Cost Of Doing Business and Impact on the Construction Industry
Introduction
The cost of doing business in construction industry sectors, particularly within housing and property development, has emerged as a significant structural challenge affecting price sustainability and market efficiency. This comprehensive analysis draws from the official report "Cost of Doing Business and Impact on Construction Industry," which provides an independent industry standpoint on the key issues facing developers.
The document highlights that high compliance costs lead to price distortions, directly affecting property prices and the affordability of homes for future buyers. By understanding the roots of these cost increases, stakeholders can identify transformational yet practical strategies for a more cost-effective and efficient housing delivery system.Understanding the High Cost of Doing Business in the Construction Industry
The Malaysian housing industry is highly regulated by various laws, policies, guidelines, and standards. While regulation is necessary for safety and planning, the report indicates that over-regulation adds to costs without necessarily adding productive value to the houses themselves.
New compliance measures are often imposed by separate agencies through separate laws, leading to a substantial cumulative increase in compliance burdens. These regulations can limit supply and create inflexibility, making it difficult for the industry to adapt to market changes.
The core argument presented is that the cost of doing business in construction industry operations is inflated by unproductive expenditures. For instance, cross-subsidies and holding costs do not enhance the quality, size, or specifications of the final product. Instead, they act as financial barriers that distort market prices. The report emphasizes that a cost-benefit analysis of these regulations is essential to assess whether the social benefits outweigh the public costs, such as increased housing prices and reduced affordability. Without such analysis, regulations may constitute unnecessary barriers to development.
Key Drivers Increasing the Cost of Doing Business in Construction Industry
The document identifies four primary key issues that significantly drive up the cost of doing business in construction industry projects. These issues are interlinked and create a complex web of financial pressures on developers.
Overzealous Planning Requirements Reduce Sellable Land
One of the most significant factors affecting the cost of doing business in the construction industry is the reduction of net sellable land due to planning requirements. A certain percentage of land acreage must be utilized for public facilities, roads, drainage, and other infrastructure. Beyond specific thresholds, land must be surrendered for public facilities like schools, hospitals, and police stations.
Recent years have seen a notable reduction in sellable land to only 40%-45% of the total land area. This loss of opportunity means fewer housing units can be built and marketed, resulting in less housing supply and increased land cost per unit. For example, in strata developments, parking requirements are a major compliance issue.
Each additional parking lot can cost about 8.5% of the Gross Development Value (GDV). Buyers who do not need these spaces still pay for them as part of the housing price, further distorting value perception.
Cross Subsidies Create Price Distortion
Cross-subsidies are a peculiar feature of the property industry, particularly in affordable housing and Bumiputera quota allocations. The cost of doing business in the construction industry is heavily impacted by these mandatory subsidies. Affordable housing quotas, which can be as high as 70% in some states with prices capped as low as RM42,000, can only be implemented through cross-subsidies from open market units. These subsidies can amount to RM100,000 or between 10% and 20% per open market-priced unit.
Similarly, Bumiputera quotas require discounts of 5%-7% on up to 30% of units, translating to a 1.5%-2% cross-funding burden on the open market. The main concern for the industry is the release of unsold quota units. The approval process for releasing these units is not transparent or automatic, creating uncertainty that adversely affects project marketing and cash flow planning. Unsold units tie up resources and attract additional holding costs, which can reach up to 0.6% of GDV.
Lengthy Process of Approval
The multi-tier approval process involving federal, state, and local authorities, as well as utility companies, contributes significantly to the cost of doing business in the construction industry. Uncertainty in approval timelines affects project planning, implementation, and cash flow. This results in higher risks, additional holding costs, and expected higher returns to buffer against construction risks.
For example, in a township development with a GDV of around RM4 billion, each day taken for approval costs close to RM95,000. A one-year approval period translates to RM35 million in holding costs, a huge amount that could have been channeled more productively into the project. These delays are unproductive and inefficient, as the additional costs do not contribute to house quality or specifications.
Quantifying the Cost of Doing Business in the Construction Industry
The report provides a detailed breakdown of compliance costs as a percentage of GDV. Total compliance costs range from 21.8% to 32.5% of GDV, depending on the type of development.
Breakdown of Compliance Costs
- Cross Subsidies: Affordable housing subsidies account for 8% to 10%, while Bumiputera quota discounts add 1.5% to 2%.
- Land and Development Charges: Conversion premiums (1%-2%), development charges (1%-2%), and loss of sellable land (6%-9%) contribute significantly.
- Holding Costs: Delays in approvals and unsold units each add 0.5% to 1.5%.
- Utilities: Capital contributions and other utilities costs account for 3% to 4%.
This data illustrates that the cost of doing business in the construction industry is not merely about construction materials but is heavily weighted by regulatory and policy-driven expenses. In strata developments less than 10 acres, car park requirements alone can add 4% to 8% to the GDV, further exacerbating the cost burden.
Case Studies of Actual Projects
Five case studies from Selangor, Penang, and Kuala Lumpur demonstrate the real-world impact of these costs. The minimum cost per unit for developing an 800-900 sq ft private affordable housing apartment is around RM214 to RM304 per sq ft on a break-even basis. When government-controlled prices are lower than development costs, losses are absorbed through cross-subsidies, making standalone affordable housing developments unfeasible for the private sector.
Strategies to Reduce the Cost of Doing Business in the Construction Industry
The report offers transformational recommendations divided into three thrusts: reducing unproductive costs, minimizing cross-subsidies, and optimizing land efficiency.
Thrust 1: Reduce Unproductive Costs
To lower the cost of doing business in the construction industry, the report recommends a full digital property development system incorporating pre-consultation, submission, approval, and payment. Local plans should be expedited and gazette to reduce approval timelines. Self-regulation via consultants (OSC 4) and online payment centers for fees can enhance transparency and speed. Additionally, cost-benefit analyses should be mandatory for all new compliances to ensure they add value.
Thrust 2: Minimize Cross Subsidies
The provision of affordable housing for B40 and M40 groups should be undertaken by the public sector through targeted rental and ownership programs. The private sector may contribute in lieu, and developers voluntarily building market-driven affordable housing should be exempted.
For Bumiputera quotas, the discount should remain, but the quota should be capped at a maximum of 30%, and discounts should be capped at a specific ceiling price. The government should also buy existing unsold Bumiputera units to relieve developers of holding costs.
Thrust 3: Optimize Land/Gross Floor Area Efficiency
Infrastructure provision, such as roads, should be undertaken by the government at its own costs. Total land surrender should be limited to a specified maximum cap, and the value of surrendered land should be offset against other payable charges. The use of plot ratio instead of density for development controls is recommended to ensure more efficient land use. Transit-Oriented Development (TOD) with higher plot ratios and lesser parking requirements, along with flexible housing specifications, can also help optimize efficiency.
Conclusion
The cost of doing business in construction industry sectors is a critical determinant of housing affordability and market sustainability. The high compliance costs, driven by over-regulation, cross-subsidies, lengthy approvals, and reduced sellable land, create significant price distortions.
By implementing the recommended transformational changes, such as digitizing approval processes, shifting social housing provision to the public sector, and optimizing land use, stakeholders can achieve a more efficient delivery system.
Reducing the cost of doing business in the construction industry will help lower housing costs and sustain prices at a more affordable level. Conscious efforts towards structural reform are necessary to ensure sustainable house prices for the nation. The industry cannot continue to operate under the same policies and expect costs to decrease miraculously.
Authorities and industry players must work together to effect these transformational changes, ensuring that the cost of doing business in the construction industry remains manageable and that housing remains accessible for future buyers.
Also read: Africa Property Construction Cost Guide