that over the course of the year.
MB:
Yeah, we've been involved in meetings the last few weeks and sort of forecasting an increase in insurance costs, especially PI and so forth with a lack of diversity on the market there at the moment and the overhead costs that's spot on, Tiffany. That's what we're seeing as well. It's interesting, one of the tenders I was in of project reviews, we potentially discussed a delayed procurement strategy for some trades to sort of look at should we look at riding out the next six months before we let them to potentially stabilise the trades. So that discussion, we haven't implemented that yet, but that actual discussion I haven't seen for a long time. So that's a potential positive sign, but it's not there yet.
TE:
And certainly, one of the interesting things that we're seeing as well is that while the data isn't necessarily telling us that wages are going up really sharply, it's in all of these sign-on bonuses and big site allowances and data that's not actually reported in the official statistics where we're seeing a lot of these price increases occur, particularly around construction labour and those trades that are the most in demand.
MB:
Yeah. And you know , I was speaking to some major electrical contractors the last few weeks, Tiffany, and that's exactly what the message that we're getting - while they've signed the new EBAs, and it might only say an incremental two and a half percent increases for a consolidated five in the year or a little bit more, the real cost in the first year is something like 16% or 17% with meal allowances and site allowances and so forth and all those other hidden costs going up. And then before getting into a regular sort of routine from there. So that's really now across the board with the tier one electrical contractors throughout the country. So that's in play right now.
SC:
Has any of the migration helped ease some of this labour constraint in the market?
TE:
From what we are seeing at the moment, Sameer, is that even though we have had the return of international migration and there are certain skills that are on the skills priority list and a lot of them are in construction, it's going to take a lot of people to actually fill some of the gaps sufficiently that we have in the market at the moment. Infrastructure Australia actually released a report last year, which said that the pipeline of work ahead is going to require a workforce double the size of what we have here in the domestic market. So that just highlights, you know, the deficiency we have in terms of the skills that we need to fulfil these projects and the demand.
MB:
And the perception of Australia internationally as a place to come and work has probably changed dramatically in the last three years as well, Sameer, from some feedback we've received, you know, in comparison to maybe Canada or somewhere like that, where you're really going to be potentially exposed to state governments acting alone. Deep lockdowns, people stuck in mid-flights on the way to Perth being turned back. All those horror stories of Melbourne being the most lockdown city in the world. There's repercussions internationally as a place to come and work is still around. So, I agree with Tiffany, a lot of work to go before those numbers really have an effect on the supply chain.
SC:
It's an interesting point that you raise about this big jump in infrastructure spending, Tiffany. So, infrastructure spending is clashing with commercial and residential construction needs. Do you see any scope for one of those three components to sort of come down, to sort of balance out this huge demand that's out there in infrastructure?
TE:
Yes, so I look certainly what we are seeing at the moment is there is a bit of a pullback from the private sector in terms of new investment. We have interest rates going up quite quickly, which means higher borrowing costs, construction costs are surging at the moment. We've seen, you know, nearly a 30% increase over the last couple of years across the commercial sector and also there's severe labour shortages as well. So, there aren't the people to actually deliver a lot of these projects and that's dampening the appetite of some clients in the private sector. So, while these economic challenges continue and while we continue to see this volatility and uncertainty, we may actually see a bit of softening in the private sector. The public sector on the other hand, they're pressing ahead. There is a huge pipeline of work coming through, not just in major transport infrastructure projects, but also in things like health and education. You know, there's a huge amount of spending that's continuing to come through and while we might see a bit of softening from the private sector, it's likely that this strong spend from the public sector is going to keep markets quite active over the next couple of years.
SC:
Matt, are you seeing a lot of work from government and is over station development some of the most attractive markets out there?
