August 4, 2023

Light on the horizon for commercial construction costs


We’re seeing construction cost growth start to ease for the first time in three years and developers showing renewed interest in residential apartment projects which is creating senior lending opportunities. Our discussions with developers, builders and other project stakeholders indicate:

A key shift for residential demand has been away from house and land packages and towards apartments due to affordability and borrowing capacity. Between 2021 and 2022 land prices increased by 17-38%, which increased the premium of houses over apartments to 39% compared to 12% pre-COVID (CoreLogic). Affordability has become a significant issue in the residential market. Mortgage repayments now account for 40% of income due to the rise in mortgage rates; previously they were 20-30% of income (RBA) Rent growth is projected to be around 10% (UBSe), while rental vacancy rates remain below 2% in all capital cities (JLL).

House prices vs apartment prices, capital cities

We expect the construction sector to remain challenged even as price escalations may normalise or alleviate. Sponsor, project and builder selection are key risk mitigants to navigating the skilled labour shortages and disruptions in global supply chains. The positive byproduct of this challenging environment for builders is supply will remain tight, hindering a rapid normalisation of production to meet demand.

The Merricks Capital Partners Fund (the Fund) has increased its allocation to residential and residual stock facilities by approximately 7% of NAV (6% to 13%) over the past 12 months and we expect this to increase a further 5-10% over the next year. In June, the Fund settled on a 37-level residential construction project in Adelaide’s CBD, that will comprise 285 apartments and 11 commercial units and is forecast to be completed in November 2025.

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