Checked by interest rate rise

Rising interest rates will limit building contractors' ability to push through price increases, states research conducted by Medium-Term Forecasting Associates (MFA).

MFA's research shows that tender price increases peaked in the first quarter of last year at 20,2%, with an average 17,5% rise for 2005. This is in stark contrast to the 5% rise in tender costs in the first quarter of this year.

These findings were confirmed by the Bureau for Economic Research (BER) at Stellenbosch University last week. A BER report on the building & construction sector forecasts that building costs were "likely to rise at more moderate rates in the year ahead".

MFA director Johan Snyman says the change between the two numbers can best be explained as a stabilisation due to comparative base effects, meaning that current levels were being compared with the very high levels of 2005. This year, the rate of construction price increases looks set to come down sharply.

He points out that in the last quarter of 2005 contractors had lifted prices by as much as 17%, but increases of only 7% are forecast for this year.

Inflation concerns stemming from a weaker rand and continued high oil prices are also likely to lead to higher interest rates beyond the 50 basis point hike in June.

Snyman says higher interest rates inevitably lead to a decline in demand for new buildings, thus easing pressure on building materials costs.

The MFA report adds: "Should interest rates continue to rise during the next two years , then one can foresee a fall in house building and possibly also in the non residential sector of the market. This could lead to a moderation in building inflation, with tender prices increasing at rates significantly below the average rise of 17,5% during 2005."

Snyman says the rise in prices allowed contractors to add to their margins last year though it is not possible to say by how much these margins were improved . "Having a profitable building & construction sector is vital so that these companies can develop further capacity to meet the huge demand that will be made on the sector in the coming years with public infrastructure projects, the 2010 World Cup and the Gautrain," he says .

The BER second-quarter report says a slowdown in demand for residential buildings was seeing profit margin erosion for contractors operating in this sector. However, commercial property development was showing more resilience to changes in the interest rate climate .

"Building activity and the availability of new building work experienced by nonresidential building contractors continue at relatively high levels. Because of the favourable demand conditions , tendering competition is comparatively weak and healthy growth in the profitability of companies was reported," the BER says.

Total building costs in the first half of the year were up by 6,2% with the BER forecasting an overall rise of 7%-8% for the year as a whole. The contractor confidence level fell from an index value of 94 in the first quarter to 87 in the second .

Article by: Nicky Smith - www.netassets.co.za