MB:
Well, yes, so agree with Tiffany. Absolutely on target there with the government work and just some comments on the public sector. Yes, I've got some really sort of interesting stories, which I can't name the projects or the clients, but we've had, you know , we've probably seen five private developments fall over in Sydney in the last four months that we've been involved with three of them where we've actually won the bid, we've won the bid, got through the process, and then a point in time the developer has realised their feasibility is in trouble because of all these rising costs. And the end result is the project's not going ahead. And so, all that time on the market going through the process, the expenditure, the investment from the tender as the client themselves, the finances, everything like that, and to have those stop, we're seeing that quite a lot. And also, not just for feasibility reasons, but for, you know, approval reasons with governments and so forth. So not sort of really, you know, with authorities and delays and all sorts of things. So, there's a real mixed bag privately. So, we've certainly got a focus to ensure a good diversification regionally with government work across the government sectors and that includes, you know, potentially stations and OSDs and things like that as well. So, I think most building companies will be looking to do that at the moment to ensure a stability in the pipeline in the next few years. There are some developers that do have a big workbook and are moving ahead and if you're smart, you'll partner with one or two of those. And so, there is a few that we're speaking to that are moving ahead. But you know, the tender lists are big. So we went through the prospects here yesterday for our New South Wales region and it was quite large. But we really had to re-look at it and how many of them are really real and are really going to move ahead even after bid. So, there's a whole discussion point required about how builders should engage with developers and so forth early on and sort of check feasibilities and have they got the real numbers and have they got the latest data really from the market where they are as to how they should move ahead.
SC:
And Matt, are you able to source raw materials now on time because, you know, say a year ago, year and a half ago, there was a lot of supply chain constraints. Is stuff now appearing? Is there enough stock there?
MB:
Yes, I think so. Our markets in Sydney and Melbourne, our projects at the moment are working through fine with supply. I haven't had any supply challenges elevated in the time that I've been here at Roberts Co whereas start of last year, obviously my previous role, we still had some switch gear and different things stuck in China, still waiting to get to the port and you're really micromanaging not just to get out of the port, but to get to the port itself. You know, to get in line with everyone else. But what we are starting to see in that is, we are, and I'm sure a lot of other cohorts are taking a more active role on the supply chain, making sure we're overseas looking at things and really looking to diversify that supply, which should result in some more surety on projects going forward now that the world's open again and we're moving. So, in a nutshell, we're not seeing anything really stopping at the moment and we're really looking to dive deeper into the supply chain to get a bit more control.
SC:
Just a question for you on overall tender pipelines. Are you seeing more bidding activity? Is bidding activity slowing down? Is it taking longer from the time you initiate on a bid to the time you close out on a bid? What's going on with bidding timelines and bidding activities?
MB:
Yes, I mean you're talking about the pipeline and then how long it takes to come to market and to turn it into a real project. Yes, that is taking longer we're finding. That's a constant discussion. Like if we were to allow in bids the expected time from after the bid goes into before you really signed the contract, compared to where it was 15 or 20 years ago, it's multiple out three or fourfold now. We've had multiple projects in Sydney delayed by six plus months, which is a real effect on a business like ours that's growing and to try and substitute a project, yes, while it's great there's still some revenue or margin banked that moves into the next financial year, but it creates a hole for that. You've got staff holding costs and so forth and how much you invest and what you do there. So those costs are really hard to realise and to have discussions with clients about. There's a healthy positive tensional discussion that you can have, but they're real discussions. So, we are seeing that it does take longer to get to market and as I was saying before, some of them don't get to market. Like we've had a project that was circa $200 million that we won the tender for, client came back seeking $20 or $30 million VE. The team worked hard to find it and that's really hard to find on a project of that size. You're really skinning the cat as there's not much being left there. That's a really tight project, team did great, really great relationship, but at the end of the day they couldn't still get the feasibility across the line. So, what advice have they got to get the cost that wrong at the start when the tender process went for six or seven weeks? You know, so, we're seeing a number of those stop in the private world, yes, but not the public sector world. As Tiffany was saying, they're moving ahead and still some challenges more in the public sector world with approvals. So, it's more the SSDA approvals or dare I say it, they're getting the council approvals and so forth. And especially in New South Wales is problematic in taking time and authority approvals. Whatever it might be, is causing some delays to a number of projects.
SC:
And Tiffany, maybe one for you. You know, there's been this pickup in risks around insolvencies in the construction sector. Is this just a return to normal or are we seeing elevated levels of insolvencies?
