KB
Hello and welcome to Talking Property with CBRE.
A podcast in which our team of experts are clients and industry specialists share insights into their that we live, work and invest through the lens of commercial real estate. My name is Kate Bailey, Director of Research in the Pacific and I'm your host for today's episode.
Today we're talking about a very topical issue. Construction costs. How high will they go? How are developers managing increases? And what is the outlook for the Australian economy?
To help me unpack this topic, I'm joined today by Carlos Cacho, Australian Chief Economist at Jarden. Jarden is a leading investment and advisory group offering a range of investment products and services to clients operating in wholesale and retail markets in Australia, New Zealand and around the world and Richard Hume, Victorian State Director of Project Management at CBRE Pacific. Thank you both for joining me today.
CC
Thanks for having me, Kate.
RH
Thanks, Kate. Good to be with you.
KB
Well, costs in construction have spiked in recent months, driven by inflation, economic stimulus and supply chain challenges. The increase in construction costs is putting pressure on a development pipeline margins and timelines. Carlos to start, could you provide a bit of an overview around what challenges you see facing the economy and how these are impacting on construction costs?
CC
I think the thing with the construction costs is we've seen both demand and supply dynamics playing in there. On the demand side, we need to realise how unprecedented this surge in home construction around Australia is at the moment. In a normal year, we build maybe 110,000 detached houses in Australia. In 2021, 150,000 detached houses started construction. On top of that, we had over 120,000 applications for the Home Builder Stimulus programme through late 2020/2021. If you go back further before that, we also had the bushfires which not only destroyed houses but also impacted the supply of lumber through some key plantations - there's been a range of factors. Then you add on the supply side, we've had these global supply chain disruptions. Shipping costs are up in some cases 10 times, so there's a range of forces here at play on both sides to really making it very, very challenging for the construction sector. Then you add to that the fact that governments are trying to stimulate demand by spending on infrastructure and the pipeline of total construction across the economy is at a record level. So and that was before we even had the floods. So it's really just the odds are really stacked up against the construction sector from both the demand and supply side, and it's a very challenging environment. It started off being mostly timber and steel earlier in the piece and now at the data we get from the ABS that I look at now, it's really broadened out pretty much any item in construction is seeing pretty decent double digit increases, which is making things very challenging for both developers, builders, for home purchases. Really everyone involved in this sector.
KB
Yeah, it sounds like a bit of a perfect storm at the moment, really and Rich from your perspective, what some of the impacts of these rising costs being on developers and do you think that it's going to alleviate any time soon?
RH
12 months, I think, at least at the moment. But when we're talking developers, I'm also referring to our clients in general, so developers are only one part of the industry, but our clients are feeling it right across all sectors. So whether it's residential or commercial, whether it's the occupiers or the investors, schools, hospitals. They're all feeling the same thing. So I'll be talking from a perspective, all clients out there, not just developers.
From an overall perspective, what we've collected in the last 12 months is a 10-30% increase in construction costs across the board and as I said before, we think that's going to go for another 12 months. Certain materials are worse hit than others. We've seen ranges of 20% increases right up to 400% increases. The key ones the steel, concrete, timber, plasterboard, aluminum, copper and when you're doing fit outs and that sort of thing technology particularly, has been very heavily affected. The escalation component in a quantity surveyors estimate who normally put budgets together, that increase has gone up 50% so that's what the industry moves in that time. We've just recently attended a $400 million new build and that escalation figure just in this year alone has increased for a project of that size from five million to nine million. So we're seeing a huge increase in costs. The big impacts are the material cost increases, the skilled labour shortage is probably the biggest issue, sub-contractors and builders coverage out in the industry. Builders and subcontractors are only pricing for real projects, which is affecting tender results and the appetite for risk. So builders at the moment aren't generally aren't providing fixed pricing across the board, they're not responding to tight programs, so there's a huge impact and it's mainly due to the supply chain disruption, the transportation bottlenecks, the war, rising inflation and labour shortages.
KB
Off the back of that then they changing any plans or changing around materials to try and combat any of these increases in costs?
RH
Definitely most builders and subcontractors, designers and clients, they're all aware of the current environment. So they're all responding at the moment. There's two types of projects out there at the moment. There's the projects that were committed pre-pandemic, so projects that have been going for two years and those builders have had to respond and clients have had to respond in a different way to the projects that are currently being planned and procured, they're completely different.
