C HECKROODT 1 lnternasionaal / International An evaluation of investment and investment decision-making in the construction industry in South Africa Abstract It seems out of a research survey carried out in South Africa. as well as the general stand of the civil engineering and construction industries over the past few years. that economical and political factors have a far greater influence on the growth of the industry than internal organisational factors. The risk associated with projects. seen within the broad spectrum of other internal and external risk factors. seems to be the big­gest concern of investors and developers. Financing construction projects is the second highest factor. and can be of critical importance. The view should always be to improve the cost-effectiveness of the decision of how and what and when to invest. It is evident that the quantity sur­veyor and/or cost engineer has an important role to play in this regard. Keywords: Finance, construction projects, economy, politics, South Africa. 'N EVALUASIE VAN BELEGGINGS EN BELEGGNGSBESLUIT­ NEMING IN DIE SUID-AFRIKAANSE KONSTRUKSIEBEDRYF Opsomming Onlangse navorsing dui daarop dot ekonomiese en politieke faktore selfs 'n belangriker rol as interne organisatoriese faktore speel. in terme van groei in die konstruksiebedryf. Risiko's veral ten opsigte van die finan­ siering van konstruksie-projekte, speel 'n kritieke rol. Dit is hier waar kos­ te-effektiwiteit en besluitneming ten opsigte van waar. wanneer en hoe beleggings gemaak word. 'n deurslaggewende rol speel. Die boure­ kenkundige en koste-ingenieur kan 'n groot bydrae maak wat betref projek- en risiko-bestuur. uitvoerbaarheidstudies. koste-besnoeiings. en kontrole oor boumateriaal en -toerusting. Sleutelwoorde: Finansies, konstruksie-projekte, ekonomie, politek, Suid-Afrika. RQS. M(URP) BSc(QS) Dip Arch. MAQS. ASAIB. AAArb. MSAID. MIHSA. Senior Lecturer: Department of Civil Engineering and Building. Technikon Free State. Bloemfontein. South Africa. A paper read at the 15th International Cost Engi­ neering Congres. Rotterdam (Netherlands). 1998. 95 Heckroodt / Evaluation of investment Introduction T he South African Construction Industry has been influenced by extensive economic fluctuations over the years gone by. During the economic isolation of South Africa, the Con­ struction Industry went through serious surviving problems. The decrease in the value of the South African currency (rand) against the American Dollar, as well as the inflation rate, contrib­ uted to this. Despite the effects of these and other economic factors, like high bank loan rates, the Construction Industry survived the dry years of international isolation. With an estimated population growth rate of 2,61 % per annum in 1995, the demand from com­ munities for infrastructure, medical facilities, educational centres and schools, as well as, most important, proper housing, has shown a tremendous growth rate. This placed enormous pres­ sure on the rate of supply of these amenities. Funds must be gen­ erated, either nationally or internationally, to supply the people of South Africa in their demands. factors influencing investment in construction projects In an address by Stals [1995], Governor of the South African Re­ serve Bank, on the factors influencing interest rates, it was stated that the interest rate is determined by forces of demand and supply of loanable funds. If the demand for loanable funds tend to exceed the supply of loanable funds, the interest rate will tend to rise, and vice versa, when demand is less than supply, the interest rate will tend to decline. Obviously, an increase in in­ terest rates indicates a shortage of funds, caused by increasing demand or a decline in the supply of funds. An increase in inter­ est rates therefor brings a clear message to borrowers: reduce your demand for loans. The construction industry is part of this staging of events. Very lit­ tle working capital is available for investment in construction pro­ jects in South Africa, and thus people are to some extent forced to make use of loans to satisfy their construction and infrastruc­ ture demands. Thus, as interest rates increased, the supply of such amenities decreased, with the demand increasing almost on a daily basis. This led to a backlog in the South African con­ struction industry in supplying in the needs of the people. Stals [1995] also mentioned that a net outflow of capital as South Africa experienced from 1985 to 1993, reduces the amount of funds available for domestic application. In a country such as South Africa, where gross domestic saving over the past decade 96 1998 Acta Structilia Vo! 5 No 1 & 2 declined from about 25 percent to 17 percent of gross domestic product {GDP). The deficit on the government's budget absorbs private saving to an amount equal to about 6 percent of GDP, against the normal 3 percent of GDP. Private consumption ex­ penditure grows at a steady 3,5 percent per annum. All these facts, according to Stals [1995], indicate that interest rates must and will be high. Were it not for the net capital inflow of about R20 billion since the middle of 1994, the level of interest rates would have been much higher in South Africa. Research related to investment in construction projects was un­ dertaken by the author during 1996. The research was done by means of an extensive questionnaire covering the period Janu­ ary 1991 to December 1995. It was targeted at Property Devel­ opers, Government Departments, Banks, Local Authorities, Insur­ ance Companies, Mining Industry and the Construction Industry as such, to determine the extent of the policy of deci­ sion-making and eventual investment in the Construction Indus­ try in South Africa. The results of the