How much will Australian construction costs rise in 2023?

A quantity surveyor (QS) is part futurist, part historian, with one eye fixed on the horizon and the other looking back at what happened in the past. The QS must understand big picture megatrends and microeconomics, must watch out for changes to government policy and geopolitical unrest, must scrutinise supply chains and scour markets for risk. Above all else, a QS must expect the unexpected.

“It is also our job to put a price on the unexpected,” says Altus Group’s President for Cost Project Management in APAC, Niall McSweeney. “Everything from war and extreme weather has come out of left field to put pressure on costs and inflation this year.”

Inflation and interest rates on the rise

In February 2022, with the Australian cash rate at an all-time low of 0.1%, Altus Group predicted at least one rate rise, with Niall noting that “financial markets have priced in four rate hikes in 2022”.

But a year later, inflation is at a 32-year high of 8%, and the Reserve Bank has raised the cash rate by 275 basis points since May.

“We always expected inflation to increase in 2022. But the war in Ukraine has had a huge impact on commodities, fuel, materials and even food in some markets and that has been an unexpected inflationary pressure. The upshot is that inflation is higher than I expected it to be,” Niall says.

Materials and their movement

Niall says he remains shocked that China continues to pursue its zero-Covid strategy, despite discontent among citizens who have endured nearly three years of forced lockdowns, mass testing and travel restrictions. Lockdowns continue to occur weekly. Niall points to the industrial park in Zhengzhou – dubbed ‘iPhone City’ – as an example, where 200,000 workers were locked down for a week in early November to curb the spread.

“China’s zero-Covid strategy continues to create materials shortages because manufacturing is not operating at its peak and there is less product going to market.” The availability of electrical equipment, for instance, has been heavily influenced by China’s lockdowns. “Delivery times for everything from lifts to main switchboards to substations continue to blow out”.

On the flipside, shipping costs – which more than doubled in 2021 – have eased, contradicting Altus Group’s prediction that shipping costs would continue to spiral well into 2022. The world’s biggest container shipping company Maersk recently forecast a slowdown in demand for freight services. “Lower production means there is less product to ship,” Niall notes.

The fluctuation in steel – Australia’s top export commodity – over 2022 has been “surprising”. But China’s peak steelmaking body expects weak demand in 2023 as COVID-19 control measures, rising raw material prices and the threat of a global recession take hold. Niall expects to see an oversupply of steel in the market in 2023, “particularly for lower grade steel, which will have an impact on prices but also have negative flow-on effects for Australia’s economy”.

Stocks of timber, which were in massive undersupply in 2021, have normalised. “There are more available timber species around, and more cross-laminated timber. Pricing hasn’t come down yet, but it will in response to simple supply and demand dynamics.” Other materials shortages – from joinery to glass – continue to be a risk to budgets. “But all in all, material shortages have eased over 2022, as we anticipated.”

Skills shortages and solutions

Altus Group predicted that skills shortages across the construction industry would hurt budgets over the course of 2022, and Niall warns that rising salaries will be an inflationary pressure well into next year. “The quicker salaries are raised to match inflation, the greater the inflationary pressure. The answer is to return to the pre-pandemic pattern of migration.”

Australia’s government has boosted its permanent migration program to 195,000 per year, up from 160,000. “This is welcome, but we need to quicken the pace of migration to attract more skilled workers. Australia’s challenge is that every other developed nation has the same labour shortages, so skilled workers considering a move are spoilt for choice.”

The “spectre” of multi-employer bargaining – which unions claim will help to grow wages, but which employer groups say is a ‘job killer’ – was one Altus Group didn’t see coming. “I am concerned we could go back to the industrial environment of the 1980s, which could cause runaway construction costs.”

Black swans and grey rhinos

‘Black swan events’ are so rare the normal economic models cannot predict them – and 2022 has had its fair share of black swans. “The year has been full of surprises. I didn’t see the war in Ukraine happening and that’s had a huge influence on markets and costs,” Niall says.

But other events, dubbed ‘grey rhinos’ because they are big, obvious and ignored until they crash, also influenced Australia’s construction industry. A year of flooding rains, for instance, is a clear consequence of climate change that scientists have spent two decades foreshadowing. But as Niall says: “The rains and floods worsened as the year has worn on – and I don’t think anyone expected that Sydney would have its wettest year on record, for example.”

his has been a pain point for contractors operating to budgets set well before La Niña arrived on our doorsteps. Costs soared and continency budgets were soaked up as construction sites paused for week after wet week while clients simply shrugged and said it was not their problem. Meanwhile, local price indexes escalated as the cost of replacing flood-ravaged homes rose by more than 20%.

Government leadership and levers

Builders have spent much of 2022 weighing up the rewards on a set of scales unfairly tipped towards risk, Niall says. Infrastructure construction contracts signed before the pandemic have been labelled “unworkable”.

In response, governments have begun exploring the “aspiration” of alliance contracting. “But as material supply has improved and prices have eased this has drifted to a side conversation. These is still a problem in the market with a limited number of companies prepared to take on projects of a certain size – and I think the shift away from fixed price contracts will continue in 2023, but only in certain sectors.”

Legislative changes around quality, environment and industrial relations are also adding to the escalation pressures in the industry. “They are all necessary, but there are a number coming at the same time.”

Then there’s government spending. Australia’s three tiers of governments have allocated an eye-watering $248 billion for infrastructure over the four years to FY2024-25. The outcomes of the upcoming Victorian and New South Wales state elections may influence government spending in the short-term. “But government spending will need to be reined in to control inflation.”

Consulting the crystal ball

The bad news first. Niall expects insolvencies across the construction industry to increase in 2023. “The trigger is always the Christmas shutdown, but the announcements are usually made towards the end of the first quarter.”

But there’s good news too. “Despite the ups and downs for 2023, Altus Group still expects costs in Australia’s construction industry to stabilise in 2023. We have got past the pandemic panic, and with a strong pipeline of work, Australia’s construction industry is well placed to weather the storms ahead.”