Profits slump for Lebanese contractors as work dries up
Despite the slowdown in Lebanon’s real estate market, new projects are still under way, albeit at a slower pace.
Developers are coping with holdbacks and adapting to the shift in demand from large- or medium-sized apartments to small ones, particularly in Beirut.
Profits margins are still within the 20 to 30 percent range, sometimes up to 40 percent, experts say, as most developers finance projects through equity rather than debt, which limits strained sales during difficult times to meet loan obligations.
Most developers, who view the downturn in the market as temporary, can afford to sit on unsold projects until spikes again.
However, small- to medium-sized contracting companies that are feeling the pinch of soft real estate activity lack the luxury of time, which larger developers can afford.
Fixed overhead expenditures and fierce competition are putting pressure on profits margins amid decelerating growth, as Lebanon feels the ripples of the Syrian crisis, a number of contractors told The Daily Star.
A slower growth rate since 2011 is adding to the woes of contracting firms, which have already seen their profit margins slide in the past six years due to the increasing number of contractors who entered the booming Lebanese market back in the 2006-10 period.
Statistics from the Central Bank show that cement deliveries, an indicator of construction levels, declined 4 percent year-on-year in the first quarter of 2012 while the area of newly issued construction permits decreased by 3 percent.
Both indicators have grown at a compounded annual growth rate of 19 and 11 percent respectively between 2006 and 2010, according to data by the Central bank.
Ralph Chahine, managing partner at NN-Electric, says profit margins have been dropping from an average 20 percent over the past 10 years to around 12 percent in 2012.
He explains that the boom in the real estate sector since 2006 has encouraged more contractors to enter the Lebanese market, driving profit margins lower as competition intensifies significantly.
According to Credit Libanais’ research unit, foreign direct investments to the Lebanese real estate and residential sectors surged from $1.65 billion in 2006 to an estimated $3.47 billion in 2010 before entering a phase of relative consolidation.
Indicating lower demand in the property market, the number of real estate transactions dropped by 3 percent year-on-year in the first quarter of 2012 following a 12 percent drop in 2011 compared to 2010 with the value of property transactions falling 7 percent.
“Now that we are witnessing a slowdown in the real estate sector, the competition is even fiercer,” Chahine adds.
Lebanon’s political and security instability is accentuating the problem, Chahine says, adding that developers are putting projects under development on hold and consequently freezing contracts and down payments.
Bidding for projects under such circumstances, contractors are accepting margins as low as 10 percent for large projects and between 15 to 25 percent for small ones, Chahine adds, to compensate for fixed monthly overheads.
NN-Electric, a relatively small contracting company with eight full-time employees, incurs fixed monthly operational costs of around $20,000 excluding the direct labor cost.
Others industry members put profit margins at even lower rates.
Ghassan Daoud, head of the estimation department at Zerock, a contracting company that employs around 90 people excluding labor, says profit margins on large projects could reach as low as 5 percent.
“In a best-case scenario, the profit margin could amount to 10 percent,” Daoud adds.
The fierce competition is not only forcing contractors to lower profit margins but to take additional risks to lure developers.
“Developers require contractors to present guarantees such as performance bonds while on the other hand the developer takes no risk and could delay payments or cancel contracts, ” Daoud says.
Daoud warns that if the economic situation in the country remains sluggish, some small contracting companies could be forced to lay off employees or hire fewer freelancers.
“For example, we used to bid for a minimum of three projects per month ... now we are sometimes bidding for just one,” he adds.
After averaging 8 percent between 2007 and 2010, Lebanon’s economic growth slowed down with a real GDP growth rate at 1.5 percent, down from 7 percent in 2010, according to the International Monetary Fund.
The damage inflicted on the contracting industry due to slowing growth is not limited to reduced profits, Chahine says.
Furthermore, the reputation of the sector is being tarnished as some contractors are slashing prices at the expense of quality to win more projects bids, Chahine explains.
He argues that the actions of a few are harming the sector as a whole.
Chahine adds that even those who continue to strive to ensure quality work are unintentionally failing as they hire less experienced graduates to reduce costs.
However, some contractors are cheating intentionally, an industry insider, who wished not to be identified, tells The Daily Star.
These individuals make lower initial bids to win the project but compensate for the difference when clients, mainly of luxury apartments, ask for variations, the industry member says.
Surprisingly cheap bids sometimes catch the eye of consultants who reject the tender, Daouds says. “And sometimes they don’t,” he adds.