German construction industry still booming, despite surge in building costs

Germany's construction industry is still booming, despite the pandemic and rising costs. Headlines indicate a record monthly volume of new orders in August 2021. The Ifo business climate index improved for the construction sector for the 6th month in succession (from 11.1 to 12.9 points).

In contrast with other important economic sectors such as retail, manufacturing and business services, construction companies view both the current situation and future expectations more optimistically than previously. Current orders will last for the next 5 months and companies are still expecting a significant increase in construction activity.

According to the federal statistical office Destatis, there was a new monthly record level of new orders in August 2021 in the order of €7.87 billion. This is an increase of almost 20% compared to the same month the previous year.

However, this comes with a note of warning - the values have been driven by a sharp increase in prices, mainly for building materials, and there is now a clear shortage of workers to man the building sites. Building costs for conventional residential new-build have risen by almost 13% year-on-year, which is the biggest increase since the 1970s. So the real increase in volume adjusted for inflation is actually 5.7% compared to the previous year.

The percentage increase is also due to the pandemic-related downturn in the volume of new orders from the previous year, especially orders from the public sector. Looking at a longer review period, there was actually a more realistic and marginal 1.5% year-on-year increase in orders in the period January to August.

The main reason for the increase in prices is a hike in the cost of materials. For example, prices for wood products have increased by over 100% over the last year, steel products have risen by 80% and plastic components such as pipes and insulation materials have risen by 30% to 40%. Only part of the increase in costs can be passed on to the client or consumer. There have also been shortages of individual products, which have been delaying building activity. 91% of construction companies have reported shortages or delays in the delivery of components.

Many companies indicated that they are looking to recruit staff, indeed the most significant hindrance to further increases in volume on top of the scarcity of materials is now staffing. Both have both caused delays in commencements and completions, which is hitting builders’ incomes.

According to a new study by the Ifo Institute, one third of construction companies are struggling with recruitment. There is a particular shortage in the areas of technical skills required for the energetic refurbishment of existing buildings in order to comply with environmental requirements, for example in the areas of heating, sanitary installations, ventilation, air-conditioning and insulation in which 75% of all available jobs are currently still open.

Prices for residential properties have reportedly increased by around 10%. Previous reasons for the increases had been the scarcity of available product at a time of population growth and demographic shift and the prevailing low interest rates, but now price hikes are also due to increases in the cost of materials and a shortage or workers - firstly due to the pandemic and now the exodus of eastern European workers to their countries of origin. This shortfall is expected to be followed by an increase in salaries for construction workers. This is a particular problem for the new coalition government, which has promised to promote the construction of 400,000 new residential units p.a.

The construction industry has been able to pass increased costs on to the consumer with varying degrees of success. German inflation has risen to 4.1% p.a. in September. Some cost increases have been successfully recovered from purchasers of condominium apartments, who had been expecting to pay more in the prevailing circumstances. It is more difficult to pass on increased costs to tenants, who often belong to less affluent socio-economic groups and may occupy subsidised housing. Landlords have been attempting to include CPI indexation clauses in residential tenancy agreements.

Many construction companies had calculated contract prices on the basis of 2020 levels and are having to take a hit when completing projects at 2021 prices. But this will not continue and increased prices will inevitably be passed on to the customer. This may result in adjustments to construction contracts, whereby price fluctuations will be carried by both the client and the construction company, but these have been rare to date.

There is no shortage of demand for building services and new orders continue to increase as the country emerges from the effects of the pandemic. However, the sector is now struggling with the fallout including shortages of materials and construction workers and significant price increases across the board, with the ensuing problem of recovering cost increases from clients and consumers, who have also been hit by the pandemic. The increased orders are due in part to post-crisis catch-up, which conversely is also responsible for the hike in costs and shortage of manpower. Whether this will be a temporary situation and how long it will last remain to be seen.