Rising building cost squeezes mass market projects more

August 7, 2008
Rising building cost squeezes mass market projects more
Developers' margins for prime projects less affected: Jones Lang
LaSalle study
By KALPANA RASHIWALA

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.