New regulations and infrastructure projects bring clarity and optimism to Vietnam's construction sector

There is certainly no shortage of work for companies in construction-related industries as Vietnam has continued to enjoy stable economic growth, a recovering real estate market and a steady stream of foreign direct investment. With upcoming free trade agreements and demand for infrastructure development continuing to rise, the future, at least in the short to medium terms, looks good. Indeed, the industry is expected to stay on course in the following years after entering a growth cycle in 2015. However, the industry is still relatively new and issues remain to be sorted before it reaches maturity. The sector remains vulnerable to the vagaries that come with being a more liberalised market. This was highlighted when a sharp contraction in construction work between 2011 and 2013, owing to declining property prices and a real estate freeze, caused the compound annual growth rate to fall from 19.7% to 7%.

The government has, however, made some positive steps in helping to buttress the sector in the form of new regulations for governing build-operate-transfer (BOT) and public private-partnership (PPP) arrangements, among other models, as well as new rules for improving market transparency and resolving inequality between local and foreign contractors. The simple fact that both the population and urbanisation are expanding rapidly will mean a raft of upcoming housing and infrastructure projects. “Growth in the industry has been tremendous and a lot of things have been happening over the past year,” Pierre-Jean Malgouyres, general director of Archetype Group, Vietnam’s largest multidisciplinary construction consultancy, told OBG. “There are projects everywhere across all segments, especially residential but also commercial and retail. Hospitality is also growing fast with a 25% increase in new arrivals in 2016.”

Nuts & Bolts

The construction sector expanded by 10.1% in 2016, marking the second-highest growth rate after 2015 in the past five years, according to the General Statistics Office (GSO). The construction and industry sector also accounted for 24.7% of all employees over the age of 15. The GSO forecasts that the average growth of industrial and civil construction and engineering at about 6.6% between 2017 and 2025. This will be driven in large part by infrastructure and residential projects. A host of foreign manufacturers are also establishing production facilities in the country, which means a concomitant demand for industrial properties such as industrial parks, warehouses and logistics facilities.

Market Size

In terms of market size, in 2016 there were 120 construction firms on the Hanoi and Ho Chi Minh City exchanges, equivalent to 19% of listed businesses. Market capitalisation of the construction sector is still quite low at some $1.7m, slightly more than 3.5% of market value, according to the exchange. Of this the top-20 biggest companies account for about 80% of the sector’s value and many of the listed companies are small and medium-sized enterprises.

Residential house building in urban areas is expected to be a key building block in the sector’s growth, owing to better credit facilities for the middle- and low-income population, which in turn means there will also be a number of infrastructure projects required to support the new developments.

Key Segments & Players

State-owned companies have traditionally been involved in the construction of infrastructure and have mostly secured projects such as power plants, transport and other national infrastructure using public funding. However, more private involvement is expected going forward with the emergence of PPPs. Meanwhile, private companies have generally dominated the residential and industrial segments. Indeed, seven of the top 10 property developers in Vietnam are private companies, according to the Vietnam Report, an independent research company. The upscale market has been buoyed by a growing middle class and the inflow of foreign investment, spawning demand for better quality homes and commercial buildings. Affordable housing is also expected to witness rapid expansion in upcoming years due to the country’s demographics, with the number of households growing from 17.2m in 2005 to 21.5m in 2015, according to the Ministry of Planning and Investment (MPI).

Infrastructure Investment

This combined with other driving factors such as expanding tourism and retail business as well as an influx of foreign manufacturers should mean plenty of investment in new infrastructure, which will in turn give a boost to construction firms. The MPI estimates that the country should be investing $200bn in infrastructure development during the 2010-20 period.

The government has already started rolling out projects, and in 2014 it issued a list of 127 infrastructure developments suitable for foreign investment in the run-up to 2020. In this regard, the government has been increasingly active in promoting projects involving transportation, utilities, industrial zones and energy infrastructure. Once under way, this activity will support the proliferation of supporting industries, such as construction and building materials.

Transport & Logistics

Transport infrastructure development is key for developers as logistics costs are currently a burden. The logistical situation has deterred investors, while the condition of the country’s roads is another significant problem. With companies seeking better services, there has been a growing trend for logistics firms, from Japan for example, to establish logistics centres with facilities like cool storage and other sophisticated systems.

There are now plans to under way for a massive expansion of the country’s motorway network, namely the construction of 21 new expressways, with a total distance of 6411 km. The government is also planning to build 26 airports — 10 international and 16 domestic airports — by 2020. Though beset by delays, the construction of a metro line in Ho Chi Minh City, once completed, is expected to spur residential and office development outside the city centre.

