Office development sq.m. as a proportion of total stock is at cycle highs, in the 10%-21% range in the CEE-6 capital cities. It is 10%-28% in the Polish regional cities and at a peak in the industrial sector as well, reveals Colliers International, global industry-leading real estate services company, in its latest research report “CEE construction markets: The Icarus effect”.
“In Greek mythology, Icarus flew too near to sun, melting the wax on his wings and he plunged into the sea. We believe this is the correct analogy for construction markets in CEE, currently. Economic sentiment indicator appears to have passed its recent peak in most of the CEE countries. And examining the top of the last cycle in 2007-08, we found that it was spikes in construction costs and prices that helped define the turn at the peak even before the 2008-09 Global Financial Crisis struck,” Mark Robinson, CEE Research Specialist explains.
We found that it is labour shortages in particular that appears to be driving up construction costs and with minimum and average wages looking likely to rise at similar rates to last year in the CEE-6 in 2019, the heat is not abating. Romania and Hungary look to us to have the most profound labour supply and pricing issues, whilst demand growth momentum looks softer in Slovakia and might unfold in the Czech Republic. Bulgaria appears to have the least supply-side worries presently, whilst Poland’s larger and more liquid construction market may help it weather any incipient downturn.
Demand to return to Earth
Customer demand ranks as the most important factor for developers to consider in the opinion of Colliers‘ Valuation experts in the region. But unfortunately the peak momentum of economic
growth in CEE may have occurred already and thus construction new orders sentiment may deteriorate moderately from the present record levels in 2019-20.
Low labour supply melts the wings
The end 2018 wage growth and labour shortage situation dwarfs that of 2006-07, both in CEE and in the EU as a whole. When wages have risen by a quarter or by up to half in less than 3 years, profitability comes under pressure. Development costs for typical office projects in the capital city CBDs rose c.5%-17% over the last 12 months. It looks like 2019 is another year of wage hikes in the CEE-6, with our estimates of national wage rises in the 5%-10% year-on-year, cross-sector minimum wages increasing 7%-10% and outliers like Romania’s just-announced stunning 58% year-on-year minimum wage hike for construction workers. So, development costs may well go higher, in the face of slowly melting demand.
Hotspots or havens
Hungary appears to have the most severe labour and materials cost worries presently and we believe general contractors have put their execution prices up substantially. Romania’s minimum wage move indicates real strain on construction labour supply. Slovakia’s demand may be cooling faster than its peers whilst Czech economic growth peaked earlier, in 2017, than the rest of the region. Bulgaria appears to have the least supply-side worries presently, whilst Poland’s larger and more liquid construction market may help it weather any incipient downturn.
The Achilles Heel. Will the falls continue?
Economic sentiment in the CEE-6, even with the fall since February, remains at historically elevated levels, so not predicting a recession as yet. The deteriorations in sentiment are mostly export-led and correlated to the economic/export slowdown in the Eurozone. Ahead for CEE-6 and Europe in 2019 are Brexit and potential trade issues with the US. Brexit itself may also lead to lower investment in the CEE-6 via the EU’s Structural Funds programme from 2020 onwards, affecting civil engineering construction.
Soaring too high – construction prices have jumped
Construction prices for commercial real estate in the CEE-6 have jumped. The change in GLA development costs for a typical 15,000 sqm office space located in the capital city’s CBD is,
according to our Valuations experts, ranged between c.5% and c.17% over the past year in the CEE-6 region. Locations in Budapest (10%-15% up) and Bucharest (11%-17% higher) have seen the more significant pricing pressures through 2018.
Supply side factors defying gravity
Labour shortage is now the most important single constraint across the region. Financial constraints, which encompasses project risk, currency risk, debt interest costs and wage/margin
pressures remains the second-most important constraint. Low unemployment rate levels are a major concurrent signal of the labour shortages. The Czech Republic’s 2.2% in October 2018 remains the lowest in the EU. As unemployment rates have, there is an increasing reliance on immigration to fill the gaps on the construction sites.
Labour force hubris – pay hikes sustaining into 2019
Even given the economic slowdown unfolding across Europe and potentially in the CEE-6, wage pressures look likely to sustain into 2019 in the region. National minimum wage recommendations being enshrined into law now are for hikes of between 7%-10% this year.
These levels are an anchor for the expectations of the most unskilled workers on a construction site.