Building costs a headache for developers

By William Kemble-Diaz and Dominic Whiting

LONDON/SINGAPORE (Reuters) - Soaring construction costs are squeezing the profits of property developers around the world but that could be good news for real estate investors if it helps to rein-in the supply of new buildings as occupier demand wilts.

"There is not a lot of reason to add product and in the end that is what makes this cycle different to other cycles we have been through," Chuck Leitner, global head of Deutsche Bank's (DBKGn.DE: Quote, Profile, Research, Stock Buzz) alternative investments arm RREEF, said at the Reuters Global Real Estate Summit.

"For a pure developer it is not good news but for a real estate investor actually it probably is good news," he said.

Higher funding costs as banks buffer their lending margins and toughen their underwriting due to a global credit crunch has added to the strain felt by developers, while a Chinese iron ore supply deal this week signals more steel price hikes to come just as labor and raw material prices are rising.

"There is no input into the development equation that is going to be lower in the next 12 months," said Mike Hussey, managing director of the London portfolio for Britain's biggest listed property company, Land Securities (LAND.L: Quote, Profile, Research, Stock Buzz).

In the Middle East, India and China, where the bulk of the world's construction is centered, developers have relied on steep increases in sale prices to keep their housing and commercial projects lucrative.

But with property markets now slowing, 50 percent rises in building costs across Asia in the last couple of years are starting to bite.

DUBAI

In Dubai, the combined cost of labor and materials has doubled since 2006, hurting firms that have sold apartments before construction begins.

"That's a major worry for Middle East developers," said Abid Junaid, executive director of Dubai's ETA Star Property Developers. "They have sold buildings off-plan ahead of construction, and there's no leverage to increase prices."

Echoing several executives at the Summit this week, Junaid said inflation was the biggest question mark on Asia's property landscape.

"We're just at the tip of the iceberg," he said. "We don't know the time frame for it will play out."

Events this week suggest building costs will continue to rise. Chinese steel producer Baosteel (600019.SS: Quote, Profile, Research, Stock Buzz) agreed on Monday to a price hike of up to 96.5 percent for iron ore it buys from producer Rio Tinto (RIO.L: Quote, Profile, Research, Stock Buzz)(RIO.AX: Quote, Profile, Research, Stock Buzz).

The global price for steel, used for the skeletons of top-grade buildings and to give concrete walls, floors and columns tensile strength, has risen 50 percent this year.

Steel can account for anywhere between 5-20 percent of construction costs, and more in a country such as Japan where the threat of earthquakes looms.  Continued...