So the poor developer of the poor builder that signed up to fix prices pre pandemic are the ones that are really struggling at the moment. You know, they're struggling with subcontractor attendance on site buildings that have taken on fixed prices and taken on the risk of escalation and they've had to wear that over the last two years that 10-30% that I spoke about. There's been extensions of time because trades just aren't turning up to site or there's just a real shortage of skilled talent and what's happening, these builders are generally running late, they're generally losing money because they've had to absorb all that in the last two years and it's a really tough environment for those projects underway.
We're seeing clients and builders where they're taking a reasonable middle ground where both giving a bit and arriving at a reasonable sharing of that pain, for example, it might be an extension of time without cost to a builder. Things like that and then there's the projects that are being planned, as I said at the moment, and they're being delivered in a completely different way. Different budgets are being set at the moment. The quantity surveyor are building in that 10-30% escalation into their numbers. So that affects the feasibility and then all the design consultants are also being much more careful on how they design their buildings. They're avoiding or dealing with those lead time pressures and the cost pressures on those certain type of materials and the good smart developers and the smart designers are all addressing it in that sort of early stage of planning. So definitely seeing changes in the way we deliver projects, and that's just going to continue for another 12 months.
KB
Yeah, Carlos, you touched on that big boom that we've seen in the amount of residential construction starts over the past 12 months, and obviously bill prices are going up, interest rates are going up, debts getting harder to source. What's your outlook on the domestic housing sector?
CC
It's a challenging outlook, to say the least. When we look at the housing market, we really think the key underlying driver all comes back to interest rates. They determine how much people are able to borrow and, ultimately, how much they're able to pay for housing and with the RBA likely hiking the cash rate through this year to at least 2.5% maybe higher, that's going to have a big impact on how much people can borrow. We estimate that's probably going to see borrowing power reduced in the vicinity of around 20-25% and we’re forecasting at the moment that's going to see house prices fall around 15-20% nationally, which would be the largest correction since the 1980’s.
For housing construction, it's important to remember that, really, the new housing is basically substitute for existing housing as a buyer you've got a choice between buying an existing home or buying a new home, whether it's a new build apartment or a house and land package out in the outer suburbs and so if existing housing becomes materially cheaper, that's going to mean what people are willing to pay for new housing or the attractiveness. New housing is going to change as well, and so we do expect that we are going to see quite a pullback in building construction and particularly approvals over the next 12 to 18 months.
As Richard said, it's going to take a while to flow through if we look at the total amount of work outstanding, the pipeline of residential construction work. We've currently got a record high pipeline there. It's worth on our estimates about 10 to 12 months of current activity levels, so it's not going to be until this time next year that pipeline starts running out and so the industry is not going to face the pinch right away but we're starting to see some of the leading indicators suggesting that's going to come down, and that slowdown is probably going to last into 2024 we think at the early it's just given the lags between building approvals and actual construction activity, particularly for those larger high rise projects which take a long time going from land acquisition to concept and design and sales and approval and actually doing the work on the ground. So we do expect it's going to be a while that we see a bit of softness through the construction sector but importantly I guess to note on the other hand, you do still have a lot of government infrastructure work, a lot of government investment going on. There are certainly some areas of strength, and we're seeing it. Not just residential construction driving the current demand, but also areas of non-residential construction that Richard touched on their commercial building, hospitals, health, education, offices, etc. So there are going to be other pockets that can offset some of that weakness. We expect on the residential side, they are much less sensitive to interest rates than rise in construction is.
Rich did touch on staff shortages as well and we know that unemployment is at a 50 year low or so. A lot of businesses are struggling to find staff, especially the construction sector. What's your outlook on this, and do you think it's going to be resolved anytime soon?
