It is no secret that construction costs are on the rise in Australia. 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 excellent news for the construction industry, but it could spell trouble for homeowners planning to renovate or build their new homes. So what can you do to protect yourself from rising construction costs? First, we will cover why we are seeing increasing costs for construction and what you need to be aware of in this situation.
There are various factors contributing to increased costs of construction, but the most notable factors include:
• The rising cost of materials such as 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 substantially impact the residential property market. CoreLogic Head of Insurance Solution, Matthew Walker, warned that it could impact all homeowners and property investors, 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. So it is 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 is not just a shortage in skilled workers and essential building materials contributing to rising costs but also market demand. As a result, Australia has been on a ‘home building boom’, particularly after the federal government’s HomeBuilder scheme was introduced in 2020.
How to protect yourself if you are looking to build your home or renovate
There are generally two contracts when you engage a builder for a construction project. It is imperative to be aware of these contracts if you want to take out a construction loan through your lender or mortgage broker. If you are aware of these two contract types, you may be able to protect yourself from rising construction costs better.
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 Consumer Affairs Victoria, which provides a checklist of what to be wary of in this instance.
2. Cost-plus contracts
The other type of contract generally used is a cost-plus contract.
These contracts have some benefits if you do not mind the administrative work. With these contracts, you are not locked into a fixed price. If prices for materials like structural timber or metal products increase during the construction project, the cost of your project will increase. This process allows you to receive invoices for each expense incurred from your builder as the project owner. However, it 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. This contract may work for you if you do not personally mind the extra workload of monitoring costs and staying up to date with progress payments throughout your construction project.
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. The entire risk is passed onto you under these contracts as materials increase the cost.
Find the right loan features for your needs.
Tips for dealing with builders: 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, consider another important step: make sure your builder is in good financial shape. This is particularly important 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. However, if a builder requests more significant than 10 progress payments, this may indicate potential cash flow issues, so tread carefully.
3. Finally, 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, do not hesitate to reach out to one of our experienced Construction Loan experts to discuss your concerns!
This article is prepared based on general information. It does not consider individual financial objectives or needs and is not financial product advice, and the content is quoted from the Yellow Brick Road Blog.