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Fletcher's exit from 'vertical construction' leaves a gap in the market; seen pushing up costs, RLB says

Tuesday 24th April 2018

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Fletcher Building's intention to exit the 'vertical construction' sector leaves a gap in the market for large-scale commercial and government projects and is pushing up building costs, according to a report on industry trends.


Global property firm Rider Levett Bucknall's report on New Zealand trends in property and construction for the second quarter of 2018 said Fletcher's announcement in February that it will stop bidding for 'vertical construction' work after fulfilling its existing contracts "introduces a high degree of uncertainty over who will fill the gap in carrying out construction of high-rise and commercial or government buildings".


In February, Fletcher Building's Building + Interiors (B+I) unit confirmed two-year losses totalling $952 million. New chief executive Ross Taylor said B+I was now focused "on project delivery only" and was "ceasing all bidding on vertical construction projects in New Zealand". 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 and unless those dynamics changed, the company would no longer work in the sector, Taylor said.


"The exit of Fletcher Building from the market leaves a gap in construction sector firms operating in the 'vertical construction' sector with a large enough balance sheet to take on construction projects of that magnitude," the Rider Levett Bucknall report said.


"Besides leaving a gap in companies who can carry out large-scale commercial and government developments, Fletcher Building's exit from the sector is putting upward pressure on construction costs," the report said.


Non-residential construction cost inflation fell to an annual 4 percent in the fourth quarter of 2017, 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 moderating to 4 percent by late 2019 and ease to around 3.5 percent in late 2020 as capacity pressures in the construction sector ease.


"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."


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 labour, 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."



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