Overall, spending on non-residential infrastructure has increased from $18.2m in 2005 to some $31m in 2016 owing to construction activities carried out in electricity, gas, water, transportation and communications, according to the MPI.

Energy & Industry

The government has announced plans to spend more than $80bn on power generation and the development of the country’s electricity network, according to the National Electricity Development Strategy for 2006-25, and is also angling to build more industrial zones that would need transport facilities, sewerage and electricity transmission facilities. The Ministry of Industry and Trade (MoIT) has also approved a renewable energy development plan for the Northern Plains and Midlands until 2020 that would require about $80bn through to 2020 and $147bn for the 2020-30 period.

These developments will also help to address is the rapid pace of urban expansion, which has been outstripping existing infrastructure that has become overburdened with issues such as traffic, housing and urban environment. The urbanisation rate has increased from 26.5% in 2005 to 31.6% in 2015. Furthermore, since 1999 the number of cities with at least 4000 inhabitants has grown from 629 to 780, according to the Urban Management Department within the Ministry of Construction (MoC).

Due to the increasing density in the major cities, as well as the growth of the tourism industry, the development of secondary cities is seen as critical to the country’s economy overall well-being. However, to move forward with such development, a uniform, consistent and sustainable macroeconomic policy is required. “Issues that require attention include the right ownership regulation, the synchronous development of transport infrastructure, attractive investment policies and political stability of society,” Le Viet Hai, chairman and general director of the Hoa Binh Construction Company, told OBG.

Private Funding

Financing these developments, however, is one of the major challenges the government faces in going forward. It is estimated that the public funding capability can only meet 30-40% of annual demand for infrastructure development as there is still a large debt burden stemming from state-owned companies. Furthermore, public expenditure is estimated to rise faster than tax revenues.

In light of this the government has turned to PPPs to narrow the funding shortage, passing a decree in 2015 that created a unified legal framework to promote private investment in infrastructure projects. The decree has replaced unimplemented regulations for pilot PPP projects (formerly, Decision 71) as well as the regime for BOT, build-transfer-operate and build-transfer projects under Decree 108. According to a World Bank report, “the PPP Decree is an important reboot for PPPs in Vietnam”. The report further noted that the earlier Decision 71, “offered an ambitious vision but lacked sufficient detail to allow PPPs to be implemented. In addition it was deemed incompatible with the higher-ranking Decree 108 (on BOT projects) on some key issues such as differing caps on the permissible level of government support. Thus, PPP got off to a bit of a false start with Decision 71.”

PPP projects in the planning phase include the Hon Khai island deepwater port, the Ho Chi Minh monorail and the Long Thanh Airport. However, the report noted that the government would still need to provide specific capital to projects, which represented a potential downside risk as owing to high public debt the government’s ability to fund infrastructure projects will be limited in the following years.

Amendments

In other legislative moves intended to support the industry, the government amended the Construction Law in 2014, with the aim to improve the efficiency of quality control as well as foster transparency in the granting of permits. The Law on Bidding was also passed in 2013 to address shortcomings in the bidding procedure by improving transparency and resolving the inequality between domestic and foreign contractors. Under the law, foreign bidders can take part in international bidding, but they must form partnerships or sign sub-contracts with local contractors. To create jobs for locals, foreign firms can only employ foreign labourers when there are no qualified Vietnamese workers available. This is also intended to give domestic contractors to access more advanced technologies.

Vietnam’s labour costs in the construction/ industry sector are low compared to countries in the region, averaging VND4m ($179) a month from 2011 until 2016, according to the GSO. This has made Vietnam competitive compared to higher-earning countries such as China, but the low pay also means it is harder to attract highly skilled workers. However, these costs are expected to rise in upcoming years as Vietnam’s minimum wage will see a 7.3% increase in 2017. However, this is considerably less than the average yearly increase of 15% over the past 10 years.

One area of concern for investors is Vietnam’s current land and property laws, which many say still do not provide clear guidance on issues related to the legal nature and rights of land ownership and usage, and which are also missing procedures for land distribution and transfers. The cost of some key building materials has also become pressing concern.

Materials

Local construction developers have been facing a rise in domestic steel prices owing to growing construction demand, the real estate market’s recovery and high consumption. Steel sales in 2016, for example, amounted to more than 15m tonnes, a 23.7% year-on-year increase, according to the Vietnam Steel Association. The sector exported $2.4bn worth of steel materials, but imported nearly $9bn, due to surging local development. The demand has been outstripping supply by around 30%, making Vietnam one of the biggest steel importers in ASEAN, according to the World Steel Association. In 2016 Vietnam imported 18.4m tonnes, with 10.9m tonnes of this total coming from China, representing a 14.4% increase over 2015, according to Customs data.