CC
Yeah, look, it's absolutely a massive issue, the labour shortages across the economy. We've got unemployment at 3.5%. You have to go back to the seventies to find a lower unemployment rate than that. In the recent NAB survey, 90% of firms were saying labour availability is a constraint on their production. The only thing that they're worried about more than the labour shortages is actually the cost of labour. That's everything that's higher on their list of concerns at the moment. So it is a real big challenge. It is important, though, to remember that you know that strength in the labour market is also a positive for the economy. We're running strong. Yes, inflation is a challenge. We've got supply chain issues, rising rates, so it's a challenging environment. But the strength in the labour market is likely to be a key source, that strength that supports the consumer through this challenging time. In terms of how this gets resolved, it's going to take a combination of demand and supply. We do expect that as interest rates go up and consumers pull back and see construction moderate there will be a bit of a moderation in the demand for labour. But also we've got to remember that borders have been closed for the last two years and so the working age population in Australia is about 400,000 less than it would have been if we continue to the pre-covid rate of growth. So we've got a lot less people here. We've had a massive boom in demand and so that reopening of borders is also going to help a little bit. Now, we're not expecting migration to snap back to where it was right away. I'm sure you're aware of all the headlines around visa delays. I spoke with some migration agents recently who say it's taking about 6 to 8 months to get a visa approved. at the moment pre-covid that was 2 to 4 weeks and so migration is coming back. But it's probably going to be a little bit slower than we hoped. But we hope that as we're getting into 2023 beyond, we should see that steady stream of skilled migrants coming back into Australia and helping to alleviate those labour supply shortages and bringing those highly needed skills that we need for so many areas, whether it's areas like tech or engineering, construction as you mentioned, there's really severe skills shortages in a lot of these areas that can't be fixed just with domestic training in the short term.
KB
God, that's a huge number 400,000. It's pretty remarkable just that amount of migration flow that Australia has been getting the last couple of years and how important that is to helping us progress and move forward.
Rich, what advice are you giving your clients at the moment, and particularly those that might be in the early stages of planning a development, what are you telling them?
RH
I think being able to adapt to the current environment is an obvious statement. But it's not an easy solution. I mean, selfishly, you know, if a client or a developer doesn't have the internal capability or the internal resources, the knowledge of what's going on, engage an external project manager, which is exactly what we do, who was working in the environment the whole time. He knows the best players in the market. But the most important thing which have always said on project delivery, is you've got to do the work and the prep up front. The more you do up front, the more effort you put in to setting the project well up front, the more chances you will have of a successful delivery, and that that's choosing the right consultants, choosing the right delivery methodology and to spend the time upfront, getting the design documentation correct and the project will not run itself or to be a much more smooth process. If you have to build in the next 12 months, allow enough time to adopt alternative procurement methods. Probably one of the key issues there is engaging with the market, engaging with industry players early. So there's what's called the early contractor involvement or engagement. So currently, with the design, you start engaging with builders, subcontractors and suppliers to make sure that the design that you're developing incorporates the right material selection, the right design to minimise the exposure with all these challenges that we've just mentioned, and if you're lucky enough to have that time to do it, that early engagement is critical. They're probably the main things.
As I mentioned that delivery method that's very, very important. So probably the biggest difference is that developers and clients aren't necessarily going with a traditional, fully documented delivery approach. It's more open book these days where a building gets involved early advises or maybe even on a fee and helps develop the design, and that evolves into a sort of an open book arrangement where builders aren't pricing in excessive risk for labour shortages, availability and that escalation that I've mentioned. So it's really working with the market, engaging consultants who know what they do and managing it properly from the start, they’re probably my main areas of recommendation.
KB
Yes, some solid advice there. Carlos, to finish this off today, get the crystal ball out. What is your outlook on the Australian economy over the next couple of years?
CC
My ball is a little bit foggy at the moment but suffice to say look, it's a challenging outlook in the near term. We've got probably the most aggressive pace of rate hikes we've seen at least 30 years, the highest level of inflation in decades. A lot of pressures on family and household budgets, with those two factors in particular, particularly the fact that a lot of that inflation is driven by essential. So it's driven by food, fuel, rent, electricity, areas of spending we can't really avoid. But it's also important to realise that the starting point is strong. As we discussed, we've got the lowest unemployment rate in 50 years. We currently have the surprisingly given all the challenges, we've got the best outlook for business investment we've seen in more than 10 years with really strong growth in investment intentions, not just in construction, but also in equipment and in software in other areas. While house prices in construction are going to probably fall materially ahead, we've got to remember we've just come off a record boom. House prices had the fastest, strongest boom we've seen over the last two years, so yes, they're coming down but the economy is coming from a real place of strength as we go into this, and at some stage, we're going to see easing again from the RBA. Expectation is that probably by the second half of 2023 we're going to see rate cuts from the RBA, and that's going to put a bit of a floor and a bit of support underneath the housing market. It's going to help household budgets, help people afford to borrow a bit more and probably set us on a bit more of an even keel.
KB
Okay, that's something to something to look forward to back half of 2023 then. Well, thank you both so much for your time today. That has been a really fantastic discussion, and I've got a lot out of it. Rich, particularly around, you know, costs staying elevated for the next 12 months and Carlos some great insights on the economy there, particularly around migration as well.
So thank you both for your time.
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Until next time.
