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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:

  • Cooling construction costs: Some core material prices are plateauing after +10% year-on-year growth since 2020. Rebar steel is now under $800/mt after trading at $1,000/mt in March 2023.
  • Wage inflation is still a concern: Contracted wage inflation remains a major concern for developers and builders, but most wage cost increases (5-8% per annum) are now known for the next 2-3 years based on each Enterprise Bargaining Agreement.
  • Opportunity in residential apartments: Developers remain concerned about project feasibilities with high costs and macro economic uncertainty. We’ve seen the biggest increase in potential borrower enquiry for finance relating to residential apartments, with the undersupply outlook for capital cities giving developers more comfort than other sectors. We’ve seen $2.4bn of new residential apartment projects in our pipeline in the last 6 months compared to $900m in 2H 2022.
Steel Rebar Futures

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 citiesHouse 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.