TE:
Yes, so a lot of the insolvencies that have occurred are happening for a range of reasons, but primarily it's because of the cost increases that we've seen over the last couple of years. In a lot of instances, clients and builders had entered into a fixed price contract and with costs increasing so substantially, a lot of builders actually made a loss on their projects. And there are still projects coming through the pipeline that are being impacted by this. So that's really eroded margins, it's really impacted cash flow for a lot of businesses. We're not just seeing it with builders as well, it's subcontractors as well on the lower levels and also the smaller businesses where cash flow is a big challenge for them. So certainly, I think that now moving forward, builders are being a lot more careful with risk and we're seeing a lot more risk mitigation strategies being incorporated. So, whether that's things like a rise and fall provision in contracts or really having a better understanding of what's happening in the market, that's really started to pick up. So, moving forward, we're probably not going to see the same level of insolvencies that we have already, but possibly there still could be a handful more to come through where businesses are just operating at this loss and really it's only a matter of time. So, I think moving forward, it is a bit more of a positive outlook and certainly with the losses that we've had in terms of insolvencies, that does impact a market in terms of the pool of available workers and that also impacts tendering activity as well. But hopefully the situation should improve over the next sort of 12 to 24 months.
SC:
Matt, is it a big issue when you're looking at a project and scoping it out?
MB:
Yes, absolutely. And Tiffany's correct there. So, from what we're seeing, we're hoping there's not, whether it be subcontractors, builders or smaller businesses, we hope there's not any more insolvencies. But we think there will be. There has been some recently, quite large ones. Subcontractors that have gone down as we know some builders quite recently, nationally. So, it's very alarming and I think the tail of the last few years is certainly going to sting a few people. And cash is king. Basically, if they don't have the cash balance and can't trade their way through, they're going to go. So, we expect most builders' and subcontractors' profits and margins this financial year would be dramatically down from where they've been and potentially still a tail in the next financial year as well. So, there's certainly those projects still going. You know, our belief at the moment, my belief, it's really time to sort of us builders especially to have a good look at ourselves in lockdown. Be serious and have a serious talk to clients about, you know, rise and fall provisions and risks going forward, unrealistic bids and unrealistic margins. You can't survive on a 2% or 3% margin on a bid. Businesses just can't survive. And so, it's not a dirty word to talk about a margin and most clients will welcome a discussion from what I've experienced in recent months about, you know, how do we approach this the right way and how do we add value to your projects rather than just going for the cheapest price and can you select on value rather than price? Yes, that might be the same people sometimes really trying to work through that with clients and have that intelligent discussion. And we've got some developers that are there at the moment. So, you know, I had a phone call from a developer the other day really trying to work with us. We're doing a project for them in Melbourne at the moment. They're locking down their pipeline the next 12 months. They're not starting anything but they really want to stay in touch, share knowledge. They're open to us if we see a subcontractor in trouble, they want talk to us about it and how they can help us because it helps them. So that's really positive and pragmatic discussion that we're seeing from some progressive developers, which is really good to see. But you know, still, there's some in the private world that there's a race to the bottom. Which I think as builders, we've got to push back collectively and ensure that we also do the same with our subcontractors. I had a good talk to a couple of national sort of tier one contractors the last few weeks and they're pushing us to make sure when we put them on a list, it's like for like, it's tier one subcontractors on a list, don't sneak a tier three in and expect their price to drop down to that tier three level. Because that's what you see with some of the insolvencies in the subcontract market. We've had one on two of our jobs and the price to replace them goes into the millions. And to be fair, we probably didn't have them on the right price at the start. You know, we're part of the blame there. We didn't have the right price at the start. We took a lower price that went up the line. Developers see that as the market, but it's an unrealistic market. And also, the risk profile that we've had in other conversations from developers or even some government bodies, dare I say it: "well this is the market, you need to accept this". Well, it's not actually, the market's been unrealistic the last few years, we need to have another talk about that. But you can have a sensible talk. We talked about escalation just before. You can pick out the spikes, one or two spikes, not across the board, and really do a [indecipherable], you know, if Reo drops, they should also get the benefit of that at the same time. So, I think that would be a really, really good discussion and that's what we are looking to do with some clients and also how we can partner with them based on value rather than a straight out drag race to a cost. So that's what we are looking to encourage across the board.
SC:
And is construction cost moving at very different paces around the country? We're hearing Brisbane is really tight. You know, there's probably a little bit more capacity in Sydney and Melbourne, but what's your perspective?
