Construction costs are rising at an above-average rate

Construction services and materials such as wood, metal, and concrete are more expensive than they have been in decades. According to the Federal Statistical Office, the construction price index, which includes all costs for real estate construction, rose by 29 percent between 2010 and 2020. Experts predict that costs will continue to rise until 2024. But why are construction costs rising so dramatically? There are several factors at play here!

1. Supply bottlenecks: The coronavirus pandemic has led to significant supply bottlenecks, resulting in long waiting times on construction sites. In addition to the coronavirus pandemic, the war in Ukraine has further exacerbated supply bottlenecks. According to the principle of supply and demand, construction prices have risen due to the shortage of building materials and high demand.
2. Higher energy costs and the CO2 tax: Rising energy costs and the CO2 tax are forcing companies to raise their prices in order to remain economically viable.
3. High demand: Large buyers in China and the US have particularly high demand for materials such as steel, wood, and plastic, which in turn leads to material shortages and supply bottlenecks, driving prices up.

Rising construction costs are bringing many construction sites to a standstill, and future builders are canceling projects or worrying about their financial survival. There is one ray of hope, however, as rising construction costs do not necessarily affect existing construction contracts.

Take a look at your construction contract with the construction company: As a rule, rising construction prices should not affect a contract that has already been concluded, as it is calculated at a fixed price. The material procurement risk should therefore be borne by the construction company, provided that a fixed price has been negotiated. Of course, this only applies to construction projects carried out with a construction company. Anyone building their own home must expect rising construction costs and, if necessary, additional financing.

How rising interest costs affect real estate financing

While real estate prices have been skyrocketing for years, historically low interest rateshave convinced builders to finance their projects—but now interest costs are also rising. Why is this the case? There are two main reasons: the rise in the key interest rate and the consequences of the war in Ukraine.

The principle of the key interest rate works as follows: European banks can borrow money from the ECB (European Central Bank) at an interest rate that is paid to the ECB. The banks pass these interest costs on to their customers, which automatically increases the interest rate on loans. However, a few years ago, the ECB lowered the key interest rate to stabilize the economic situation. The result: historically low interest rates, which made real estate loans particularly attractive. But if the ECB now raises the key interest rate again, interest costs will rise significantly. In this scenario, higher interest rates and loan installments will lead to a high supply of real estate and low demand, which in turn could cause real estate prices to fall.

Development of the European Central Bank's interest rate for main refinancing operations from 1999 to 2022
Source: Statista 2022

The ECB has already raised its key interest rate three times in 2022 due to inflation, increasing it from 1.25 percent to 2.0 percent in October. This has resulted in rising interest and borrowing costs. For example, interest rates on ten-year loans have risen from around one percent to around four percent, causing financing costs to skyrocket.
The war in Ukraine is also having an impact on interest costs, as interest rates will have to be raised further to curb inflation, which is being influenced by the war.

Impact of rising energy costs

In addition to high construction costs and rising interest costs, skyrocketing energy costs are also a major concern for property owners. Since the start of the war, electricity and gas costs have risen sharply, placing an extreme burden on the economy and private individuals. The rapidly rising energy costs are particularly evident in the energy efficiency of a property: Factors that indicate good thermal insulation are more important than ever —well-insulated windows, the condition of the insulation, and the type of heating are reasons to decide for or against a property. Properties with poor energy efficiency lose value because, even when space is at a premium, no one wants to pay extremely high utility costs. In contrast, the value of energy-efficient buildings increases because they save on utility costs, even if the rent is higher than for an energy-inefficient property, for example. Sellers and buyers should carefully consider the energy efficiency of a property.

Index-linked rents: inflation determines the rent

Index-linked rents are based on the official consumer price index for private households and therefore rise in line with inflation. In the long term , this is a fair and popular model. However, inflation means that index-linked rental agreements can now pose a high financial risk for tenants: in addition to rising gas and electricity costs, rental costs are also increasing. It is extremely difficult to defend oneself against rent adjustments in index-linked rental agreements, as there are no rent controls or caps. To combat the sharp rent increases, tenants are calling for financial support from politicians and a legal cap on possible rent increases.