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How cost distribution structure of a development project could influence builders’ decision in adopting advanced construction technology?

March 24, 2024
MALAYSIA
Dr Foo Chee Hung

Digitisation, automation, and the increased use of information and communications technology (ICT) forms the main concept of the 4th Industrial Revolution (IR 4.0). The incorporation of IR 4.0 into the construction industry – also known as Construction 4.0 – will see a variety of interdisciplinary technologies that integrate the construction process at all stages of the value chain; not only limited to increasing productivity, but also streamlining project management and procedures, as well as enhancing quality, safety, and sustainability.

However, the construction sector is often regarded as “risk-averse” when it comes to the adoption of advanced techniques or new methods. In Malaysia, the preference in using lower cost but foreign labor-intensive “conventional” construction method is deemed as the main reason that hampered the efforts made for the country’s construction industry to become a world-class player. Though there are promising constructions technologies that have emerged for decades, most of the products, methods, and techniques used in the construction sector still remain mostly unchanged, resulting in an industry plagued by flat profitability, poor safety records, and massive loss of resources.

To many advocates of advanced construction technology, internal factors such as labor, cost, time etc. are the root cause that hinders the success of adopting new technology (Figure 1). This is because property development is a process of developing land into a higher use value, which involves complex activities that engages with large sums of investment spread across the pre-development stage, actual construction stage, and post-development stage. In the case of Malaysia, the process could spend a long gestation period spanning 5 to 6 years from land purchase to completion, making property development a high-risk business. Unless builders that adopt new technology will acquire significant benefits over those that follow previous practices, otherwise they are likely to keep business as usual in order to keep the construction cost of a project manageable (certain percentage of the gross development value (GDV)).

Some may even attribute the problem to external factors such as influences from third parties and decision maker’s commitment, where builders are reluctant to change the way of doing things owning to their “profit-seeking” nature, coupled with the lack of knowledge and awareness of the latest technology development and availability. Builders are said to willingly go for advanced technology only if other companies or their competitors have shown a successful story. They are just way too “conservative” as they often require empirical evidences from vendors such as increased productivity, safety, and waste reduction; or a convincing ROI for their investment in technology before adopting any new construction technology.

(Source: Universiti Malaysia Pahang (UMP))
Figure 1: Factors affecting the adoption of emerging technology

However, the selection of what kind of construction technology to be used goes deeper than just considering both these internal and external factors as suggested above. It relates intact with the cost distribution structure of the project, which in turn plays an important in determining the financial viability of the project. Such a cost distribution structure is different from country to country due to the varying business environment – where it is all about how resources distribution is made among gross operating surplus, wages, government taxes etc. – resulting that some countries could be gaining larger advantages that others in terms of adopting advanced technology. This is an important aspect that often overlooked by many.

For example, labor cost in developed economies tends to be significantly higher than the one in developing countries, since the labor force in developed economies is predominately highly skilled that attracting premium wages. This contrasts with developing economies where the construction labors are generally earning a pittance as unskilled workers due to the abundance of domestic workers (like Indonesia) or the influx of migrant workers from the neighboring countries (like Malaysia).

A relatively lower labor cost in developing countries will motivate builders to adopt a more labor-intensive construction approach, while a higher wage cost in developed countries will motivate builders to invest in advanced construction technology in order to reduce their dependence on labor. This, in turn, leads to a higher construction cost in developed countries (Table 1). In most cases, a higher construction cost can result in a higher house price; but in certain cases, it is not, subject to other factors such as land cost and builder’s profitability.

(Note: * Retrieved from World Population Review; ** Retrieved from Turner & Townsend; *** Retrieved from Numbeo, referring to a residential high-rise unit in city center)
Table 1: Comparison on construction cost, labor cost, and average house price among selected countries, 2023

A better insight can be drawn by comparing Malaysia and Singapore: two countries that share the similar geographical background, but with different economic level that results in different cost distribution structure in their property development process. Consider the following two scenarios:

a) the low land cost-to-Gross Development Value (GDV) scenario in Malaysia (Scenario A), where land cost is less than 15% of GDV (which is derived from the recent land acquisition in Semenyih, Selangor, by Mah Sing at an entry cost point of RM392.04 million and with an estimated GDV of RM3.3 billion); and

b) the high land cost-to-GDV scenario in Singapore (Scenario B), where land cost could even reach as high as 50% GDV (which is derived from the land acquisition in 2021 at Tanjong Katong, Singapore, by Sunway-Hoi Hup JV at an entry cost point of SG$815 million and with an estimated GDV of SG$2 billion).

In terms of builder’s profit margin, a comparison on operating margin between Malaysian and Singapore top-10 public listed property developers finds that it is averaging at 14.8% and 19.8%, respectively (Figure 2); which is about the same and to some extent, could signify that property development in Malaysia is not less competitive than the one in Singapore. Suppose the same profit margin – let say 20% GDV – is to be achieved in each of the above-mentioned scenario, the respective proportion of construction cost (the combination of both hard and soft costs) to GDV for these scenarios will be 65% and 30% (Figure 3).

