Chinese contractors not bringing lower prices - yet

Chinese worker in Israel Ammar Awad, Reuters

The foreign building contractors brought to Israel to combat high housing costs are taking time to have an impact.

The Ministry of Finance last week published another in a long series of housing market reviews showing stagnation in the market, this time in the second quarter of 2017. Young couples are waiting for discount homes, purchases by investors have reached their lowest point in a decade, and homeowners looking to move upmarket are also waiting for the trend to change.

It is obvious to everyone that the key to lowering housing prices is increasing the supply, but how can the contractors be persuaded to build under conditions of uncertainty? The government has been proposing the same solution for over five years - if you don't do it, we'll bring foreign companies here to build housing.

In October 2016, the Ministries of Housing and Construction and Finance announced that they had selected six foreign construction companies (out of 50 that submitted bids) - five from China and one from Portugal – that would be authorized to build housing in Israel. The ministries said that the companies would begin building in Israel in 2017, and would be listed in the database for only five years, with three-year extension options at the Ministry of Construction and Housing's discretion. The ministries also asserted that the foreign companies would bring industrialization and competitive prices, resulting in lower prices for homebuyers.

The Ministry of Construction and Housing promised this week that construction of a residential project for the first time by a Chinese company would begin in November 2017, after two companies signed agreements with Israeli developers. Real estate industry sources cast doubt, however, on the Chinese companies' ability to fill the vacuum created in the construction sector. At present, they say, the prices offered by the companies are higher than the those charged by Israeli construction companies.

The Ministry of Construction and Housing says that contractor licenses have been issued to four of the six companies so far, and the other two companies are in the process of obtaining licenses. The next step is for them to present a signed agreement with developers for carrying out a project in Israel, after which the Ministry of Construction and Housing will allow them to import up to 1,000 Chinese workers.

What is actually happening? "I met with two of the Chinese companies," says D. Rothstein Construction & Assets Co. Ltd. (TASE:ROTS) CEO Avishai Ben-Haim. "I gave them plans and asked them to give me a price for the work. It's ridiculous, but I got a higher price than the bids I got from leading Israeli construction companies. If these companies want to penetrate the construction market in Israel, they have to offer a penetration price. It's even worthwhile for them to forego a profit at the beginning if they establish their standing; then they can earn money later.

"Not only is that not the case, however; they even asked me for an advance. I have to give an advance to a company earning billions in China? The only reason that these companies might be able to offer cheaper prices than Israeli companies is the lower-paid workers they can bring here.

"That might really happen, but it will take time, and it certainly won't happen in the next year. The companies have to get used to the rules in Israel, and deal with all the problems that Israeli construction companies have to deal with. What if a problem crops up? Does anyone think it's easy to foreclose a guarantee from a Chinese government company? It turns out that the numbers at the moment don't change the equilibrium. In another year, however, things could be different. I only hope it happens."

Differences in mentality

For the Chinese companies, the conditions for construction in Israel are of course different from those in China and other countries in which they have previously operated, and that has economic significance.

Itzhak Segev, who represents Chinese company Longxin Construction Group, one of the companies selected by the Ministry of Construction and Housing to build in Israel, explains, "There are major differences in mentality between the work methods employed in Israel and in China. In Israel, things are conducted according to European standards that don't exist in other countries for safety, work hours, living quarters on the site, workers' rights, and so forth. Because the Chinese companies don't know about the conditions in Israel, they price the risk into their bids.

"There are excellent Chinese companies, but they are used to bringing containers to the site. They are used to the workers not being restricted in their working hours and working on Saturdays. The calculations in Israel are therefore different, and the price can't be the same as in China. It should be realized that these are serious companies, both the private and government ones, with sincere intentions, and they cannot afford failure in the first project. They want to play it safe, and so things take time. In the company I represent, there are five Chinese engineers, one of whom also studies Hebrew all day. The biggest gap here is the language.

"Anyone who thought that it would happen quickly was wrong. I'm optimistic that we'll have an initial contract for building 200 apartments, mainly in order to study the market, by the end of the month. This method will be successful, and construction will get under way in November 2017."

