What do escalating commercial building costs mean for your insurance?

Building costs in New Zealand have risen rapidly in recent years. Over the last couple of years, labour and material shortages have fed fuel to the fire.

If you own a commercial property, rising construction costs are going to have an impact on its rebuild value and, therefore, your insurance premiums.

Paul Higson explains why commercial building costs are escalating, how this could affect your property insurance, and what the future might hold.

Why are building costs rising so quickly?

COVID-19 has caused major supply chain issues in the construction industry, affecting both labour and materials.

On the labour front, the lack of immigration has left construction companies unable to fill much-needed positions. In addition, efficiency on building sites has dropped due to health and safety requirements, including restrictions on the number of workers allowed on site and cumbersome sign-in protocols.

On the materials front, the initial outbreaks and lockdowns caused port closures and disruption. Ports are now congested and struggling to catch up with the backlog of ships, which means there’s a shortage of containers. Due to this, container costs are more than three times higher now than they were a year ago. In other words, the cost of importing materials has increased.

There are several other factors influencing building costs, such as:

• Inflation
• Carbon emissions measures
• Increased public holidays and sick leave provisions
• Higher transport costs due to rising fuel prices

It’s important to note that escalating construction costs aren’t exclusive to New Zealand. COVID-19 has affected the construction industry on a global scale.

How much have building costs increased?

Cost increases have taken place across the board, affecting both residential and commercial builds. For this article, we’ll focus on commercial building costs.

According to Stats NZ, the annual value of commercial building work consented in the year ending September 2021 was $7.7 billion, up 10% from the previous year. Education and industrial build projects faced the largest cost hikes.

Material prices appear to be driving the increase. Over the past 12 months, we’ve seen increases in material costs as high as 40%, with the price of vital materials like structural timber and steel up by 20%. However, most material cost increases seem to be around the 5-10% mark.

We’re also seeing evidence of labour cost increases, but these have been occurring at a slower pace than expected. Over the next six months, we’re expecting to see a further 12% increase in material costs and a 5-7% increase in labour costs.

What does this mean for my commercial property insurance?

Firstly, it’s important to understand that if your property is being valued for insurance purposes, we’re not looking at its market value – we’re looking at its rebuild value.

When we’re assessing market value (e.g. for a mortgage valuation), we tend to look at the income that can be gained from the property and the market return on that income. We might look at construction cost data if we’re valuing a specialist property like a cinema, but generally, we don’t put too much weight on construction costs.

When we’re assessing a property for insurance, on the other hand, we need to look much more closely at current building costs.

Let’s say you’re taking out property insurance for an office building. If that building was to burn down, your insurance company needs to know how much it would cost to demolish the building and rebuild – and how inflation might affect that figure.

So even though it may have cost $10 million to construct the office building a few years ago, your insurance company may need to insure it for a value of $12 million, because that’s what it might cost to rebuild now.

How does this affect commercial property owners financially?

When the rebuild value of your property goes up, your insurance premiums will likely follow suit.

Escalating building costs might also mean that your insurance company asks for more regular valuations. Ten years ago, insurance companies were usually happy to have a new valuation done every two to four years. But with construction costs rising so quickly, we’re finding that insurance companies are now insisting on a new valuation every two years – or sometimes annually.

What does the future hold?

Commercial building costs will likely continue to rise, but perhaps not to the same degree. We’re expecting a slowdown for several reasons:

• Higher interest rates – these are likely to dampen demand for both commercial and residential build projects, easing material and labour shortages.
• COVID-19 vaccines – as these become more accessible and are adopted worldwide, the hope is that factories will be able to meet demand and material prices will begin to stabilise.
• The reform of the Resource Management Act – this will influence the degree to which infrastructure construction can ramp up over the coming years, which may create more efficient processes.

We’re anticipating that commercial building costs will (in general) rise around 10% over the coming year, but we’d expect to see this tapering off to around 5% the following year.

How we can help

We understand that many commercial property owners will be concerned about rising building costs and how this impacts their insurance premiums. But if you’re paying for property insurance, it’s important to make sure your property is valued accurately so that you’d be covered in the event of serious damage.

We have offices located nationwide, which means we have access to a large pool of construction cost data. This allows our valuers to draw on data from other regions if comparable local data isn’t available and provide a thorough, up-to-date assessment of your property’s rebuild value.

Get in touch with a valuer today

This article was originally published by TelferYoung