How much should we allow for escalation 2008-2018?

Thursday, 9 July 2009

Increasingly we are asked by clients how much to allow for escalation over the next ten years. Will construction costs jump up again like they did earlier in the decade or will they be more subdued? This week we look at that question and launch our report, "What should we allow for escalation 2008-2018?"

 

Of course nobody can foresee the future, so the usual disclaimers apply. We can only take the things that we have observed in the past and try to apply them to the future. But construction cycles give us useful clues to what may happen. Construction costs follow the main construction cycles and can increase and fall over a ten year period. By making assumptions about the main drivers of construction costs, and the construction cycles between now and 2018 we have produced forecasts of annual escalation.

 

After a long period of strong construction costs the market has changed, with costs now falling. Construction costs peaked in most regions in the third quarter of 2008. Since then construction costs have fallen up to 10% depending on region. Most construction cost falls have come about as the result of increased competition forcing main contractors and sub-contractors to reduce margins.

 

Building material costs have not fallen except for those materials exposed to commodity prices, ie structural steel, copper cable, aluminium claddings, petroleum based plastics. A fall in the exchange rate has increased the cost of some imported manufactured items, such as plumbing products, lifts and escalators, tiles, electronics and imported machinery.

 

Wages are still increasing and the enterprise wage negotiation system will prevent wage falls except where sole subcontractors are prepared to work for less.

 

The government stimulus package, wage increases and building material costs are placing a floor under construction costs. From mid 2009 only modest falls will occur and in most cases flat costs will be the norm until 2010-11. Thereafter construction costs may start to increase, slowly at first. We think that a residential upturn is coming again starting in NSW by 2011-2012 with the potential to push up construction costs. This will quickly ripple out to Brisbane and Melbourne, and later Perth and Adelaide.

 

The mineral sector will recover and the energy sector is poised to take-off. The demand for skilled trades will pick up in these sectors and this will feed through to higher construction costs in the middle of the period.

 

By 2015-16 another cyclical slowdown could occur as the various cycles run their course. However this is unlikely to have as dramatic an impact as the current downturn.

 

Over the next ten years construction costs will probably not increase as quickly as the last ten years. The next ten years promise slower growth in construction costs with most increases coming in the period from 2012.

 

The following chart compares annual compound construction cost increases over the two periods.

Cost increases over the next ten years may be smaller

To access the report "What should we allow for escalation 2008-2018?" subscribers can simply click here. If you don't have a subscription but still want a copy we can email you one. Simply email and we'll get it to you.

Happy reading

Gary Emmett

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