Escalation of Construction Costs

Recently, we have taken a very topical approach in our blog writing. This one will be no different and will focus on the enormous rise we have seen, and continue to see, in the cost of construction.

While the reasons for this escalation are complex and numerous, we will focus on some of the key areas that have directly contributed to the rising cost of building.

We will also examine some of the flow on effects of these increases, as we are witnessing the direct impact through our business and that of our clients.

Reasons for the Escalation of Construction Cost

Insurance Increases and Increased Cost of Compliance

Anyone who has paid an insurance premium in recent times, whether for property insurance or business insurance, knows that their premium has had a significant increase. In the last few years, our country has forged through savage bushfires and continual flooding, meaning the amount of insurance claims would have increased exponentially. Insurance companies, like any business, need to remain profitable, so they inevitably must recoup their losses from these claims by increasing premiums.

Consider that this cost increase is symptomatic of what is happening more broadly (i.e. cost escalations in all expense categories), so businesses are feeling the squeeze from all sides.

The cost of compliance is another example of an increasing pressure on business. As regulation through most industries continues to tighten, as does the enforcement of such regulation businesses cannot afford to ignore this critical area of business, or it could result in their demise. As such, the only real option is to allocate more
resources to ensure you keep up with your compliant requirements. This increased cost inevitably must be passed on to customers in order for the business to remain economically viable.

Material Shortages

The materials shortages that the builder and developer industry is currently facing is largely a result of the disruption in the supply chain of building materials from the covid-19 pandemic. This has been caused by the numerous lockdowns right across the world, as well as border lockdowns, and natural disasters. These materials shortages make it impossible for developers to accurately predict when a construction project can commence (and therefore finish) as well as the cost of the project.

Labour Shortages

Our recruitment agency recently advised us that Australia (currently) has 7.1 jobs available for every 1 job seeker. If you’ve been finding it difficult to employ people, that probably won’t come as a surprise.

The labour shortage has been driven by a number of factors, including the deficit of workers coming from overseas due to the restrictions and uncertainty around travel during the covid-19 pandemic. With substantially fewer skilled and unskilled workers coming into the country, as well as longer and more frequent periods of employee absenteeism (think of the isolation requirements, not to mention recovery time for those who caught the virus), it is not difficult to understand the flow on impact.

Another factor is the higher volume of work being required in our country. Through a combination of work outflow generated by the recovery from the many natural disasters we have experienced (and continue to experience), and a construction boom from property development and from everyday Aussies spending their dollars on their homes, there has been an avalanche of work available and fewer people to do that work.

Building and Renovation Boom

As we’ve just touched on, the building and renovation boom has been another legacy of the covid-19 pandemic. As people have been spending more and more time at home, through lockdowns, isolation periods, working from home, and lack of ability to travel, they have saved a lot of normal expenditure. It is understandable, therefore, that people have wanted to spend their money on improving their living environment.

As the normal rate of home improvements, renovations and new builds resultantly skyrocketed, everything became more scarce, including the necessary building materials and the availability of the contractors to do the work. When demand increases significantly, and supply simply cannot keep pace with that demand, prices inevitably must go up!

Impact of Escalation of Construction Costs

Difficulty in Obtaining Fixed Price Contracts

As a result of the escalation of the cost of construction supplies, such as timbers, metals and other materials; there is increased uncertainty in the net cost of a building development. I.e., developers and builders cannot confidently quote the cost of building, knowing that their materials pricing is increasing rapidly (sometimes
changing from week to week) and, therefore, cannot risk agreeing to a fixed price contract.

This inability to risk agreeing to a full price contract stems from the fact that, in all likelihood, the development programme will go well over budget, risking the developer (or builder) going into liquidation if they cannot cover the excess. Subsequently, during this escalation, many builders are resorting to “cost-plus”
contracts as an alternative. These contracts allow for builds that go over budget by ensuring that the client understands and agrees that they need to be able to pay for the base amount and then some to fully cover the building costs.

Alternatively, for a builder (or any contractor) to provide a fixed price contract, they must allow sufficient margin to account for the raw materials cost escalation, though by doing so, they potentially price themselves out of the work.

Uncertainty for Developers (Timing and Cost of Development)

Currently within Australia developers are faced with two major issues that directly impact the timing and cost of a project. These two problems are essentially the surge in demand for new builds/renovation and the major disruptions in the supply chain of building goods. As a result of this, builders cannot confidently predict when building will commence or the cost for the build as they do not know when building materials will become available or how much these materials will cost.

Rising Property Prices (Due to the Rising Cost of Development)

Due to the aforementioned reasons, regarding the increases to construction costs, it is a function of simple economics that property prices have to rise. If a development costs a developer more to construct, they will factor that increased cost into the pricing for the sale of the developed property. Of course, an important ingredient for this to work is for there to be adequate demand in the market for the finished product.

Demand in our industry, certainly in the industrial segment of the market, has not slowed, which has helped to underpin the uplift in sale values that have been necessary to warrant the increased cost of development. We are seeing strong demand from owner-occupiers as well as investors, as investors continue to view our
property market to be a sound class of investment.

Again, there are many complex, and nuanced, factors that come together to build pressure on pricing in the construction industry, but even considering the above examples, it is easy enough to understand why we are in this position.

As for how long this will last, and what ‘normal’ will look like into the future, only time will tell.

If you have a property you are considering developing, or redeveloping, and you would like to know the latest rates in the market to assist you with your planning, we would love to help, so call one of our commercial property experts today.