A symbiotic relationship in the construction sector

InvestmentRizwan Sajan

With building materials being a main component of project costs, any fluctuations in their prices can affect the overall expenditure. They represent about 40-50 per cent of the construction costs of a project, depending on its nature, usage and size. So while you have to source best-quality materials, you have to also look at the best prices.

After a four-year slump, the value of GCC projects bounced back in 2013, touching $156.3 billion (Dh574.11 billion), up by roughly 31 per cent year-on-year, according to reports.

The Construction sector, primarily of commercial, residential and mixed-use buildings, accounted for 41.4 per cent of total projects, reaching nearly $65 billion of awards in 2013. Construction is the fifth-largest sector in Dubai with a GDP share of 8.4 per cent in the first quarter of last year, up by 2.3 per cent year-on-year, according to a report by Dubai Chamber of Commerce and Industry.

Total trade in construction materials reached Dh19.4 billion during the same period, up by 5.4 per cent year-on-year, accounting for almost 6 per cent of Dubai’s non-oil trade. The industry should get a further boost as the city’s foreign trade is expected to reach Dh4 trillion by 2020, from Dh1.3 trillion in 2013.

The cost of major construction material categories rose marginally to 97.2 points in the second quarter last year, and the emirate’s rapid growth could push prices for materials and labour higher over the next few years.

Of the 16 major groups, six showed price increases, eight posted price decreases and the remaining two exhibited relative price stability. The biggest price increase was noted in marble and stones for a fourth consecutive quarter, up by 17.6 per cent year-on-year in the second quarter of 2014, reflecting the expansion of luxury construction sub-sectors.

For contractors, it is important to buy the right materials at the right price. Initial costs include the purchase price, which often governs decisions about what to use. When it comes to material trading, a trader makes money both ways—when buying and selling. Similarly, a contractor could gain financially by squeezing the supplier on pricing, and discounts could help him make extra money on the project.

This is why contractors spend a lot of time and resources sourcing building materials from big players who can give them the best price.

Several other factors are also taken into consideration such as the durability of the materials, energy savings and value in paying higher initial costs in return for a lower lifetime cost.

For example, an asphalt shingle roof costs less to install than a metal one, but the latter lasts longer so the overall cost works out much lesser per year.

However, there are risks while considering long-term costs of materials if the building is damaged by fire or wind, or if materials are not as durable as advertised. The cost of materials should be taken into consideration to bear the risk of buying combustive materials to prolong their lifespan.

In terms of logistics, it is important that the materials are supplied well in time. If they arrive late, contractors have to factor in additional costs for lost time. Therefore, the integrity and professionalism of the supplier is vital in the overall construction supply chain management.

Big contractors have established supplier databases and existing relationships with major players. In order to keep the costs under control, large contractors usually source major items such as cement and steel rebars from the manufacturers directly at factory prices.

This way, they cut off middlemen such as traders and wholesalers and end up guarding their businesses from potential price fluctuations in international markets.

Some are also involved in materials price hedging — fixing prices at a certain level for a certain period to offset potential losses in case prices increase. In any case, price fluctuation affects the cost of construction.

To put it in layman’s terms, if building material prices increase by 10 per cent, it wipes out the profits for a contractor who could be working on a project with a margin of only 5 per cent. And building material price appreciation during project execution can be a contractor’s worst nightmare. One needs to create safeguards against such inflationary pressures.

On some occasions, contractors make provisions to revise the value of a contract based on price fluctuations. However, in most cases, they take any increases into account in their bids.

Building material prices have remained more or less steady over the past six months, with minor fluctuations. As demand was low in general, there was a slight drop in the prices of certain items, which has been offset by the increase in freight rates.

Due to low global demand and excessive supply, steel prices in China fell steeply. However, the shortage of raw materials ensured that prices of wood-based items remained unchanged. With the end of the holiday season, the next six months are traditionally active for the region’s construction sector.

The buyers are back to buying. This has already placed a lot of pressure on prices, and the expected increase in shipping costs means that they will rise considerably in the coming days.

Source: Rizwan Sajan, Special to Property Weekly
Founder and Chairman of Danube Group

Al Nisr Publishing accepts no liability for the views or opinions expressed in this column, or for the consequences of any actions taken on the basis of the information provided.

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