TE:
Yes, Brisbane. Look, Brisbane is really hot right now. There is a lot happening there. We've obviously got quite a lot of investment from the state government, which is driving a lot of new projects across health, across infrastructure, those sorts of things. But we're also seeing quite a big uptick from the private sector too. There's a lot of major developments going on in residential, commercial, these big projects that are happening across the city. And we also have the fact that the Olympics are coming there as well. So, getting ready for the Olympics and all of the planning that's going into these new venues and upgrades to venues as well. So, there's a lot happening there. Certainly, in Melbourne and Sydney it's probably not as hot as what we're seeing in Brisbane, but there's still quite a lot of activity underway. There's still big pipelines and backlogs of work to be completed and that are still ongoing at the moment, but we're probably going to see a little bit of softening over the next two years in terms of construction activity, and this is going back to that point of the private sector. So, the private sector, obviously we're seeing less new investment, we're seeing some projects get held, so that's going to ease some of the pressure on markets in terms of market capacity.
MB:
Yes, look, we agree we're seeing that as well. There's still a pipeline in Sydney and Melbourne and a little bit different, you know, whereas Melbourne's is sort of fair bit CBD wise, Sydney's a bit more spread out in regional and quite a mix. But Brisbane's certainly taking off. We're not in the Brisbane market. We don't have any plans to go to the Brisbane market for different reasons, but what we're concerned about there is the amount of work coming up in Brisbane. You know, even the major projects such as the Cabarita development, the waterfront, everything that's going on at the moment is really going to be the supply chain can't handle that up there. So, there'll be a drag of supply chains heading north. There'll be a drag of skilled project directors, engineers and everything looking to go north. So how Sydney and Melbourne manage that going forward will be an interesting challenge. I believe so because I don't think that supply chain in Brisbane can manage the work coming up at all. And they're used to a lot smaller market, so it's a dramatic shift up in that market. But down in Sydney and Melbourne, you know, I think the end of last year, I think the tower crane index was actually up, but we're seeing potentially Melbourne a bit drier supply now. So, needing to partner with the right developers and, and also public sector work. And Sydney, the challenge definitely is in the private market as I was talking about before whether the jobs actually really go ahead even after a tender versus the pipeline and health, the pipeline and schools, the pipeline with Metro and transport at the moment. Major, major projects all happening in the next four years that needs a really solid pipeline of tier one, tier two subcontractors, but they're also required up in Brisbane. So, I think that could potentially lead to some pricing escalation in the tier one, tier two subcontract market because of simple supply and demand. But we'll need to monitor that closely here going forward.
SC:
And my final question is - Matt, I'll start with you and then move to Tiffany - what would be your best advice to a developer who's about to kick off a new project?
MB:
Yes, look my best advice, and we have had this discussion with some developers the last few weeks, is sort of really be smart about the early advice you get. Early partnering; we know everyone seems to want to do a drag race to a bid, which is what's been happening for 30 years, but look what it's doing to the market to be frank about it. We've got insolvencies across the board; we've got probably more to come. It's not good for anyone, it's not good for developers, it's not good for the market, it's not good for the economy. So, I think if they can really focus on a partner that provides value to the development, a number of us contractors are more than happy to provide that sort of, as a partnering, you know, call it a lost lead early on and provide some cost advice from the market along with the consulting fraternity as well to really provide some advice early on. Just make sure the feasibility is correct. So, we're asking some developers now if we can have our eyes on some sort of numbers so we can give some early advice even when a tender comes out. So, some do, some don't because we really want that surety ourselves. So, the best advice is to be smart about early advice, early partnering, look for a value for money partner and look for surety of development versus lowest cost.
SC:
Tiffany?
TE:
Yes, so my advice to a developer is really to try and be across what's happening in the market you're building in and to know your risks. Having a good understanding of what competing projects are underway, what the market capacity is, whether or not there's significant shortages. This is all really going to help to provide a better understanding of potential cost increases that may come across your project. So, markets have been really volatile over the last couple of years and we've seen things change quite quickly and quite dramatically as well. And this has really caught a lot of developers out and also builders as we've seen with insolvencies. So really ensuring that you're across the market and understanding what sufficient escalation allowances are likely to occur on projects, that's really important and we would recommend seeking advice for that, getting independent advice in some instances, more than one source as well. So that would be my advice to developers.
SC:
Great. Thank you so much for your time, Matt and Tiffany. It's been a fascinating conversation and there's clearly a lot to consider this year as the market unfolds. Thanks for tuning in to the latest episode of Talking Property with CBRE. If you'd like the show and want to check out more, visit
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