(Source: Companies’ filings)
Figure 2: Profit margin for the top 10 Malaysian- and Singapore-listed property developers for the latest financial year (2022/2023)
(Source: Calculation by author)
Figure 3: Breakdown of the project’s major cost with different scenarios

For Scenario A (Malaysia), land cost is small in relation to the completed development value. Since construction cost – the major contributor to GDV – is subject to the free-market force and regulatory/industrial practices, which is deemed to be fixed and have little room for adjustment; land cost plays an important role in determining builders’ profit margin. The lower the land cost means the higher the profit will be. This is how those township players leverage on their land bank to stay competitive over their competitors.

While builders in this scenario may have more flexibility in pricing their properties, it could, sometimes, result in overpricing as builders tend to reap a higher return by selling the future value of properties. Also, any small increases in input costs – due to the shift from “conventional” construction to IBS construction, for example – will directly result in builder’s margin compression. Should the profit margins – let say 20% – be retained, there will be a cost transfer in the form of higher selling prices to the customers. In order to maintain their competitiveness in the market, especially amid the declining homebuyers’ affordability and unabated construction inflation, like present, builders will likely to operate their projects in the “conventional” way as the adoption of higher cost technology could have implications on the profit margins.

In the case of Scenario B (Singapore), where land cost is the major contributor to GDV, the per-unit builder profit is more sensitive to changes in land costs than to changes in construction costs. Since the holding cost for land is high, should the market plummets when the developer is ready to build, changes to land value will drastically alter the overall project value. Under such circumstance, builders in Scenario B are likely to speed-up their construction process, or else, they would have to pay higher interest for that piece of land or to absorb a lower profit margin. Hence, builders are keener to adopt advanced construction technologies, or even to bear with the short-run variations in construction cost, in order to ensure they will have enough profit for the risk taken to build the projects.

From here, one should realise that though the construction cost and labor cost in Malaysia are relatively lower in comparison to the one in Singapore, it is not conjuring an image of “greedy profit-seeking” builders that making excessive or unreasonable profits through using low-cost, low-productive construction method. Instead, it indicates that Malaysian builders are trying to become more competitive in their domestic market which is generally demonstrating a lower property selling price than the one in Singapore.    

One should also realise that technology transformation could have accomplished productivity gains in the long run, but certainly not in the way many would envision or what prevailing narratives seem to suggest due to the lack of integration among applications. Sometimes, technology transformation could end up creating more technical “debt,” should one just implement new technology for the sake of “implementing technology” without taking into account the “marketplace reality,” “business-as-usual practice,” and the “capacity and compatibility of change” of each stakeholder at different level and scale. This will not only deprive the capital of the appropriate returns, but may also have the opposite effect of disincentivising investments.

The successful implementation of advanced construction technology in developed economies is the result that emerges out of the necessity and desires of the societies. The reason that these countries become proficient in emerging technology are mainly attributed to events that have spurred this on, including the industrial revolution, war time, and post war housing crisis; which have caused a great shortage of housing supply to the societies. Though the demands for housing in these countries are temporarily fulfilled by taking the advantage of mass production through advanced technology; house prices can hardly come down due to the strong demands from the societies.

Furthermore, the main driving force of some developing countries’ active involvement in construction technological innovation (like China) is mainly aimed for coping the huge housing demand following the increasing urbanisation rate. Since the supply of housing is lack behind while competition is tough among builders, leverage on advanced technology is needed, so as to increase construction productivity, as well as to outperform competitors. However, higher housing demands will eventually lead to higher house prices, though increased construction productivity serves to shorten the process of closing up the supply-demand matching. \

To conclude, many problems and issues in the property development can easily be solved by simply “changing the way of doing things” without even involves a drastic change in the common way of doing business. What is holding Malaysian builders back from innovation, increased R&D investments, and higher productivity are the lack of financing, over-regulation, excessive corruption, and protectionist supply chains. Since financial viability is important for builders to kick start a project, and that they will always strive to keep the construction cost down in order to offset the ever-rising cost of doing business posed by artificial regulatory barriers; any attempts from the government that could help enhance the project development process, or to drive the heavily regulated real estate industry towards a higher level of efficiency, are more than preferable.

Ts. Dr. Foo Chee Hung is a Professional Technologist registered under the Malaysian Board of Technologists. He is currently the manager of Product Research & Development at MKH Berhad. Prior to this, he held the Head of Research position at the Construction Industry Development Board (CIDB). Dr Foo has a PhD in Urban Engineering from The University of Tokyo. His research interest is in sustainability, affordable housing, green building, building quality assessment, Industrialized Building System (IBS), and urban ecosystem. Dr Foo is also a member of the Institution of Engineers Malaysia (IEM) and REHDA Selangor Planning Policies and Standards Sub-committee; a research committee with REHDA Institute (RI), a GreenRE manager, a Certified Sustainable INFRASTAR facilitator & a Certified MyCREST Qualified Professional and Assessor.

Disclaimer: Any opinions expressed are entirely the author’s own and do not necessarily reflect the views of PropertyGuru and its entities.

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