Tender price inflation forecast
As activity levels tail off, construction shouldn’t assume prices will fall
With the German economy slowing, it is tempting to assume that tender price inflation will fall as client demand cools. While past similar situations suggest that this is likely, it is by no means assured. Especially due to the the beginning of rising labour costs in order to catch up with inflation, coupled with a shortage of skilled labour, a drop in tender prices may be overshadowed by these other factors. Thus, slowdowns are seldom identical, and those preparing for the current downturn need to examine its specific circumstances to identify how they will be impacted.
A look at the number of building construction permits, for example, shows 2022 to be the first drop in numbers in the last few years, with the number of permits dropping below the last four years of permits, back to 2018 levels.
Figure 8:
Building permits issued in Germany by year
Source: Statistisches Bundesamt (Destatis)
However, there are still pockets of growth, especially in the current industrial and infrastructure outlook. Data centre projects are booming, and do not appear to be slowing. The EU’s commitment to having an alternative to fossil fuels is shown by the large clean energy infrastructure projects that are currently running, being tendered and in the pipeline.
Rising construction costs have had, and are continuing, to have a major influence on pricing. Over the past two years, construction costs have risen well over 30 percent, but this trend is beginning to change. Q4 2022 and Q1 2023 have seen the yearly amortised rate fall to 10-12 percent per annum, with Q2 falling further to just over 3.0 percent (amortised rate), and it is expected that we begin to return to ’normal’ escalation rates (3-4 percent per year).
Source: Statistisches Bundesamt (Destatis)
High fuel prices have had and are having a large impact on all fuel-based materials, which contribute to the previous material price increase. Contractor expectations in Q1 2023 suggested that, even though the pace of material cost rises is likely to slow and stabilise, material prices are unlikely to regress over the next year.
Some stabilisation of material prices is starting to be seen, however, this regression is only in a few areas, and not across the board. These regressions are minimal when compared to the cumulative rise of material prices that we have seen over the past three years, and prices are not expected to regress significantly enough to have any major impact on tender prices anytime soon.
Source: Statistisches Bundesamt (Destatis)
Overall, these factors suggest that even with the inflation-cooling effect of a slowdown, for now, the construction industry prices may continue to slowly rise. While deflation may eventually occur, clients and contractors need to be proactive in tackling cost pressures on a project-by-project basis, tailoring their approach to factors such as region, sector, project size, procurement route and market.
Success will come down to getting the basics right: assessing risk at an early stage, dialling up productivity gains to increase efficiency and forging close, agile relationships with supply chains through early engagement and closer ties. Together, these strategies can all help to mitigate the impact of the construction escalation as the slowdown begins to have an impact.
What does this mean for our forecast?
Our central scenario estimates that construction tender price escalation will increase by approximately 5 percent in 2023 on average. This is much lower than the rise that we have seen in the last two years (over 15 percent per year), but still significant, especially when added as a three-year total (approximately 35 percent rise since the beginning of 2021). We are forecasting the construction escalation to slow further to 2.0–4.0 percent in 2024, which we are expecting to continue to hold steady for the next couple of years.
Figure 11:
Tender price inflation in Germany: forecasted annual percentage changes
Source: Turner & Townsend data forecast
Our forecasts are representative for Germany as a whole and escalation may vary by project size, value, procurement route and region. Projects need to be assessed on an individual basis and may not always align to our central scenarios. For further assistance on cost assurance and inflation analysis in your area, please contact Turner & Townsend.
Softening market conditions as well as the market cooling will help lower industry price pressures for the remainder of 2023 as contractors are beginning to have to actively look for future contracts, unlike over the past few years where contractors have been turning down work due to full order books. Economic turbulence and less confidence in the market and investment are leading to more projects and programmes being delayed and/ or cancelled.
Material costs are also stabilising and combined with the fact that extended lead times are less problematic, this will contribute to a potential reduction in the pace of tender price growth by more two thirds when compared to the previous two years. Prices, however, are expected to remain relatively stable, as a shortage of skilled labour coupled with rising labour costs continues to affect the industry, reducing the pool of available skilled labour, thus affecting tender pricing.
Although our central construction forecast doesn’t suggest that construction deflation will occur for now, it is a very real prospect and prices could potentially fall, depending on the project pipeline and investment confidence, in 2024. Germany’s economic performance, and the construction industry’s resilience to a weakening of the current activity, will play a heavy part in pricing moving forwards.
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