Res build inflation dips slightly

FNB Commercial Property Finance's (CPF) revised Residential Building Cost Index for the fourth quarter of 2008, constructed by Industryinsight, indicates a mild decline in residential building cost inflation.

The index reflects the average building cost per square metre, as charged by building contractors when winning tenders in the formal residential property sector. It should thus be seen as reflective of the combination of contractors' pricing power, as determined by market conditions, and their input costs. It excludes affordable and so-called "RDP" housing. The average building cost per square metre was measured at R5,832 for the fourth quarter.

Year-on-year (y/y), building cost inflation measured 6,5% for the fourth quarter, slightly down from a revised 7,5% in the previous quarter. The inflation rate in the fourth quarter remains tame by comparison to the 38,8% recorded at the last major peak in the third quarter of 2006. The slowing pace of inflation in 2008 was reflective of very weak residential demand, average house prices heading toward deflation at that stage, and thus low contractor pricing power. But the fact that recorded building costs were still increasing despite the weak residential market, is probably reflective of contractors also having to deal with strong input cost inflation.

While the FNB Residential Building Cost Index's y/y inflation rate of 6,5% remains moderate, the trend of ongoing inflation remains very significant in the context of a very weak residential property market where existing house prices are declining.

The differential between input cost inflation and house rice deflation makes it extremely tough for contractors to deliver new stock to the residential market.

This has positive and negative implications.

From a developer/contractor point of view it is bleak situation, and could remain this way for much of 2009.

However, ongoing input cost inflation, resulting in ongoing overall building cost inflation as quoted by contractors, is a very important event, because the maintaining of a higher replacement cost of housing (i.e. the cost of acquiring new houses) relative to the price of existing property is crucial in keeping the market in some sort of balance, of at least slowing supply until demand can catch up to restore the balance.

The result of the expected continuation of some sort of differential between input cost inflation and house price deflation in 2009 is expected to be further decline in the volume of residential buildings completed, as contractors battle to reduce input costs in order to keep up with expected ongoing house price deflation for most of the year.

On the commercial property building side, one can see the signs of a weakening market too, with overall commercial building cost inflation of only 1,7% in the fourth quarter of 2008. However, one needs to split commercial building costs up into the three main sub-segments.

In so doing, we see that rampant building cost inflation in the area of office space is the key driver of the overall building cost index. It is reflective of an office property market that has lagged the cycle, and has had low vacancy rates until recently.

Retail property, on the other hand, is experiencing building cost deflation that is probably indicative of this sector being in a multi-year slowdown, while industrial property building activity will have to contend with some mediocre times emanating from a current manufacturing recession.

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