The perfect storm

As UAE cement supplies slow and the cost of construction materials soar, work has halted on some projects.
The perfect storm
By Sean Cronin
Thu 10 Apr 2008 04:00 AM

As cement supplies slow to a trickle on building sites across the UAE and the cost of construction materials continues to soar, work has ground to a halt on some projects while others face delays of up to five months.

Minoo Jamaji has been working in UAE construction for 20 years and even he can't remember a bigger crisis facing the building industry.

A cement shortage is holding many major projects to ransom while the cost of key building materials including readymix concrete, structural steel and rebar is escalating - forcing many developers to either halt their projects or source materials from the black market.

This will have a bigger impact on the smaller contractors, who won’t be as sophisticated as the larger companies when it comes to hedging against material price increases.

"This is a very big problem. Some jobs have stopped. Other projects are delayed by as much as five months. Government projects are being given priority," says Jamaji, the managing director of UAE civil engineering contractor Roshan Construction.

The crisis threatens to delay US$1 trillion worth of projects in the Gulf state, as it seeks to build a global financial and tourism hub.

Record oil revenues have helped the UAE develop lavish real estate projects such as the Burj Dubai, the world's tallest tower and the ‘Palm' islands, built from sand reclaimed from the sea.

But the real estate boom has also driven inflation, which advanced more than 9% last year.

Construction costs rose at about twice the rate of inflation in 2007, rising by about 20% according to research from international cost consultant EC Harris. The price of steel reinforcement rose by 46%, and structural steel gained 38% while cement prices ended the year 30% higher.

Those gains could be exceeded in 2008 as the industry is hit by fresh price hikes across steel, cement and readymix concrete.

The cost of steel rebar, which is used to strengthen concrete in buildings across the region, gained around 7% between January and March 2008. Steel that would have cost US$750 per tonne in January, cost more than US$800 per tonne last week, according to industry trading platform MESteel.

Real estate developers are starting to feel the pressure as projects are delayed, costs rise and contractors invoke contractual claims or threaten legal action to recoup losses on contracts.

"It's a very crucial time for us," says Mohammed Ali Al Hashimi, CEO of Zabeel Investments, which has more than US$4bn invested in the UAE real estate market.

"At the end of 2008 we have our first real development being handed over - Tiara Hotel & Residences - and we've had to endure a substantial increase in construction costs.

Cement producers have been unable to raise their prices because of a government-imposed cap aimed at curbing record inflation in the UAE. At the same time, cement production costs have soared because the gas needed to operate production facilities is becoming more expensive.

The government removed custom tariffs on cement and reinforced steel last month in an attempt to ease cost pressures in the industry, but the US$80 per tonne price cement cap remains in place.

The lifting of import duties has not elicited much cheer from construction companies which say that the material is difficult to import and store, particularly as humidity increases as the industry enters the difficult summer months.

Middlemen have been profiting from the government-imposed price caps by buying cement from the manufacturers and selling it on to increasingly desperate contractors.

Real estate analysts are warning that the rising cost of materials may wipe out property developers' profit margins if selling prices fail to keep pace with, or exceed, the cost of building. "Up until now property price increases have served as a cushion against the rising construction material prices.

If property prices slow, then this will have a negative impact on developer margins," says Roy Cherry, an analyst at Shuaa Capital, the UAE's largest investment bank.
This will have a bigger impact on the smaller contractors, who won't be as sophisticated as the larger companies when it comes to hedging against material price increases and negotiating contracts," he says.

Jamaji of Roshan Construction says that many real estate developers could face financial difficulties as a result of the most recent price increases.

"Some developers will be faced with the choice of either putting more money into their projects, or going bust," he says.

Some developers will be faced with the choice of either putting more money into their projects, or going bust.

Jamaji believes the solution may be for the government to nationalise the cement factories to ensure that the local construction industry receives a regular supply.

The price volatility and material shortages are also dissuading construction companies to bid for new contracts because they are unsure whether they will be able to resource the projects should they win them, according to Jamaji.

The cement crisis could deepen as the industry enters the second quarter because four factories in the emirates of Ras Al Khaimah and Fujairah have ceased production due to the "breakdown of machinery and equipment", according to a research note from HC Securities Brokerage.

Many major construction projects in the UAE are governed by fixed-price contracts where contractors have limited protection against rising material prices. Others include so-called ‘price escalation clauses' which allow construction companies to pass on material price increases to their clients.

"Rapid increases in the cost of materials could put some contractors at risk, especially those who are locked in with fixed price contracts with less understanding developers, and this could definitely fast-forward consolidation in the industry as some firms are taken over or risk going out of business," says Cherry.

Jamaji says that contractors who have been stung by significant material price rises are seeking to enforce ‘force majeure' clauses within their contracts, more usually associated with events such as wars or strikes.

The cost crisis in the construction industry comes as Gulf states, including the UAE look to find ways of curbing inflation which is threatening to derail economic growth.

Rampant price increases have led the UAE Ministry of Economy to introduce controls on a range of items while also removing import duties. Other GCC states have also introduced price caps to reign in record inflation as their currencies linked to a weakening dollar have made imports more expensive.

Real estate costs have been the biggest driver of inflation in the UAE as the price of homes and apartments have soared since Dubai allowed foreigners to own homes in 2002, sparking a six-year real estate boom.

Apartment rents have almost doubled in Dubai over the last three years according to real estate consultancy Asteco, while premium office space has more than tripled over the same period.

The International Monetary Fund has warned that the UAE must slow government spending if it wants to reduce inflation.

"Its challenge now is to address the housing constraint that is pushing up inflation while sustaining growth and ensuring macroeconomic and financial stability," said the report published in December.

As landmark projects such as the Burj Dubai near completion, the UAE's world-famous construction sector may be entering its most turbulent period in recent years.

Cement shortages are combining with rising costs across other key building materials at a time when developers may not be able to absorb them. For the real estate industry, it could represent a perfect storm.

RELATED LINK:Builders lament price of cement

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