Choosing the construction technology in property development

THE construction industry is one of the main drivers of Malaysian economic growth.

In contrast to developed countries which are deemed as successful examples of adopting advanced technology in the construction industry, the preference for using lower cost but foreign labour-intensive conventional construction methods in Malaysia is said to be the main factor that is hampering efforts to make it a world-class player.

Hence, there is talk that builders should honour more advanced construction technologies, in order to increase productivity, streamline project management and enhance quality and safety of construction projects.

However, selecting the construction technology to be adopted goes deeper than just labour and cost factors. It relates to the cost distribution structure of a project, thereby determining its viability, which is an aspect that is often overlooked. For example, consider the following three cases:

(a) low land cost-to-gross development value (GDV) scenario in Malaysia, where land cost is less than 15% of GDV;

(b) medium land cost-to-GDV scenario in Australia, where land cost is about 20% to 30% of GDV; and

(c) high land cost-to-GDV scenario in Singapore, where land cost reaches more than 50% of GDV.

Assuming the same profit margin – let us say 20% GDV – is to be achieved in each scenario, the respective proportion of construction cost (the combination of both hard and soft costs) to GDV for these scenarios will be 65%, 50% and 30%.

In Scenario A, land cost is small in relation to the completed development value. Since construction cost – the major contributor to GDV – is subject to the free-market force and regulatory/industrial practices, which is deemed to be fixed and have little room for adjustment; land cost plays an important role in determining the builders’ profit margin.

The lower the land cost means the higher the profit will be. This is how those township players leverage on their landbank to stay competitive over their competitors.

While builders in this scenario will have more flexibility in terms of pricing their properties, it could, sometimes, result in overpricing as builders tend to reap a higher return by selling the future value of properties. Also, any small increases in input costs – due to the shift from “conventional” construction to Industrialised Building System construction – will directly result in margin compression.

Should the profit margin – let us say 20% – be retained, there will be a cost transfer in the form of higher selling prices to the customers. In order to maintain their competitiveness in the market, especially amid declining homebuyers’ affordability and unabated construction inflation, like in the present, builders will likely to operate their projects in the “conventional” way as the adoption of higher cost technology could have implications on profit margins.

For the remaining scenarios, Scenario C in particular, where land cost is the major contributor to GDV, the per-unit builder profit is more sensitive to changes in land costs than to changes in construction costs. Since the holding cost for land is high, should the market plummet when the developer is ready to build, changes to land value will drastically alter the overall project value.

In such circumstance, builders in Scenario C are likely to speed up their construction process, or else they have to pay higher interest for that piece of land or to absorb a lower profit margin.

Hence, builders are keener to adopt advanced construction technologies, or even to bear with short-run variations in construction cost, in order to ensure they will have enough profit for the risk taken to build the projects.

This article is contributed by MKH Bhd product research and development manager Dr Foo Chee Hung.

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