Colliers research director Chris Dibble says in his latest report, out on Friday, that demand outweighing supply in a low interest rate environment isn’t the only reason rents & capital costs are expected to continue appreciating.
“Construction cost inflation for new residential & commercial buildings shows just how much pressure there is on prices to keep rising,” he said.
“Since the mid-1980s, construction costs have increased phenomenally. The construction cost price index – as derived from Statistics NZ’s capital goods price index – shows just how much this growth has been.
“Despite cost pressures in the residential sector being below the commercial sector pre-2000, this changed in early 2003. Between 2008 & 2011, residential cost pressures for new-build properties stabilised after the global financial crisis, but were soon to go exponential along with house price rises.
“Meanwhile, commercial property construction prices faced a different growth path. The costs to construct shops, office & industrial premises dipped after the global financial crisis in 2008 at a rate that had not been experienced after 1980. This was only a shallow decline which flattened out until 2013, before the sector took off again.”
Mr Dibble said some of this construction cost growth related to pressure from the Christchurch earthquake rebuild, but said: “It highlights just how little capacity we have in New Zealand to rectify major imbalances between demand & supply, especially in a low overall inflation rate environment.”
The second chart, of the annual percentage change in the index by sector, shows the residential sector had 2 key periods of growth that were out of step with the commercial sector, in 1994 & 2008-09.
“In 1994, the construction cost growth rate/year for commercial property was about half of the residential sector. This coincides with a 45% rise in real house prices in Auckland between mid-1992 & late 1995, according to the Reserve Bank.”
The other pivotal time was after the global financial crisis: “Residential construction cost changes flat-lined, but didn’t reach negative territory like its commercial counterpart. Similarly, house prices also remained relatively flat.
“The current annual growth rates in construction costs in the residential sector reached 6% in the year to June 2016, above the 36-year average of 5%/year. Current trends indicate that this rate of construction cost growth may have slowed, potentially correlating with a recent slowdown in house price appreciation in Auckland since the latest measures of loan:value ratio restrictions implemented by the Reserve Bank.
“The commercial sector has already experienced a slight slowdown in construction cost price rises. While still in growth mode, at about 3%/year, this is below the 36-year average of 4%/year.”
Mr Dibble said the outlook for non-residential construction costs was for a slight dip over the short term, just below the long-term average. The latest forecasts from the NZ Institute of Economic Research showed non-residential construction cost inflation between 2016-19 at 3.2-4.1%/year – the highest sustained inflation in the sector since the construction boom of the mid-2000s.
The institute didn’t expect the inflation to be as high as in the mid-2000s because of 2 factors: the low inflation environment would limit the extent to which rising costs could be passed on, and strong net migration was helping to mitigate skills shortages in the building sector.
However, Mr Dibble concluded: “Costs rising by this rate year-on-year will ultimately lead to unavoidable cost rises in rents & prices for both residential & commercial property.”
New development phase
He said the Auckland office sector was entering a new phase of the development cycle, with activity the highest in almost a decade “This should alleviate some of the pent-up tenant demand in an undersupplied market. The Auckland cbd vacancy rate, at 5.5%, is at an all-time low, while the metropolitan rate of 6.2% is at an 8-year low.
Mr Dibble said 103,313m² was under construction in the cbd and 84,353m² was on hold. In the rest of the metropolitan area, 66,341m² was under construction and 30,000m² on hold until new anchor tenants can be secured.
Attribution: Agency research.