Building and construction 2004

23rd January 2004 By: nkolola halwindi

Although the level of confidence in the building industry increased significantly last year, the slow pace of delivery of significant projects as well as the deferment of capital projects in certain sectors is holding back the construction industry, with low profit margins worsening the situation.

However, declining interest rates on the back of consecutive tax-reducing Budgets will hopefully unlock further consumption expenditure, thereby stimulating growth.

Research conducted by the Bureau of Economic Research (BER) shows that the business confidence of contractors operating in the residential sector improved relatively sharply during the last quarter of 2003, a development attributed to a sharp drop in mortgage rates over the past year that has boosted the afford- ability of housing.

The more favourable business conditions have resulted in a drop in tendering competition and a consequent improvement in the profitability of construction companies operating in the housing sector.

Increasing shortages of skilled labour and building materials were reported by respondents to the survey, which, in time, could exert upward pressure on building costs.

According to senior economist at the BER, Dr Charles Martin, building activities in the nonresidential sector, such as office parks, shopping malls and industrial accommodation remain unfavourable and new work remains scarce.

Although the lowering of interest rates should underpin activity levels in the year ahead, a real revival is only expected to materialise in the second half of 2004, he predicts.

According to Martin, contractors operating in this sector consequently indicated in the fourth quarter survey that the demand for non-residential building work remained sluggish and tendering competition relatively keen.

No material improvement is expected in the short term.

The rate of increase in building costs, as measured by the BER building cost index, is slowing at present.

The strong rand is likely to continue to have a moderating impact on input costs over the short term.

However, Martin anticipates that the stronger effective demand for building is likely to lead to an acceleration in building costs this year, forecasting that they will increase on average by 10% this year.

He states that the key driver for an increase in building confidence is the lowered interest rate.

Despite the fact that the level of confidence has improved, margins, particularly among major con- tractors, have dwindled.

According to Martin, the low margins are a reflection of the scarcity of work and high competition.

“We anticipate a positive upswing until early 2006, as well as positive improvements in business con- ditions,” he anticipates.

Labour costs are measured by the customer price index that rose by 5,1% during the year ended August 2003.

This is significantly below the 10,4% recorded in the year to August 2002.

In a similar manner, the average increase in building material prices has dropped from 13,7% in the year ending July 2002 to 8,5% in the year to July 2002.

It seems as if the inflationary effects to the rand depreciation experienced during 2001 have worked their way through the system, with construction material prices now having stabilised at much higher levels.

According to the Construction Industry Development Board (CIDB), 2004 should see growing commitment and understanding that the construction industry needs to grow rapidly to meet South Africa’s growth and development targets.

Board CEO Spencer Hodgson says that a targeted economic growth rate of 5% a year would require the industry to double its output over a ten-year period.

Therefore, the industry should double its capacity all round, including professional capacity and skills development, as well as accelerating the rate of empowerment, he forecasts.

“We are anticipating a significant increase in empowerment deals, hence we see industry and government setting new empowerment goals,” remarks Hodgson.

“Growth and empowerment are closely related, because it is only when real sustainable empowerment takes place that we will be able to see meaningful growth in the industry,” he emphasised.

Last month saw the signing of one of the largest empower- ment deals in terms of percentage of ownership, in which building contractor Stocks Building Africa (SBA) signed an empowerment agreement with black economic empowerment (BEE) group Leswikeng Building, in which the latter acquired a 30% stake in the building contractor.

Explaining the rationale behind the decline in margins despite the increase in confidence, Hodgson observes levels of competition are still high and tenderers undercut prices in order to win contracts.

Currently, the industry is so easy to enter that anyone can submit and win a tender, he says. Hodgson cites an incident in which 18 companies were tendering for a project in Gauteng and the lowest tender was R10-million, while the highest was R64-million.

“The difference in pricing is a clear indication that many inexperi-enced bidders are simply taking a chance.

At the same time, clients are looking for means of cutting costs and endeavour to award contracts to the lowest bidder, he adds.

More often than not this results in poor quality, delays and escalating costs during and after construction, observes Hodgson, adding that the unregulated nature of the industry and the tendering process creates an environment in which the industry cannot grow sustainably due to pressure on the margins.

A number of initiatives in the pipeline, including the CIDB Register of Contractors, will begin to bring greater certainty for all stakeholders.

Hodgson is optimistic about the future of the industry, stating that with the expanded public works programme as well as a renewed commitment from government to capital projects, the construction outlook for 2004 is brighter.

He further observes that the increasing involvement of the private sector in big projects also offers opportunities to the industry, which has already seen government commitment through the expanded public works programme, as well as the Treasury, which has promised some R37-billion in total additional allocations over baseline in the next three years.

