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Building costs a headache for Asia investors

SINGAPORE (Reuters) - Property investors in Asia are worried that soaring construction costs are squeezing profit margins, and see little respite as a Chinese iron ore supply deal this week signals more steel price hikes.

In the Middle East, India and China, where the bulk of the world’s construction is centered, developers have relied on steep increases in sale prices to keep their housing and commercial projects lucrative.

But with property markets now slowing, 50 percent rises in building costs across Asia in the last couple of years are starting to bite.

In Dubai, the combined cost of labor and materials has doubled since 2006, hurting firms that have sold apartments before construction begins.

“That’s a major worry for Middle East developers,” said Abid Junaid, executive director of Dubai’s ETA Star Property Developers. “They’ve sold buildings off-plan ahead of construction, and there’s no leverage to increase prices.”

Echoing several executives at a Reuters Global Real Estate Summit this week, Junaid said inflation was the biggest question mark on Asia’s property landscape.

“We’re just at the tip of the iceberg,” he said. “We don’t know the time frame for it will play out.”

Events this week suggest building costs will continue to rise. Chinese steel producer Baosteel 600019.SS agreed on Monday to a price hike of up to 96.5 percent for iron ore it buys from producer Rio Tinto RIO.LRIO.AX, which is likely to fuel higher steel prices.

The global price for steel, used for the skeletons of top-grade buildings and to give concrete walls, floors and columns tensile strength, has risen 50 percent this year.

ETA Star Property Developers Executive Director Abid Junaid smiles during an interview at the Reuters Real Estate Summit in Singapore June 23, 2008. REUTERS/Vivek Prakash

Steel can account for anywhere between 5 percent and 20 percent of construction costs, and more in a country such as Japan where the threat of earthquakes looms.

The price of other building materials from sand to cement has also risen sharply.

ILL PREPARED

In India, a building boom sparked by easing rules on foreign investment in the construction industry has lifted costs by 50 percent in the last couple of years.

Developers have still made profit margins of anywhere between 30 percent and 100 percent because property prices in many areas have quadrupled, but those days are probably over. Home prices are cooling, and developers have seen sales drop by about half from last year.

“They won’t be able to make the huge profits they were making,” said Pranab Datta, managing director for India at consultants Knight Frank. “And many may end up losing money if they’re behind schedule on projects.”

Chinese developers are feeling the squeeze from all directions, with rising costs adding to the headaches of a clampdown on bank lending, higher land appreciation taxes and other government measures aimed at cooling the property market.

Property prices are flat or falling in some cities in southern China, such as Shenzhen and Guangzhou.

Some foreign investors in India and China could be ill prepared for inflation, according to Kurt Roeloffs, Asia head for Deutsche Bank’s property investment arm, RREEF.

“One problem is budgets are based on historical inflation rates rather than today’s,” Roeloffs said. “That can be compounded if it’s based on high sales prices, and the market softens, like in China and India.”

In Asia, RREEF tries to negotiate the kind of guaranteed maximum price contracts with builders that are common in Australia and Europe.

“They’re not common in China and India unless you’re working with international contractors, and even then there are many contingencies,” Roeloffs said.

For the host of new property funds being raised for Asia, timing of deals has become more critical than ever, as buying land cheaply and setting sales costs right can make or break a project.

MGPA, which has just raised a $3.9 billion fund for Asia, said it cut costs on an office development in Singapore by using equipment from a neighboring site rather than ship it in.

“A year ago, people were saying piling would be expensive, but the piling machines just had to roll 500 meters to our side when they’d finished the casinos,” said Simon Treacy, Asia head for MGPA, which is partly owned by Australia’s Macquarie Bank

MQG.AX.

“It comes down to supply and demand at that time.”

(For summit blog: summitnotebook.reuters.com/)

Editing by Kim Coghill

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