Rising Cost of Building – Supply & Demand

December 16, 2013

“$550 000 for a one bedroom do-up!”  Week after week our daily newspaper run these headlines. The property market is reaching new records, specifically in the growth centers across New Zealand, and most significantly in Auckland.  Underpinning this is demand from growing optimism in the property, construction and infrastructure sectors.

The Auckland property market in particular is worryingly overheated. It’s already passed the heady days of the mid 2000’s for average house prices, the IMF recently flagged NZ housing as 25% overvalued.  S&P  has put on notice smaller NZ banks with a significant exposure to residential property.  All this is on the back of an economy that is yet to fully break the shackles of a recession.

The Reserve Bank has already signaled their concerns and the possibility of having to lift  the OCR in order to open the relief valve on house inflation.  This is all at a time when our cousins across the Tasman have just headed in the opposite direction. The potential consequences to the NZ dollar and knock on effects to our critical export markets and the wider NZ economy, which are travelling at a completely different speed, could be severe.

Basic economic principles of supply and demand apply. Very low numbers of new builds over the last few years have resulted in an under supply of new homes at a time of increasing demand.  Result: upward pressure on prices. The construction industry has been slow to react, but is gradually showing signs of life. Despite a slight splutter in March, the number of building consents  has increased in the first quarter of 2013 for both residential and commercial projects continuing the underlying upward trend.  This is from the record low in March 2011 and after four years of very low activity. There is obviously a lag between gaining consent and handing the owner the keys, so is this increased supply enough to ease the price pressure?

Government doesn’t think so and is now getting serious. In an attempt to head off the need for an OCR hike they have introduced measures to constrain credit, increase the supply of land and new buildings by making it easier to develop. As a result building consents are set to increase and probably dramatically with 39,000 new dwellings in  Auckland over the next three years being the stated intention under the Housing Accord between Auckland Council and Government.

So what does all this mean for future building costs? Should we be calling the architect, draw up that dream house and build it? During 2011 and 2012 construction costs were relatively stable with tight margins, mostly achieved by running leaner teams and utilizing more subcontractors desperate for work. The low demand and over supply meant prices remained muted. Most industry analysts have been predicting an increase in build costs as the recovery takes hold and the Canterbury rebuild gathers pace.

Trade skills are in high demand, and this is only set to increase as the Christchurch rebuild and the effects of the Auckland Housing Accord gather momentum.  Recognizing a potential constraint on future labour supply and the resultant cost pressures several companies are actively recruiting overseas. The wobbly overseas economies and the increased rewards here may entice some expats to return. This may help offset some price pressure on the labour market, however rates will inevitably rise.

With the demise of many construction companies during the downturn there is also less competition, or perhaps more realistic competition, from those left in the market.   At a time of increasing demand this will add fuel to the inflationary fire.  And as more pie becomes available for material suppliers to share around, they will and are restoring some of their pre-recession margins leading to further price rises.  We are now seeing at least some of this first hand with a marked increase in tender prices during the first part of 2013.

So is it a good time to build?  With the significant pent up demand in Auckland and the rebuild in Christchurch, it may never be cheaper.

Heidi Van Eeden & Harry Dillon

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