June 25, 2008 / 1:27 PM / 11 years ago

Building costs a headache for developers

LONDON/SINGAPORE (Reuters) - Soaring construction costs are squeezing the profits of property developers around the world but that could be good news for real estate investors if it helps to rein-in the supply of new buildings as occupier demand wilts.

Global head of Deutsche Bank's alternatives investment division RREEF, Chuck Leitner speaks at a Reuters Real Estate news summit in London June 25, 2008. REUTERS/Luke MacGregor

“There is not a lot of reason to add product and in the end that is what makes this cycle different to other cycles we have been through,” Chuck Leitner, global head of Deutsche Bank’s (DBKGn.DE) alternative investments arm RREEF, said at the Reuters Global Real Estate Summit.

“For a pure developer it is not good news but for a real estate investor actually it probably is good news,” he said.

Higher funding costs as banks buffer their lending margins and toughen their underwriting due to a global credit crunch has added to the strain felt by developers, while a Chinese iron ore supply deal this week signals more steel price hikes to come just as labor and raw material prices are rising.

“There is no input into the development equation that is going to be lower in the next 12 months,” said Mike Hussey, managing director of the London portfolio for Britain’s biggest listed property company, Land Securities (LAND.L).

In the Middle East, India and China, where the bulk of the world’s construction is centered, developers have relied on steep increases in sale prices to keep their housing and commercial projects lucrative.

But with property markets now slowing, 50 percent rises in building costs across Asia in the last couple of years are starting to bite.

DUBAI

In Dubai, the combined cost of labor and materials has doubled since 2006, hurting firms that have sold apartments before construction begins.

“That’s a major worry for Middle East developers,” said Abid Junaid, executive director of Dubai’s ETA Star Property Developers. “They have sold buildings off-plan ahead of construction, and there’s no leverage to increase prices.”

Echoing several executives at the Summit this week, Junaid said inflation was the biggest question mark on Asia’s property landscape.

“We’re just at the tip of the iceberg,” he said. “We don’t know the time frame for it will play out.”

Events this week suggest building costs will continue to rise. Chinese steel producer Baosteel (600019.SS) agreed on Monday to a price hike of up to 96.5 percent for iron ore it buys from producer Rio Tinto (RIO.L)(RIO.AX).

The global price for steel, used for the skeletons of top-grade buildings and to give concrete walls, floors and columns tensile strength, has risen 50 percent this year.

Steel can account for anywhere between 5-20 percent of construction costs, and more in a country such as Japan where the threat of earthquakes looms.

The price of other building materials from sand to cement has also risen sharply.

INDIA, CHINA

In India, a building boom sparked by easing rules on foreign investment in the construction industry has lifted costs by 50 percent in the last couple of years.

Developers have still made profit margins of 30-100 percent because property prices in many areas have quadrupled, but those days are probably over. Home prices are cooling, and developers have seen sales drop by about half from last year.

“They won’t be able to make the huge profits they were making,” said Pranab Datta, managing director for India at consultants Knight Frank. “And many may end up losing money if they’re behind schedule on projects.”

Chinese developers are also feeling the squeeze, with rising costs adding to the headaches caused by a clampdown on bank lending, higher land appreciation taxes and other government measures aimed at cooling the property market.

For the host of new property funds being raised for Asia, timing of deals has become more critical than ever, as buying land cheaply and setting sales costs right can make or break a project.

MGPA, which has just raised a $3.9 billion fund for Asia, said it cut costs on an office development in Singapore by using equipment from a neighboring site rather than ship it in.

Global head of Deutsche Bank's alternatives investment division RREEF, Chuck Leitner speaks at a Reuters Real Estate news summit in London June 25, 2008. REUTERS/Luke MacGregor

“A year ago people were saying piling would be expensive, but the piling machines just had to roll 500 meters to our side when they’d finished the casinos,” said Simon Treacy, Asia head for MGPA, partly owned by Australia’s Macquarie Bank (MQG.AX).

“It comes down to supply and demand at that time.”

(For summit blog: summitnotebook.reuters.com/)

Editing by Kim Coghill

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