- Cyprus Property News Magazine - http://www.news.cyprus-property-buyers.com -

Why have construction output prices not fallen?

OUTPUT in construction recorded its steepest drop in 2012 since the long recession in the sector that began in the second half of 2008, with the construction production index falling by 22% compared with the previous year.

Construction output also recorded its steepest decline on a quarterly basis, falling by 27% in the fourth quarter compared with the same period of 2011, to 57.8 (2005=100).

This is the lowest index on records that began in 2000. It means that construction output is only around quarter of the size it was 12 years ago: in the first quarter of 2000, the construction output index was 76.5 (2005=100).

The decline in 2012 was across both subsectors: building construction fell by 19.8%, while civil engineering tumbled by 27.3%.

The steeper decline for civil engineering is probably related to building projects in the run-up to Cyprus holding the EU presidency in the second half of 2012. Civil engineering projects recorded a small 1.2% increase in 2011.

As regards building construction, this has been hit by oversupply built up during the boom period and tighter credit conditions thereafter.

In an earlier Financial Mirror article, Sapienta Economics explained how by 2011 Cyprus had a total housing stock of 431,059 but only 309,300 households to fill them, meaning a housing oversupply of around 120,000, which was too large to be filled by holiday home-buyers.

Construction output prices down in Q4

Despite the decline in construction, output prices have taken a long time to respond. Output prices fell by only 0.4% overall in 2012 although they fell by a steeper 2% year on year in the fourth quarter. Does this mean that construction companies are still squeezing the end-buyer for profits?

Cyprus output construction costsProbably not. The main reason for the slower decline in prices, despite tumbling demand that should depress prices, is related to the cost of materials inputs.

Input prices of materials, reported as the price index of construction materials, are heavily influenced by oil prices.

As can be seen from the chart, input prices dropped after the peak in mid-2008 but started to climb again from the beginning of 2009 and did not drop off until the last quarter of 2012.

brent crude oil priceThis more or less matches the path of oil prices. According to the Economist Intelligence Unit’s monthly Global Outlook, Brent crude fell from $97.66/barrel in 2008 to $61.86/b in 2009, then climbed to $79.63 in 2010, $110.94 in 2011 and $111.97 in 2012. It is expected to drop to $106.60 in 2013.

As input prices fell, the chart shows that developers in Cyprus followed suit, cutting output prices. But they carried on cutting long after construction input prices had started to rise again.

Developers have seen a deep cut in profit margins

The result is a widening gap between the amount developers pay for inputs and the amount they can charge once the project is completed. In other words, a deep cut in profit margins.

One can reasonably infer from the rapid rise of unemployment among construction workers that the developers have responded to lower demand and tighter margins by laying off staff. We can also assume that in some cases the staff laid off have been replaced by cheaper and not necessarily officially registered workers in their place.

How to re-skill and retrain the 6,717 unemployed construction workers registered at the end of March so that they can be employable in other fields is a huge undertaking with no easy answers. At least in Cyprus we have a wealth of knowledge on what has and has not worked elsewhere via Professor Chris Pissarides, the chairman of the new economic advisory council, who won his Nobel Laureate through research into labour markets.

Fiona Mullen – Director, Sapienta Economics Ltd