Rising building cost squeezes mass market projects more

Source : Business Times - 7 Aug 2008

Developers’ margins for prime projects less affected: Jones Lang LaSalle study

A 20 per cent rise in construction costs will shrink developers’ profit margin for a mass-market private condo by 55 per cent; but for a project in the prime districts, the profit margin will contract by 25 per cent, according to a Jones Lang LaSalle (JLL) study on the impact of rising construction costs on the property market.

The sensitivity analysis assumed land cost of $1,600 per square foot (psf) of potential gross floor area (GFA), base-case construction cost of $500 psf of GFA and selling price for the condo of $2,520 psf for a prime condo project. For a mass-market project, land cost and base-case construction cost were each assumed at $300 psf of GFA, and a selling price for the condo of $720 psf was imputed.

In both cases, a 20 per cent base-case developers’ profit margin was worked into the model, and the effects of construction costs rising by 10, 15 and 20 per cent respectively on profit margins studied.

‘As construction costs are usually at a bigger proportion to suburban land costs compared with the high land prices transacted in prime residential projects, any increase in construction costs will present a greater change in the profit margins in a mass-market project than that in a prime residential project,’ the study observed.

Given current weak outlook for home prices, ‘the unceasing escalation in building tender prices will definitely impact the profitability of residential developments’, JLL argued. ‘This will affect developers’ sentiments, which will be evidenced in their future land-bidding strategies,’ it added.

‘Rising construction costs, coupled with a ceiling selling price, will put downward pressure on land tender prices,’ the study predicted.

A BT story last month highlighted that, for the first time in at least two decades, construction costs for some 99-year leasehold condo sites bought at state tenders are actually higher than land costs. This is taking place against the backdrop of soaring construction costs and a weak home price outlook, resulting in developers lowering their land bids.

JLL’s study pointed out that pricing of mass-market condos, typically built on 99-year leasehold suburban sites bought at Government Land Sales (GLS) tenders, tends to be more illiquid. Prices of such entry-level private housing is often benchmarked against public housing prices as this market appeals to public housing upgraders. ‘For affordability reasons, developers are also resistant to push the prices of such mass market projects beyond a certain level at the risk of being priced out of the market,’ the study said.

Going forward, with concerns of weakened market sentiments and rising construction costs, it will be interesting to see how many 99-year leasehold residential sites will be triggered for release from the GLS Programme’s reserve list, as well as whether bids put in for the residential sites on the confirmed list will still be as competitive and will meet the government’s reserve price, JLL said.

‘Another question posed will be whether the government will be ready to accept tender bids that will fall below market expectations,’ it added.

The government launches reserve list sites for tender only upon successful application by a developer that undertakes to offer a minimum price acceptable to the state, while confirmed list sites are launched according to a prestated schedule regardless of demand.

This year, the government did not award the Ten Mile Junction site in Choa Chu Kang (which was to have a residential component) and a landed housing plot at Westwood Avenue in Jurong, as the respective top bids were too low.

In the private land segment, the en bloc sales market has been weak because of a ‘price misalignment between developers and collective sale site owners’ arising from developers being less willing to match the asking prices, JLL noted.

The Building and Construction Authority’s Building Tender Price Index rose 23.7 per cent last year and market watchers expect it to continue increasing this year.

High construction demand and competition for limited resources, insufficient tendering capacity among contractors, sub-contractors and suppliers, as well as volatile commodity prices, have contributed significantly to the increase in building tender prices.

Rising construction costs will lead to diminishing profits for developers as well as bearish land strategies, JLL said.

JLL also highlighted other implications of rising construction costs. With the government announcing the delay of $4.7 billion of public sector projects to ease pressure on construction demand, the potential benefits from these public sector projects, especially from public health care, will be delayed, JLL said. The construction of the new complex that will house the Communicable Disease Centre as well as a new hospital in Jurong, are among the projects delayed.

‘In addition, rising construction costs have also been a concern for the public housing sector, especially issues on whether increased costs will be passed on to the public,’ JLL’s report said.