Rising Construction Costs Impact Everyone in the Property Market

It’s no secret that construction costs are on the rise in Australia. In fact, a report from CoreLogic showed that national construction costs increased by 7.3% over the 2021 calendar year. This rate of increase is the highest annual growth in construction costs since March 2005.

This is great news for the construction industry, but it could spell trouble for homeowners who are planning to renovate or build their new homes. So what can you do to protect yourself from rising construction costs? We’re going to cover why we’re seeing increasing costs for construction and what you need to be aware of.

Increased costs:

There are various factors contributing to increased costs of construction, but the most notable factors include:

• An increase in the cost of supplies like structural timber and metal products.
• A skill shortage in the construction industry. There are difficulties with importing skilled workers, meaning the cost of local labour is on the rise, particularly as the demand for renovations and tradespeople continues to rise.

CoreLogic Research Director Time Lawless said, “There is a significant amount of residential construction work in the pipeline that has been approved but not yet completed.”

“With some materials such as timber and metal products reportedly remaining in short supply, there is the possibility some residential projects will be delayed or run over budget.”

“With such a large rise in construction costs over the year, we could see this translating into more expensive new homes and bigger renovation costs,” said Mr Lawless.

Who does this impact?

The rise in construction costs could have substantial impacts on the residential property market. CoreLogic Head of Insurance Solution, Matthew Walker, warned that all homeowners and property investors could be impacted, not just homeowners looking to renovate or business owners.

“In these times of rapidly rising home and construction costs, under insurance can quickly become a real threat to what is a most valuable asset. It’s important that homeowners keep track of their sum insured and annually check that it is sufficient should the worst occur by using their insurer’s rebuild calculator or giving them a call,” said Mr Walker.

It’s not just a shortage in skilled workers and essential building materials contributing to rising costs but also market demand. Australia has been on a ‘home building boom’, particularly after the federal government’s HomeBuilder scheme.

How to protect yourself if you’re looking to build your home or renovate

There are generally two types of contracts when you engage a builder for a construction project. It’s particularly important to be aware of these contracts if you’re looking to take out a construction loan through your lender or mortgage broker. If you’re aware of these two contract types, you may be able to better protect yourself from rising construction costs.

Generally speaking, there are two types of construction contracts:

1. Fixed price building contracts

This is the type of construction contract most lenders will insist on, as it clearly defines the scope of your agreement with your builder: the price you pay is agreed, even if prices for things like building materials increase during the construction project.

Generally, an experienced builder will add a margin for pricing changes, so you can expect to pay a little extra here, however, you are protecting yourself from the shock of any significant price increases for materials like timber or steel.

You can find guidance on these contracts at Fair Trading NSW, which provides a checklist of what to be wary of.

2. Cost-plus contracts

The other type of contract generally used is referred to as a cost-plus contract.

These contracts have some benefits if you don’t mind the administrative work associated with them. With these contracts, you’re not locked into a fixed price. If prices for materials like structural timber or metal products increase during the course of the construction project, the cost of your project will increase as well. This process allows you as the owner of the project to receive invoices for each expense incurred from your builder but can create a situation where the builder has less incentive to save costs during the build as they are not necessarily working within an agreed quote. If you don’t personally mind the extra workload of monitoring costs and staying up to date with progress payments throughout your construction project, this contract may work for you.

However, you need to be aware that if you require a construction loan to proceed with your project, most lenders generally refuse to accept applications based on cost-plus contracts. Under these contracts, the entire risk, should materials increase in cost, is passed onto you.

Careful examination of any contract with a builder is essential, so never feel pressured to sign on the spot. Take the contract home to review. Most building contracts these days tend to be plain English, but it will always be in your best interests to have a professional review any legal document.

If you establish that your contract is in good shape, with the risk of any blowout in costs resting on the builder, there is another important step to consider: make sure your builder is in good financial shape. This is particularly important in times when construction companies may be operating on low margins in an uncertain market. So, what can you do to protect yourself?

1. Avoid contracts that require a large deposit. For example in NSW, the deposit cannot exceed 10% of the contract value. Making large payments when work has not yet been completed is a risk best avoided.
2. Look at how many progress payments are required. Generally speaking, most builders can operate with 5 or 6 progress payments, depending on the size of works and other factors. If a builder is requesting greater than 10 progress payments, this may be an indication of potential cash flow issues, so tread carefully.
3. Finally, go ahead and ask the builder about their financial situation, for those that avoid providing an answer, you may wish to avoid doing business with them.

If you have any questions about construction loans, don’t hesitate to reach out to one of our experienced YBR Home Loans experts to discuss your concerns!