Oil at $147: Jamaica’s Construction Sector Under Maximum Commodity Pressure — August 2008

Publication Date: August 3, 2008 | Coverage Period: July 3–August 2, 2008 | Category: Monthly Review

Month in Brief

• Crude oil reached its all-time intraday record of US$147.27 per barrel on July 11, 2008 — a peak that has no historical precedent and that placed Jamaica’s fuel import costs, already at crisis levels, in an entirely new register of severity; the Jamaican government’s fuel subsidy and relief arrangements were under acute fiscal pressure.
• Following the July 11 record, oil prices began to ease from their peak — by early August, prices had retreated to around US$120 per barrel, offering some tentative relief, though remaining far above the levels of 2006 or 2007.
• Jamaica’s year-on-year inflation rate rose to double digits, driven primarily by food and energy costs; real wages fell as price increases outpaced nominal wage growth, compressing household disposable income and constraining consumer spending across all categories, including housing.
• Fannie Mae and Freddie Mac continued to deteriorate: by late July, the US Congress had passed the Housing and Economic Recovery Act of 2008, which included explicit provisions for a government rescue of the two GSEs if required — a measure that underscored the depth of the US mortgage system’s distress.
• Jamaica’s construction sector reported that several major projects had been suspended or scaled back as developers and contractors struggled to manage costs that had risen 20–30% over eighteen months without commensurate increases in achievable sale prices.
• The Bank of Jamaica kept its policy rate on hold, acknowledging that while inflation was running well above target, a rate increase in the current demand environment could prove counter-productive; the BOJ expressed concern about the pass-through of imported commodity prices into the domestic price level.

Housing Market Overview

The month of July 2008 will be remembered in Jamaica’s housing market principally for the extraordinary commodity price environment it delivered — an environment whose impact on construction costs, household budgets, and investor sentiment was severe and, in some respects, unprecedented in the modern era of Jamaican real estate.

When oil reaches US$147 per barrel, the cost of everything connected to construction rises: diesel for equipment and transport, bitumen for roads and waterproofing, plastics for pipes and fittings, and energy-intensive materials such as cement and glass. For Jamaica, an island with no domestic oil production and a heavy dependence on imported energy across all sectors of the economy, the July oil peak was not a distant financial market event but a real and immediate cost that landed on every building site, every household, and every business on the island.

Residential transaction volumes continued to run well below the levels of 2005–2006. Buyers who had been sitting on the sidelines through the first half of the year showed no sign of re-engaging with a market where the cost of a new build had risen substantially, where financing rates remained punishing at commercial levels, and where the global economic outlook was, if anything, deteriorating. The second-hand market offered more value but required buyers to navigate the same financing obstacles.

One market segment that showed unexpected resilience was the land market in selected areas of the Corporate Area and in some north coast communities. Land, as a raw asset, does not carry the same direct exposure to construction cost inflation as completed residential units, and land prices in premium locations remained broadly stable — supported by the limited supply of well-located, titled, and serviced plots and by demand from buyers who were deferring construction until cost conditions improved.

Government Policy and the NHT

The Golding government’s focus through July remained principally on the macroeconomic stabilisation challenge rather than on housing-specific initiatives. Managing the fuel price shock, containing inflation, defending the exchange rate, and maintaining fiscal sustainability in the face of rapidly rising import costs absorbed the bulk of the government’s policy attention and its limited fiscal bandwidth.

The NHT, operating within a framework set well before the current cost environment materialised, continued to disburse mortgages and deliver units under existing schemes. The Trust’s management was, however, engaged in a comprehensive review of its development pipeline, with a particular focus on those schemes where construction cost overruns threatened to render units unaffordable to the income groups they were designed to serve. Some schemes were being redesigned to reduce unit sizes or specification levels in order to bring delivery costs back within affordable price ranges.

One positive policy development was the continued progress of the HAJ’s land servicing programme in several parishes, which was expanding the supply of titled, serviced land that could subsequently be developed by self-builders using NHT mortgages. This approach — separating land delivery from housing construction — has the advantage of allowing households to manage construction costs over time and to benefit from NHT financing for both land and construction separately.

Construction Sector

The construction sector’s travails in July 2008 were, by any measure, the most acute in living memory. Caribbean Cement Company’s gate price, while not publicly disclosed in granular terms, was tracking global energy costs closely, and contractors were reporting effective cement costs that were 25–35% higher than two years previously. Steel rebar — imported from the United States, Canada, and various Asian sources — had similarly risen sharply, driven by global infrastructure demand and, in some cases, by export restrictions from major producing countries.

