The market sets property prices not construction costs
The seemingly relentless climb in construction costs since 2010 has been a topic of much discussion for contractors and their employers, the property developers and government alike.
Recently no less an authority than property giant New World Development (0017) has said that rising costs would prop up the property market.
“The fall in prices will be limited because construction costs have continued to increase,” chairman Henry Cheng Kar-shun was quoted as saying in the South China Morning Post last week at the company’s annual results.
Cheng said construction accounted for about 60 percent of the total development cost of a residential project.
Statistics compiled by construction cost consultant Langdon & Seah show a continued increase in costs.
According to the firm’s latest construction cost report, the tender price index for the second quarter of 2013 stood at 1,713, having edged up about 1.5 percent over the first quarter, and representing an increase of 10 percent year-on-year.
Compared with the figure of 1,242 recorded for the second quarter of 2009 in the midst of last financial downturn, the increase is 38 percent.
If one goes back further to the second quarter of 2004 when the index stood at 952, the increase is an eye-watering 80 percent.
Langdon & Seah estimate that the index will climb to 1,747 and 1,765 for the third and fourth quarters respectively.
The concern over construction cost is such that the government is starting to look at this issue.
In June, the Development Bureau’s Works Branch appointed Langdon & Seah to compile a research report on the reasons for the inflation in construction cost and to make recommendations on mitigating cost.
The remarks by New World Development would perhaps ring true if pricing of their product is based on cost, which would certainly be the case for a contractor.
“The selling price of flats is solely dependent on the market value of those flats at the time of sale. Construction costs are a factor that developers have to take into account when assessing what to pay upfront for the land,” a former senior official at Lands Department said.
A real estate analyst also echoed these views.
“If real estate prices are affected by construction costs and do go up and down with them, that is, costs dictate prices, then logically real estate development will not bear any risks at all and will be a 100 percent sure-win endeavour – which it is not,” Zeppelin Real Estate Analysis managing director Stephen Chung Wai-kit said.
Construction costs, he added, were simply “just a cost item in the development business”.
There is also a time factor between construction and time of sale.
“Construction contracts are let two to three years before the time of sale [and] so cannot ever have a direct bearing on the selling price,” the former official said.
The Long Beach project at West Kowloon developed by mid-sized developer Hang Lung Properties (0101) appears to be a classic example of construction cost not bearing any relationship with selling price.
The project was built during a market downturn in early 2000s when costs and tender prices turned southwards.
The occupation permit was issued in September 2004 but it wasn’t until three years later in October 2007 that the company finally thought the price was right, selling at an average of HK$7,100 per square foot.
It only sold 605 flats out of a total of 1,829 units, although it appears 10 transactions were later cancelled.
According to government’s Building Digest records, the declared building cost was HK$1.63 billion.
With a total gross floor area of 1.63 million square feet, the construction cost per square foot of gross floor area works out to be HK$1,000.
The company bought the site at a public auction in December 2000 for HK$2.58 billion which translates into a land cost (or accommodation value ) of HK$1,582 per square foot.
As of 31 December 2011, it still had 1,234 unsold units whereupon it sold another 108 units during 2012 at an average of HK$10,600 per square foot.
“As mentioned before, we are more than happy to sell a lot more flats at similar price levels. The market however will have to cooperate,” the company said in its 2012 annual report.
Last month, the company hinted at a new round of sales around the corner with the issue of a new sales brochure.
Whether the planned sales has anything to do with the potential new supply of flats building up due to the government furiously selling land in recent years is anybody’s guess.
What is certain is that Hang Lung will not be worrying about construction costs for The Long Beach anymore.