“In support of the core policy commitments, the proposed budget framework for the next three years provides strong real growth on infrastructure and capital projects, including roads, which are prioritised at national and provincial levels.

“This will raise the level of fixed investments directly, but will serve as a catalyst for increased private sector investment with positive impli- cations for job creation and poverty reduction, particularly in peri-urban and rural areas,” promised Finance Minister Trevor Manuel during his preliminary budget speech towards the end of last year.

The national and provincial capital expenditure will increase over baseline by about R10-billion.

Some of the spending areas, according to this framework, include an additional R750-million over the next three years for maintenance and backlog rehabilitation of the roads network, as well as the upgrading of strategic provincial roads, construction of four new prisons, a hospitals revitalisation programme, trans-frontier park infrastructure and urban renewal projects such as Gauteng’s Blue IQ.

Hodgson reports that the National Treasury is in the process of de- veloping a delivery management system in the public sector that will ensure that the projects deliver according to plan.

Safety is one of the critical areas in the industry, he says, adding that new safety regulations will help improve this aspect.

The construction regulations 2003, promulgated in terms of the Occupational Health and Safety Act 1993, place emphasis on the implementation of health and safety issues by the contractor.

The regulations require that both the client and the contractor take responsibility for the implementation of the safety requirements.

Previously, this responsibility rested solely on the contractor.

Although Hodgson does not outline the projects in the pipeline for 2004, he says the year will see a number of big and small projects that will keep the industry busy.

There are already signs of activity for architects, which is an indication of a positive future, he states.

However, the future is not all rosy for the entire industry.

Despite the fact that the level of confidence in building has increased, the civil engineering side of the industry has not seen the benefits.

In fact, activity in the civil industry slowed down by an estimated 5,6% quarter-on-quarter in the second quarter of last year, reports South African Federation of Civil Engineers and Contractors (Safcec) senior economist Pierre Blaauw.

He states that confidence levels declined significantly from around 70 in the first quarter to a 50 level in the second quarter.

Confidence is believed to have declined sharply on the back of continued frustration with the lack of delivery among the large contractors.

“It would appear that the rollout of capital projects by the private sector is still not up to speed, while government spending is fragmented into smaller contracts, which are not attractive to the larger contractors, hence the increase in optimism among the smaller-sized contractors,” explains Blaauw.

He observes that the value of contract awards declined in real terms in both the six-month and twelve-month period leading up to the first quarter, compared with 2002, a development mainly attributed to the lack of consistency in project delivery, as well as work being fragmented into smaller projects.

The size of contracts plays a crucial role in ensuring sustainability in the industry, emphasises Blaauw.

However, the number of tenders remained buoyant, with a 12,85% increase in the six months compared with the same period in 2002.

Employment levels increased marginally by 1,1% in the first six months of last year compared to 2002.

In this respect, Blaauw believes consistency of work in adequately-sized projects is necessary before companies in the civil engineering industry can contemplate substantial increases in human capital.

Turnover of the industry kept on growing robustly over the first six months of last year.

The six- and twelve-month periods up to the second quarter of 2003 showed real growth in turnover of 9,89% and 18% respectively, observes Blaauw.

However, he is optimistic that the industry will improve during the year, but states that real benefits will be measurable only early next year.

One of the notable developments in the industry is the increase in cross-border activities by South African companies, particularly in the Southern African Development Community (SADC).

“The region holds great promise, with some countries displaying aggressive gross domestic product growth,” enthuses Blaauw.

About 12% of civil engineering turnover in the first half of last year was generated from cross-border activities, according to a Safcec survey.

During the first quarter, Mozam-bique, Swaziland and Botswana ranked high among the SADC countries while, in the second quarter, Mozambique and Botswana maintained their prominence, as did Zambia and Swaziland.

According to the survey, general confidence for the region was around 80 in the first quarter, but declined to under 60 in the second quarter, a development mainly attributed to the volatility of the local currency.

“It is important to note that no pre-election spending has material- ised thus far, therefore the possibi- lity exists that a flurry of work might take place during the first six months.

“Gautrain and the Berg river dam (Skuifraam) could also add momentum to growth in the industry during the year,” forecasts Blaauw.

A general concern in the industry is whether the Department of Public Works has the capacity to roll out the expanded public works programme.

It is questionable if the lower tiers of government will be able to handle large projects, therefore it seems the market will continue to be flooded with smaller projects, remarks Blaauw.

Treasury increased budget amounts over the baseline to accommodate the labour-intensive public works programme, which in turn will have certain time and monetary cost implications that will erode the benefits, and not necessarily result in a substantial increase in work for the industry, he concludes.