The local cement industry, however, is confronting an oversupply. The country has the largest cement industry in the ASEAN, with 58 cement factories running at a total capacity of 88m tonnes of cement per year. By comparison, Thailand has 11 cement factories with a total annual capacity at 46.7m tonnes. In 2016 the local market consumed between 75m and 76m tonnes — a 3m increase on the previous year, according to the MoC. The ministry also estimated that Vietnam’s sales of cement and clinker would rise by between 4% and 7% to 75m-77m tonnes in 2016. However, as of September 2016 this figure appeared to be in doubt. Total sales amounted to 55.3m tonnes for the January-September 2016 period, with Viet Nam Cement Association’s chairman, Nguyen Quang Cung, telling international media that a decline in exports and insignificant local growth were responsible for the low figures in the period. Cement exports have been hindered by a lack of dedicated ports and efficient transport logistics. Exports of cement fell 7.1% to 14.1m tonnes in 2016 and by 16% in value to $561m, with the Philippines and Thailand remaining the top destinations for Vietnam’s cement exports.

Competition

The MoC has said that more competition is expected from foreign cement companies, notably Chinese firms. The slowdown in the Chinese real estate market has also meant the country is now facing a surplus of steel, and Vietnam will be a target for Chinese imports of both cement and steel. According to steel producers, despite protective tariffs, imported steel, especially Chinese steel, is cheaper than local products – often by more than 10%. This price differential encourages importers to buy Chinese steel to sell on the local market.

The Heavy Industry Department has also pointed out that Vietnam can make steel for construction, but is not able to produce steel for the supporting manufacturing industries and it must therefore import around 13m tonnes of steel products annually. Vietnam has spent some $7bn on steel purchases, the department said. Nevertheless, today Vietnam can produce and distribute a wider range of construction products compared to years past. And due to new technologies, most contractors are able to reduce their construction costs compared to 20 years ago, when foreign constructors brought all the material from overseas. This had caused sky-high prices for the construction of high-rise and high-glass buildings, hotels, apartments and offices, which cost more than $2000 per sq metre, double that of today.

Going Green

The development of green buildings in Vietnam is still in its infancy, with approximately 40 buildings certifications in Vietnam, the majority of which are in the industrial sector. Due to a lack of enforcement of regulations, global corporate guidelines have been the only real drivers. In addition there is no need to reduce operating expenses due to low energy prices. However, green building practices are slowly emerging as an important facet of the sector. The MoC has drafted a development strategy for green building from now to 2020, which includes criteria on energy and fresh water conservation in construction as well putting standards in place to rate green and energy-efficiency projects.

“Interest in green building has increased significantly over the past few years, not only from international investors, but also from local developers,” Sami Kteily, co-founder and executive chairman of PEB Steel, a Ho Chi Minh City-based steel firm, told OBG. “New buildings must not only be able to withstand natural disasters, but also should consider the health of workers and inhabitants.” The market has indeed appeared to have reached what could be turning point as the number of projects seeking green building certification has doubled in 2016.

Melissa Merryweather, director of Green Consult-Asia, the first company in Vietnam to offer professional consulting services for the green building market, told OBG that when she first arrived as an architect 20 years ago, the development industry was also not very sophisticated and there were not many professionals in the real estate market with experience of how to package products for sale.

“Yet, the change in the last few decades has been nothing short of remarkable,” Merryweather told OBG. “You have  very  sophisticated developers now who, although there have been rough patches in last few years, have learned from their mistakes and have been able to push the government for the necessary changes such as density allocation, which allow them to make smaller apartments better suited to the realistic earnings of Vietnamese buyers.”

Outlook

After a series of lacklustre years between 2011 and 2014, the construction market has picked up considerably and will expand on the back of increasing residential demand and infrastructure needs. A key factor that will drive demand for further housing construction is the amended Housing Law and the Law on Real Estate Business, both passed in 2014 to remove restrictions on foreign ownership of residential and commercial properties.

Meanwhile, among the local population, a growing young and middle class is expected to push up demand for quality homes and investment-grade offices. Furthermore, if ratified, the impact of the Trans-Pacific Partnership agreement will have an impact on sectors related to construction, such as industrial parks, warehouses and logistics as these will attract more funds from foreign direct investors.

In a promising signal for the sector, the overall stock of apartments relative to Ho Chi Minh City’s population is low compared to other South-east Asian cities, even after the currently launched units are developed. Indeed, IMA Asia has noted that the apartment stock per 1000 persons for Ho Chi Minh City in 2015 stood at 10 and is projected to rise to 17 in 2019.