As the construction industry enters the pre-Christmas push, the most common question we are facing is ‘what is in store for construction costs in 2015?'

With confidence high, strong approvals, and increasing work on the books, the ingredients are there for construction costs to rise for projects coming to market in early 2015. However, the real questions should be ‘what does this mean for my project?’ and ‘how can the risk of cost rises be addressed?’

Taking a broad look at the market, mining investment is tapering off and the construction sector is starting to gain momentum. The Australian dollar remains high, material prices remain subdued and competition from foreign imports is intensifying. Across the board, labour remains stable due in part to mining and infrastructure projects wrapping up. There are, however, pockets where demand is outstripping supply in skilled trades. The tender market across Australia remains intensely competitive and contractor margins are being created by applying pressure on subcontractors who are being forced into positions that are unsustainable.

How this information impacts upcoming projects depends on where the project is located, the composition of the project, how the trades are let (procurement method), and the experience of the development team, including their ability to address unforeseen challenges and rising market conditions.

Queensland (QLD)

QLD residential remains strong, particularly in Brisbane, where apartments are at their strongest levels in many years. While there are growing concerns of over-supply in the newspapers, the price differential between product in Melbourne/Sydney and Brisbane is continuing to widen and this will drive increases in demand.

While construction in Brisbane has reached pre-GFC peaks, there are mixed signals and the story isn’t the same across other parts of the state. Contractors and sub-contractors are going broke, government research shows that only 18 per cent of contractors are having difficulty finding subbies (note that this is double what it was in the previous quarter) and regionally things are quiet with mining related construction wrapping up and trades returning home.

Construction costs have remained stable, largely as a result of a fiercely competitive tender market, for nearly two years, though this is likely to change. The unknowns are how quickly and how much.

Based in part on the facts listed above, economists are forecasting a slow steady increase in line with increasing approvals and mirroring steady price growth in apartments. However, the average subcontractor may not read the Financial Review. They rely on how busy the guys on the tools are and how many quotes they are doing. They feel pretty busy at the moment, but the data indicates a storm brewing – one that has a lot of similarities to the November 2003 storm.

We can excuse some of those similarities away by citing exchange rates, increased supplier capacity and competition from imports, but on the subcontract front the chief barometer is sentiment.

Leaving headline figures aside, let’s look at what impacts on sub-contractor sentiment. The data presented is a snapshot of apartment projects within five kilometres of the Brisbane CBD and the beaches on the Gold Coast. What it shows is that the volume of work in Brisbane already exceeds the pre-GFC peak by 32 per cent, but this is far from the case on the Gold Coast which is operating at just 20 per cent of its peak capacity. The combined Brisbane and Gold Coast picture is okay, but there is a growing concern that the Gold Coast residential sector will snap into action as mooted projects come to market and the Commonwealth Games approach.

So setting the mixed signals aside and focussing on the current localised data in comparison to the past, we are at the point when preferred subcontractors will be willing to increase lump sum prices and risk missing a job because they will feel that there are plenty more chances in the market. If this is correct, then we are entering a risky cost period and developers bringing projects to market in 2015 will need to consider how they deal with it.

The minimum effect will be a slow and steady increase of three to four per cent PA for 2015 (likely to impact sooner rather than later) and more of the same in 2016. This outcome is manageable if sales prices grow steadily like some market commentators are predicting.

The other extreme is the very real risk of a sharp knee-jerk ‘correction’ in prices of 10 per cent or more like the increase in November 2003. What happens after that will depend upon whether pre-sales projects continue or are cancelled.

What this means to developers depends on where in the project cycle they are and what their procurement plans are and what their risk is appetite is like. The important things for now are:

• Watch what happens with residential activity on the Gold Coast.
• Allow three to four per cent escalation for projects coming to market in 2015.

New South Wales (NSW)

NSW remains in a purple patch with approvals in both residential and non-residential above long term averages. The decrease in mining has not had a significant effect on the construction market which has been buoyed by the apartment building boom and the large infrastructure spends put forward by both State and Federal Governments.

Despite the good news, contractor overheads and profit margins continue to be tight and competition to keep forward work books full has kept a lid on runaway pricing. This is expected to continue, though demand for labour continues to be strong as the increasing numbers of large residential projects exert their influence on subcontractors. This impact alongside the burgeoning renovation market in both the residential and commercial spheres is squeezing the residential market and putting upward pressure on labour costs.

Competition between developers for a ‘point of difference’ remains strong and is having an impact on overall costs – particularly in the apartment space. These increases are, however, largely being absorbed or covered by increased sales values.

Also of note is the increased activity with planning for several large scale projects in the Wollongong CBD which will likely put additional pressure on the Sydney subcontract labour market as they come online.

We are expecting a three to four per cent increase on projects coming to market from January to June 2015, particularly within the Sydney metropolitan area.

Victoria (VIC)

Despite medium term subdued confidence, Victoria continues to see strong numbers of projects under construction particularly in the medium to high density housing sectors as evidenced by the number of tower cranes visible in the CBD and inner Melbourne precincts.

Both the State and Federal budgets have included reasonable infrastructure planned spends in roads and rail that will continue to provide a solid pipeline of projects for larger contractors.

While there are a large number of projects under construction, there are also a number of major projects awaiting approval, including the Fishermans Bend Urban Renewal Area and further high rise towers in the Southbank, CBD and Docklands precincts off the back of increased levels of foreign investment.

While the upcoming November State election looks like it could go down to the wire, both sides of government are running pro-development platforms but with fiscal constraint and subdued levels of government funded work.

Finishing trades and margins are currently under pressure, and the dependence on project cash flow means trade sub-contractors are being stretched for capacity. Cost escalation is expected to be in the order of 1.5 to two per cent in the upcoming year.

Roundup of Construction Australia-wide:

• Review your contingency and ensure it is sufficient for your project and the market
• Keep construction costs top of mind and talk to your QS about what they are seeing.
• For developers that do not build for themselves, talk to your preferred contractors about your project but avoid getting any prices until your designs are complete. Look to lock in a design and construct price while you are selling off the plan. The more indicative prices you get on preliminary designs the more you can expect the costs to creep. In market conditions like these it is often the case that the more indicative prices you get from your preferred contractor on preliminary designs the more those indicative costs will creep.