The Ministry of Construction and Housing says that two Chinese companies have already submitted construction contracts with developers, proving that despite the differences, most of which were known to the companies in advance, things are starting to move. The question of housing for the workers on the building sites, which saves the Chinese companies a great deal on costs, is still being handled by the Ministry of Construction and Housing.

According to the Ministry of Construction and Housing, the main problem in reaching agreements is demands from Israeli developers for a 25-30% discount on the going price, while the Chinese companies can afford a maximum discount of 5-10% on the price of construction.

"There are many developers waiting for the Chinese companies," says Advocate Doron Shimoni of the Shimoni & Co. law firm, who represents two Chinese companies, Jiangsu Shuntong Construction Group and JiangSu NanTong No. 2 Construction, which he says have signed agreements with developers.

"They'll back off"

"It will take time for the market to realize that these Chinese companies are serious companies with financial backing and very strong management, construction, and engineering capabilities that are authorized to import 1,000 workers, not just personnel companies importing workers to Israel. Awareness among the developers in Israel will unquestionably increase later, when they see that these are financially stable companies with a high construction standard that in my opinion is unknown in the local market.

"The Chinese also understand that they are facing a very difficult period for profits, but they are taking into account that they are entering the market for the long term, and they know that later, they will branch out from construction to both partnerships and development. These are serious companies that sent managers here, did their homework, know the rules in Israel, and want to enter the Israeli real estate market, which doesn't yet understand them," Shimoni adds.

The Israel Builders Association, of course, is opposed to bringing the Chinese companies, and did not want to see them here. "There are excellent construction companies here," says Builders Association president Roni Brik. "If the government wants the construction sector in Israel to successfully carry out its decisions in the coming years, it should bring 20,000-30,000 professional foreign workers here. When the foolish idea of bringing foreign construction companies here was raised, we warned that when contractors come here and discover the bureaucratic burden and barriers we have to deal with, they'll go right back home. For now, it looks like we were right."

"Still a shortage of construction companies"

"The great hope that Chinese companies will come in and win tenders has not yet materialized, and we have been left with a shortage of construction companies capable of carrying out projects," says Advocate David Johan, a partner in the Dr. J. Weinroth & Co. law firm and manager of its real estate, planning and construction section. According to Johan, the result is clear: "Construction prices have risen, construction contractors are being required to put up more money in order to obtain performance guarantees, and the banks are also requiring 7%, and even 10% guarantees and liens from construction contractors, which is in effect their entire profit on a project."

Johan adds, "The situation is also bad for the developers, because the banks considering financial coverage for developers are not approving the contractors, due to the state of the companies."

According to Builders Association deputy president and entrepreneurship and builders division head Haim Feiglin, the CEO of ZMH Hammerman Ltd. (TASE:ZMH), which also owns Sivan, a construction company, the problem lies more in the ability to obtain construction guarantees from the banks than the cost of financing construction.

"Because of the many contractors that have collapsed, the banks have marked construction companies as a sector in which the risk has increased, and are therefore even more reluctant than in the past to provide construction guarantees, because the likelihood of the guarantees being used is not low. Construction companies are being required to provide a guarantee amounting to 5-10% of the total cost. As a result, the lien that the developer is requiring from the contractor in the agreement between the developer and the contractor has increased in size. There will consequently be a substantial decline in building starts, and we are unfortunately seeing this already."

The continued risk in the construction industry is also emphasized by Adi Nov, deputy director of marketing at Israeli Credit Insurance Company Ltd. (ICIC) (TASE:BSSC), which assesses the construction industry from the suppliers' perspective. He says, "This is a difficult sector, in which considerable risks are incurred. The risk in the sector has not decreased in any way. The supply of contractors is constantly falling, and none of the Chinese companies that have obtained a license to work in Israel has done anything here. Over the past year, we have seen an increase in the demand from the suppliers for hedging the risks in the sector. Companies that previously would not have dreamt of asking someone to hedge risks are now looking for solutions."

Published by Globes [online], Israel Business News - www.globes-online.com - on August 28, 2017

© Copyright of Globes Publisher Itonut (1983) Ltd. 2017

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Chinese worker in Israel Ammar Awad, Reuters
Chinese worker in Israel Ammar Awad, Reuters
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