The self-build sector — which accounts for a substantial but difficult-to-quantify share of new residential supply in Jamaica — was bearing the greatest relative burden. Self-builders typically purchase materials in small quantities at retail prices, paying a premium over the bulk purchasing rates available to established contractors. They also lack access to the credit facilities that allow larger operators to manage cash flow through the extended construction cycle of a typical residential project. The result was a widespread stalling of self-build projects: foundations poured, walls started, roofs delayed indefinitely.

On the north coast, hospitality construction — hotel renovation, resort expansion, villa development — continued, albeit at reduced pace. These projects benefit from foreign currency revenues and from overseas financing that insulates them partially from the Jamaican cost environment. However, even in this segment, cost overruns were a consistent theme, and project timelines had extended materially.

Investment Climate

The investment climate for Jamaican real estate in July 2008 was shaped by two opposing forces. On one hand, the inflation environment made hard assets — land, property, physical infrastructure — attractive as a store of value; holding cash or fixed-income instruments in a high-inflation, exchange-rate-volatile environment is a losing proposition, and real estate offered the prospect of value preservation.

On the other hand, the cost of acquiring and building on that land had risen to the point where the development economics were difficult to justify at current market prices. This classic squeeze — between asset value as an inflation hedge and the cost of realising that value through development — characterised the investment logic of mid-2008.

The most astute investors were those who were acquiring land in anticipation of a future normalisation of construction costs, betting that oil prices would eventually retreat from their record levels and that the cost environment would ease. This is a long-horizon play, requiring capital that can be committed for two to five years without the certainty of a defined return. It is appropriate for some sophisticated investors but is not a strategy accessible to the broad market.

Diaspora and Remittances

July data on remittance inflows confirmed the trend of deceleration that had been building through the first half of 2008. While flows remained positive and substantial in absolute terms, the year-on-year growth that had characterised the remittance sector through 2005–2007 had given way to flat-to-modestly-declining volumes in some source markets.

The United Kingdom — Jamaica’s second-largest remittance source after the United States — was itself experiencing the early stages of a housing market correction, and Jamaican communities in London, Birmingham, and other UK cities were feeling the effects of a broader economic slowdown that affected employment in the service and public sectors where many UK-based Jamaicans work.

For Jamaican property, the diaspora channel remained important but was operating at reduced capacity. Agents specialising in diaspora-facing marketing — north coast resort properties, premium Kingston residential, agricultural land — noted a lengthening of decision timelines as prospective buyers in the US and UK assessed their own financial situations before committing to Jamaican purchases.

Affordability Watch

July 2008 represented, in terms of housing affordability in Jamaica, a nadir. The three principal drivers of affordability — construction costs, financing rates, and household real incomes — were all at their most adverse simultaneously. Construction costs were at peak levels driven by the oil price record. Financing rates at commercial levels remained in the 15–18% range. And real household incomes had fallen as inflation outpaced nominal wage growth.

The NHT system continued to serve as the critical buffer, maintaining access to homeownership for its contributor base through concessionary financing that bore no relationship to commercial market rates. But the NHT cannot serve all Jamaicans; its reach, while substantial, is bounded by contribution history, income thresholds, and unit availability. For those outside the NHT umbrella, the July 2008 housing market was, in practical terms, inaccessible as a route to ownership.

Looking Ahead

The retreat of oil prices from the July 11 record toward the US$120 range by early August offers a tentative positive signal. If this price easing is sustained and deepens, it could provide meaningful relief to Jamaica’s import bill, its inflation rate, and ultimately to construction costs. The lag between oil price movements and their effect on building material prices is typically three to six months, meaning that even a sustained oil retreat from July levels would not immediately translate into lower construction costs.

The broader global financial picture, meanwhile, remained deeply uncertain. The US housing market’s distress, the vulnerability of Fannie Mae and Freddie Mac, and the ongoing stress in global credit markets suggested that the period of elevated risk and reduced capital flows to emerging markets and small open economies was likely to persist well into 2009. Jamaica’s housing market would need to navigate this challenging environment with the tools available to it: NHT scheme delivery, patient developer capital, and the enduring fundamental demand for housing that underlies even the most difficult markets.

Jamaica Homes Monthly Housing & Development Review is published on the first business day of each month. Next edition: September 3, 2008, covering August 3–September 2, 2008.