COVID-19, War, and Strikes Cause Construction Costs to Rise 30% in 4 Years
Construction Industry: "Contracts from 4-5 Years Ago Are the Biggest Problem"
Even with Over 100 Billion Won Increase in Construction Costs, Profits Barely Avoided Losses
The Seoul Jangwi 6 District Association, which is promoting a housing redevelopment project, has negotiated with Daewoo Engineering & Construction to increase the construction cost by approximately 130 billion KRW. The contract amount at the time of signing in July 2019 was 323.16 billion KRW, but it has now been agreed to raise it to 451.628 billion KRW. In terms of contract price per 3.3㎡ (per pyeong), it rose from 4.26 million KRW to 5.837 million KRW. Although the association, which opposed the increase in construction costs, finally agreed to raise the cost by 130 billion KRW after a tug-of-war with the construction company, Daewoo E&C's outlook is not entirely optimistic. They believe it is difficult to secure profitability even with the increased construction costs.
It has been revealed that construction companies are struggling to secure profitability as construction costs have skyrocketed, especially in redevelopment projects contracted 4 to 5 years ago. They are demanding an increase in construction costs because operating under the original contract would inevitably lead to losses, but they lament that even with increased costs, it is difficult to secure profits.
According to the electronic disclosure system on the 14th, the cost of sales ratio (cumulative basis) for last year of the top five domestic construction companies by contract ranking?Samsung C&T Construction Division, Hyundai Engineering & Construction, Daewoo Engineering & Construction, GS Engineering & Construction, and DL E&C?was 92.9%. This is an increase of 2.9 percentage points compared to 90% the previous year.
Increase in Cost of Sales Due to Rising Construction Costs
With the rise in construction costs, the cost of sales for construction companies has significantly increased. According to the Korea Institute of Civil Engineering and Building Technology, the Construction Cost Index rose by 30.7% from January 2020 (118.30) to January this year (154.64). Compared to December last year (153.22), it increased by 0.93%. The Construction Cost Index reflects price changes in materials, labor, and equipment used in construction projects. Kang Taekyung, a senior research fellow at the institute, explained, "The item contributing most to the increase compared to the previous month was worker wages," adding, "Labor supply and brokerage, as well as ready-mixed concrete, followed."
Daewoo E&C recently revised the contract amount for the housing redevelopment project in Sanseong District, Sujeong-gu, Seongnam City, Gyeonggi Province, in addition to Jangwi 6 District. The contract amount was raised from 243.284 billion KRW in August 2020 to 522.661 billion KRW currently. The increase was largely due to inflation. In this project, Daewoo E&C's construction share was about 35%, but it has now increased to 50%.
A Daewoo E&C official said, "For projects where construction contracts were recently signed, some reflection of increased construction costs is possible, and if losses are expected, companies can choose not to bid from the start. However, contracts signed 4 to 5 years ago must be executed, and the difference in construction costs between then and now is huge, making cost increases inevitable." He added, "From the construction company's perspective, the more they build, the more they lose, but if construction does not proceed, residents will face delayed move-in. Therefore, this contract price increase was decided as a way to share the pain together."
The industry describes this situation as ‘biting the bullet.’ A representative from Company A said, "According to current market prices, redevelopment construction costs need to exceed at least 8 million KRW per pyeong to be profitable, and some associations are proposing amounts exceeding 9 million KRW per pyeong." He explained, "Daewoo E&C seems to have focused on maintaining work even if it does not make a profit." According to the Seoul City redevelopment project database ‘Mongttang,’ the Dogok Gaepo Hanshin Apartment Housing Reconstruction Project Association in Gangnam-gu announced a bid for contractor selection with a total construction cost of 429.5 billion KRW, which is about 9.2 million KRW per 3.3㎡.
Taking to the Streets to Demand Construction Cost Increases
Although construction cost increases are necessary, some places have resorted to street protests after failing to negotiate with clients. Ssangyong Engineering & Construction won the contract for KT's Pangyo new headquarters construction in 2020 and completed it in April last year. Conflict arose when Ssangyong requested an additional 17.1 billion KRW from KT to reflect inflation. Ssangyong claims that "unforeseen events such as the COVID-19 pandemic, the Russia-Ukraine war, and strikes by ready-mixed concrete transport unions led to additional construction costs."
Ssangyong employees held their first rally in front of KT's Pangyo new headquarters on October 31 last year. They announced a second rally on the 12th and are currently in final negotiations with KT. KT has refused to increase construction costs based on a clause in the contract excluding adjustments for price fluctuations.
As conflicts over construction cost increases between contractors and associations have arisen, the Seoul Housing and Communities Corporation (SH) has stepped in. SH is currently verifying construction costs for the ‘Sinbanpo 22nd Apartment’ in Jamwon-dong, Seocho-gu for reconstruction, and ‘Haengdang 7th District’ in Haengdang-dong, Seongdong-gu for redevelopment.
A representative from Company B said, "Contractually, subsequent construction cost increases rarely favor contractors. Nevertheless, due to the real estate market downturn, construction companies' performance has plummeted, and to prepare for real estate project financing (PF), it is crucial to minimize losses on construction costs."
A representative from Company C said, "The rise in construction material and labor costs over the past four years is comparable to a natural disaster. In such times, construction companies have no choice but to plead with clients to raise construction costs to survive."
© The Asia Business Daily(www.asiae.co.kr). All rights reserved.
