Fletcher Building’s decision to exit the ‘vertical construction’ sector leaves a gap in the market for large-scale projects and is pushing up building costs, according to a report on industry trends.
Global property firm Rider Levett Bucknall says Fletcher’s announcement in February that it will stop bidding for major construction’ work after fulfilling its existing contracts “introduces a high degree of uncertainty over who will fill the gap… for high-rise and commercial or government buildings”.
Fletcher Building’s decision to focus on existing contracts only came after its Building + Interiors (B+I) unit confirmed losses totalling $952 million, following significant cost overruns on a number of big projects, including the International Conference Centre in Auckland and the Justice Precinct in Christchurch. New chief executive Ross Taylor said while Fletcher’s broader construction businesses continued to benefit from favourable market conditions and strong growth, the B+I sector was characterised by high contract risk and low margins. Unless those dynamics changed, the company would no longer work in the sector, Taylor said.
However, the Rider Levett Bucknall report says there is a shortage of construction firms in the vertical space with a large enough balance sheet to take on really big projects.
And Fletcher Building’s exit is also pushing up construction costs, it says.
“We expect an extended period where construction cost inflation is elevated,” the report said. “The exit of Fletcher Building from the ‘vertical construction’ sector increases the uncertainty over the degree of construction cost escalation, but large cost increases are likely to see a push-back in demand as developments no longer become financially feasible. This is likely to lead to a more protracted construction cycle.”
Non-residential construction cost inflation was an annual 4 percent in the fourth quarter of 2017, down from a 5.2 percent rate in the third quarter, and 5.5 percent rate in the second quarter, according to Statistics New Zealand data quoted in the report. New Zealand Institute of Economic Research forecasts included in the report say non-residential construction cost inflation will peak at just below 5 percent before coming back to 4 percent by late 2019, and around 3.5 percent in late 2020 as capacity pressures in the construction sector ease.
The exit of Fletcher Building from the ‘vertical construction’ sector increases the uncertainty over the degree of construction cost escalation, but large cost increases are likely to see a push-back in demand as developments no longer become financially feasible. This is likely to lead to a more protracted construction cycle.”
The report noted that there has also been a recent shift in contract terms in the construction sector.
“Where previously the risk of cost over-runs had fallen on the lead contractors, alternative forms of contracts are emerging, with the risk shared between the contractor and the commissioning party,” it said.
Elsewhere, the report noted construction sector firms continue to report acute labour shortages, particularly for skilled workers, although migrants have helped ease shortages.
“Underlying construction demand remains strong, but capacity constraints continue to hamper the degree to which construction activity can ramp up,” the report said. “The announcement by the new government that it will step in to underwrite the financing of some residential developments as part of its KiwiBuild programme should ease some of the financial constraints.”