Dar Al Arkan predicts 20% climb in construction costs

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• Contractors may see margins slashed and prices hiked for buyers
• Labour shortages and Russian sanctions exacerbate pressures
• Risks of delays and builders cutting corners on materials 

Construction costs in Saudi Arabia are expected to soar by nearly 20 percent and drive down industry margins.

Gigaproject developments are at the heart of the kingdom’s economic vision to diversify away from its dependence on hydrocarbons. 

Saudi Arabia is currently the largest driver of construction activity in the Middle East region accounting for around 37 percent of all spending on construction in 2021, according to real real estate firm JLL.

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“We are already forecasting a 15 to 20 percent rise in costs in the next 12 months because all the materials that are imported are impacted by the price of transportation,” Ziad El Chaar, vice chairman of Dar Al Arkan Real Estate Development, the kingdom’s largest listed developer, told AGBI.

“We expect this increase in costs will be shared between three parties. The developer will eat a portion of that increase. The contractor will also reduce their margin by a portion, and a small portion will end up being in the hike in price.”

According to JLL’s MENA Construction Economic & Cost Insights, a range of factors will result in higher building costs in 2022. This includes the global building boom as economies revive after the coronavirus pandemic. 

This created greater demand for construction materials, as well as the kingdom’s reliance on imported building materials, particularly from China and Europe.

Labour market shortages, high energy prices, and Western economic sanctions on Russia also continue to exacerbate supply-side pressures.

“Given the impact of supply chain disruptions, commodity price increases, rising global inflation and increasing transportation costs, JLL expects tender price inflation to reach four to six percent in the kingdom this year, and slightly lower for the UAE, as an annual average year-on-year comparison,” Laura Morgan, market intelligence lead MEA, Project and Development Services at JLL, said.

“The construction industry has seen significant increases in key materials over the last 24 months and these rising costs are impacting the entire supply chain. 

“As a result of these increases, the supply chain executives are managing their risk through the increased use of fluctuation clauses and reduced tender/material price validity periods.”

Risk of cutting corners

Greater demand for construction materials such as steel is likely to continue to drive the price of steel in Saudi Arabia and other key markets in the Middle East. 

In 2021, the price of aluminium, copper and iron ore increased by between 45 percent and 51 percent, and the price of steel reinforcing bars rose by as much as 46 percent in some parts of Saudi Arabia.

Contractors and developers are anticipated to absorb the main brunt of the price inflation, creating the risk of cutting corners and putting profits ahead of quality.

Real estate consultancy Colliers said in its 2021 Construction Cost Update for Saudi Arabia that the volatility of commodity prices has caused challenges to developers and contractors in assessing future projects and in dealing with long-term contracts which were already awarded – although there has been some normalisation in Q2 2021.

“In 2022 while some headline price levels may cool slightly, construction price inflation may continue,” Christopher Seymour, head of strategy and investment Middle East, Africa and South Asia at British construction firm Mott MacDonald, said.

Seymour, who is also chairman of the Royal Institution of Chartered Surveyors’ Middle East and North Africa Market Advisory Panel, added: “As is usual under these conditions, a proportion of the increase is normally passed onto the project owners. 

“Some will be absorbed by the market depending on the sector and location.

“Quality is not directly affected by price rises, but significant increases can create the motivation to substitute materials, and must be closely monitored by designers and project teams. 

“Due to the price of energy and variable outlook on inflation across the globe, local sourcing could provide a less volatile option gaining shelter from exchange rate fluctuations and also providing a more environmentally sustainable solution.”

JLL’s Morgan said there is potential for existing developments to review alternative materials to reduce cost. 

“Conducting value management exercises is essential at early stages of design to ensure that quality is maintained while reviewing alternative products and methods,” she said. 

“Also, for new contracts, prequalifying contractors to ensure technical compliance against scope can also support construction quality. 

“In 2022, higher rents, prices and RevPAR (revenue per available room) have been achieved in sectors such as office, residential and hospitality. 

“This, in turn, means higher levels of revenue for owners/developers, which could help offset rising construction costs.”

El Chaar added: “If you are doing a very good job on project management and you have the right supervision consultant on site, you will make sure that this [cutting corners] does not happen, especially if you are using trusted contractors.”

Oil muscle

JLL’s report further noted that the Saudi market has also historically benefited from higher levels of liquidity.

The recent spike in oil prices will undoubtedly have helped in this regard. It may allow public sector agencies more room to manoeuvre when striking a balance between achieving financial returns and delivering sustainable, thriving cities and communities for the longer term. 

Higher construction costs are more likely to be absorbed rather than projects coming to a halt, the report said.

However, one building materials supplier, who declined to be named, told AGBI that while the kingdom has enough “oil muscle” to be immune to minor global fluctuations, any sharp dips could result in significant slowdowns in project activity. 

“Ultimately, they have a finite amount of oil and cannot continue to escape global conditions indefinitely and pour money into projects as they currently are,” he said.

“The next oil price drop could impact them significantly and construction activity will slow down.”