Escalating construction costs cloud Australia’s apartment outlook

While apartment and other high-rise development remains more subdued after COVID-19, construction has rebounded extremely strongly due to stimulus measures leading to cost pressures.

August 31, 2021

While apartment and other high-rise development remains a little more subdued after COVID-19, development across the rest of the residential sector has rebounded extremely strongly due to stimulus measures. The HomeBuilder and other first homebuyer incentives have seen a boom in detached house construction across Australia. In addition, infrastructure construction has also been used as a stimulus measure not just in Australia but globally. This surge in demand has put stress on the availability of some trades and materials, contributing to escalating construction costs across all sub-sectors.

Several factors are influencing construction costs, but primarily it is the availability of materials and labour. The closure of the borders has restricted the inflow of skilled, unskilled, and seasonal migrant workers to Australia. In times of high demand, this lack of available workers has resulted in intense competition within the labour market for several skilled professions. While borders remain closed, labour shortages are increasingly likely to contribute to cost escalations, particularly as Australia approaches full employment.

Furthermore, disruptions to global supply chains and the manufacturing of products used in the residential construction industry have also contributed to the higher cost of goods. Builders have reported very steep rises in timber prices, while apartment developers have been more affected by cost increases to steel, copper, and cement. The cost of timber, board and joinery rose 3.9% in 2Q21, to be up by 6.4% over the year (ABS) (See Figure 1). Electrical equipment also increased 4.4% in 2Q20, while other metal products increased by 4% over the year.

Figure 1: Change (%) in price inputs for construction materials

So, what does this mean for the apartment outlook?

In the short-term, developers will need to manage their projects carefully to mitigate potential shortages of particular trades and to minimise cost escalations on materials. Cost management and maintaining the project schedule will increasingly become a trade-off that many developers will need to consider. Some developers may opt to pivot into alternative materials to mitigate cost and time pressures. Anecdotal evidence suggests this is already happening, with many builders opting to use steel, recycled timber, or other new non-traditional building materials. However, as more demand shifts, these alternative materials are also likely to witness an increase in cost and/or lead times over the short-term.

Contract cancellations may increase as project viability continues to decline. Anecdotal evidence suggests that some detached housing developers are already choosing to compensate buyers to terminate now unprofitable fixed-price construction contracts. While apartment developers are likely to be much more hesitant to tear up contracts, we may see developers increasingly attempt to rescind contracts signed prior to these cost increases. This may allow the developer to raise gross realisations and therefore recoup some of this increased cost by reselling the unit at a higher price than the original contract. Albeit, with off-the-plan apartment sales just starting to recover and some residual stock from the last cycle still in some markets, it may prove difficult to push prices up, and such a move may stifle recovering sales rates.

Over the medium-term, a stronger than expected rebound in high-rise construction could potentially escalate cost pressures and become a larger risk to the viability and profitability of projects. Therefore, we expect to see increased hesitancy from developers in commencing construction, particularly smaller scale developers without many pre-sales, which in turn could delay the next supply cycle. Nevertheless, low supply levels remain a positive factor that will help the market balance and support the medium-term outlook for the apartment market over the next few years.