research are represented in a number of graphical and tabled illustrations, with comments and conclu­ sions, in respect of 0 Factors influencing investment in construction projects 0 Risk management conditions 0 Project life criteria 0 Factors deterring investment 0 Factors encouraging investment 0 Gross annual construction investment, the latter clearly showing a distinction between the period be­ fore and after the democratic elections of 27 April 1994 elections (the "old" and "new" South Africa). The construction industry can be considered to be in a vulnera­ ble profit and loss situation. The profit in any construction project can be threatened by a number of factors, both economically and organisationally. Internal factors in the organisation can be critical. This includes too high overhead costs, the utilisation and operation of mechanical plant, labour, as well as bad adminis­ tration with the ordering and utilisation of construction materials. However, it seems out of the research survey and the general stand of the civil engineering and construction industries over the past few years, that economic and political factors have a far greater influence on the growth of the industry than internal organisational factors. It must, however, be said that the influ­ ence of such external factors are sometimes artificial, and this 97 Heckroodt / Evaluation of investment should be attended to. Figure 1 [Heckroodt: 1997] shows some of the internal and external influencing factors. ....J w > 40 w ....J a: 30 0 ii: a.. Cl 20 w � 10 $ 0 Risk and sensitivity FIGURE 1 FACTORS INFLUENCING INVESTMENT The risk associated with each project, seen within the broad spectrum of other internal and external risk factors, seems to be the biggest concern of investors and developers. Financing of construction projects is the second highest factor, and can be of critical importance. Despite the statement of Stals [1995] that one of the more important elements to cure high inflation, is ex­ tremely high interest rates, investors participating in the survey placed inflation rate on a much lower level of priority than other factors that may have an influence on investment. The Quantity Surveyor and/or Cost Engineer should play an im­ portant role in project planning, project management, risk man­ agement and the cost of projects, paying special attention to the feasibility of specific projects in terms of project demand, project life, cost savings on projects and control of materials and plant used on site. The risks associated with construction investments should be carefully managed and monitored, so as to act pro-actively on the possible negative effects of the indicated influencing fac- 98 1998 Acta Structilia Vol 5 No 1 & 2 tars. There are various means of managing risk, as indicated by South African investors and represented in Figure 2 [Heckroodt: 1997]. FIGURE 2 RISK MANAGEMENT CONDITIONS PREDICTED RATE Of RETURN MODIFIED TO TAKE RISK ANO UNCERTAINTY INTO ACCOUNT (30.77%) Project life evaluation NO ATTEMPT MADE TO TAKE RISK OR UNCERTAINTY INTO ACCOUNT (7.69%) DIFFERENT STANOERDS USED FOR COMPARISON OF RISK OR UNCERTAINTY (15.38%) Project life and investment life are also critical factors which should be carefully monitored. That is why feasibility studies are of vital importance. Figure 3 [Heckroodt: 1997] shows the basis on which project life is determined for investment purposes, as indi­ cated by the respondents that have taken part in the research. FIGURE 3 PROJECT LIFE CRITERIA ECONOMICLIFESPAN{33.33%) SOCIAL LIFE SPAN(0,00%) Figure 4 [Heckroodt: 1997] gives an indication of the competent persons within investing organisations who are responsible for de­ termining and evaluating project life in South Africa. Investment decision-making The decision-making process concerning investments to be made in construction projects, is of critical nature. The process is a complex one owing to the quantitative and qualitative factors 99 Heckroodt / Evaluation of investment FIGURE4 PROJECT LIFE EVALUATION flowing from a particular investment option. By assuring the low­ est possible financing cost to the contractor in terms of construc­ tion investment, the project can become more cost-efficient and hence more competitive with the balance of investment options available. It is important to carefully evaluate all avail­ able investment options before arriving at a final decision. The view should always be to improve the cost-effectiveness of the decision of how and what to invest at which period of time. There are various financial options available. It is, however, im­ portant to realise that any investor has some form of risk when fi­ nancing a construction project in the construction industry. Part of the investment research was to determine which factors dis­ courage and which encourage investment in construction pro­ jects. Figures Sa and Sb [Heckroodt: 1997] clearly show that a low return on investment compared to the return on other forms of FIGURE Sa INVESTMENT DETERRING FACTORS LOW RETURN ON INVESTMENT {21.62%) investment in the financial sector, is the most important deterrent during the investment decision-making process. Uncertain poli­ tics and instability of the economy also plays a major role. Take note that the statement made by Stals [1995] about the correla­ tion between high inflation and high interest rates, is clearly re­ flected in the response received from investors during the re­ search. It is unfortunately also true that high interest rates are 100 1998 Acta Structilia Vol 5 No 1 & 2 FIGURE Sb WEIGHTED INVESTMENT DETERRING FACTORS � 50+---+-- --<---+---+- 9 ,o+---+--+---+----+- � Jo+---+---,f----t---+ § ao+--1--+--+--Httmillf+ �"'� ,;,"-'> '<"' ,._ ,;.'>'"''<-'S' ,i!-q -1'\,�-//!