Winter is coming?

After a year of geopolitical and economic upheaval, which came only a short time after the pandemic lockdowns, we take a look at the current state of the Polish construction sector and how prepared it is for what could be a troubled period ahead of us

It almost goes without saying that much of the economy took a serious hit during the pandemic. Real estate, being built on the need for people to have buildings to live, work and congregate in, was certainly not immune to this – and so certain segments, such as hospitality and traditional retail, suffered greatly, whereas others, including warehousing, actually thrived as the latest technology was refined and put into action to remove the need for shopping in malls and other previously crowded places. This was ‘the new reality’ – a hi-tech future accelerated into being by the Covid crisis, where people worked, shopped and were entertained at home. As a result of the upheaval, many sectors were turned upside-down, and as the economy recovered they have had to adjust themselves to the new situation.

Construction, on the other hand, turned out to be one of the least impacted sectors, as Bartłomiej Sosna, a construction market expert at research company Spectis, explains: “It’s hard to say that the construction market even needed to recover from the pandemic – it was actually quite stable at the time. There was the initial panic in the early stages, but the level of orders wasn’t affected so much in the end. The contraction of the market in 2020 was only 2 pct, which wasn’t a serious correction.” Along with warehousing, another real estate segment, the residential market, was also given an unexpected bounce by the pandemic. Any problems prospective home buyers might have had with viewing houses and flats or signing contracts in person were soon resolved with the help of the latest tech. But it was the growth in demand due to the need to spend more time at home (for such things as working and learning), together with the fact that the cost of taking out loans was still low more than a decade after the financial crisis, that really gave this sector – and the construction firms who specialise in it – a post- pandemic boost. “After the pandemic, there was a huge increase in the volume of residential construction, as interest rates were still low at that time, while warehouse and industrial construction was given an enormous boost by the massive growth in the demand for e-commerce. This sector is still going strong and should act as a stabiliser into the future,” adds Bartłomiej Sosna. “The pandemic didn’t really have such a negative impact on the construction sector,” agrees Jakub Jędrys, the head of the building and project consultancy at Savills in Warsaw, who goes on to explain: “In 2021, the market actually grew by above 3 pct and we really entered 2022 with very good prospects, with a strong pipeline and healthy revenues. The full recovery from the pandemic was expected to take place this year, but we know what happened in February.”

Inflated expectations

As we are all now too aware, certain events have conspired to prevent 2022 from building on last year’s economic recovery. Initial projections for the further growth of the construction market had been quite optimistic at the beginning of this year, but then two things happened: inflation started to soar as a consequence of all the money pumped into the economy to keep it afloat during the pandemic, together with the outbreak of the war in Ukraine, which added to the inflationary pressure that already existed. “In the spring we expected the market to grow by 4 pct in 2022, but in the autumn the projections were revised downward to 2 pct. However, this wasn’t due to any deterioration in market activity – it was more to do with prices. Inflation has been higher than expected, which means higher prices for materials and manpower, thus eating into the profits and finances of construction firms,” explains Bartłomiej Sosna. Jakub Jędrys agrees that the projected 2 pct growth, while lower than had been expected at the beginning of the year, is still a decent figure considering everything that has happened and gives us an explanation why the growth is still positive: “In the first three quarters the growth stood at 8.9 pct, but in September it was just above 0 pct when compared with the same period of 2021. This is lower than the projections at the beginning of the year, which were more optimistic, especially when the data from the first quarter were factored in. So this is quite a good result – positive growth, despite everything. And this growth has been driven by the good 2021 and start to the year that we had, when there was still a strong pipeline of projects. What we are hearing from the market is that this 2 pct result is still on the positive side – the carry-over since 2021 has been enough to keep the figure at this level.”

However, Jakub Jędrys also points to a metric that casts more of a shadow on the present situation – the business tendency, that is, the expectation of market players that their economic situation will improve over the next three months: “What’s more worrying is the business tendency, which according to Statistics Poland was negative at -21.9. While a different index shows that the industry willingness to take on new work at the beginning of the year, when order books were full, was 30–40 pct, but in October this had increased to 70 pct as new orders dried up. So the order pipeline has dropped dramatically,” he admits. Bartłomiej Sosna adds to this that: “It’s good that the dynamic is still positive, but H1 growth was about 10 pct, so the revised projection of 2 pct for the whole year reveals the scale of the slowdown. The final quarter of the year normally accounts for the bulk of the annual growth, as this is when invoices are completed. So the poor result for the last quarter is set to have a huge impact on the annual growth. The figures for the cement market are usually a good indicator of what’s happening on the wider construction market – sales volumes have been down by 10 pct over the last few months and probably the growth in this figure for the whole year will be around zero pct,” he explains.

“The demand on the residential market will return. Market players need to be patient – this is a temporary slow- down, not a major recession,” insists Bartłomiej Sosna of Spectis

Spiralling costs

The post-pandemic inflation stoked by the war has been having an impact in various ways, none of which are beneficial to the health of the construction sector. “The high inflation at the moment is to a huge extent due to the war, but it was already an emerging problem before the conflict erupted. Since then energy prices have been higher than expected over each subsequent month. This is a major problem for construction firms as they need to finish projects in line with their budgets” admits Bartłomiej Sosna of Spectris. Jakub Jędrys goes into further detail about how the war has directly impacted Polish construction: “In Q1 and Q2, material prices sky-rocketed, some by 200 pct and others, such as steel, by as much 500 pct in April alone, since Ukraine is the main exporter of steel to Poland. Wood is mainly imported from Ukraine and Russia, so the break in these supply chains has had a huge effect on the price of this and other materials.” Jakub Jędrys also highlights another problem related to this year’s price rises: “As money across the economy becomes tighter, there are also issues related to delayed payments for orders as these can push the costs of buying materials up even further. Constructors have tended to agree to, for example, a 60-day window with suppliers for paying for materials and would expect to be able to pay for them in 30 days, once they begin receiving payments for the order. But if these payments are delayed, this adds to the credit they pay for this window,” he explains. However, as he points out, in September and October, some stability returned to material prices, which rather than sky-rocketing started to move up only in line with inflation. “In November, prices have still been stable, and while some increases are still visible, some, such as for wood and timber, have actually gone down – although this is more related to there being fewer projects than previously, as it was the shortages of these materials that had been pushing their prices up,” adds Jakub Jędrys.

Another potential issue for the construction sector, which was also a problem before the outbreak of hostilities across the border, has been the shortage of labour on building sites and the worry that the war would exacerbate this, given the number of Ukrainians who worked on them. However, as Bartłomiej Sosna explains, the situation has actually eased somewhat since then: “There were problems back in March and April with labour shortages, as well as the fear that tens of thousands of Ukrainians working in Polish construction could return to their home country to fight. This didn’t happen, and with the slowdown of the market the labour shortages have become much less of an issue. But there could be problems in the future, if many Ukrainians leave to work on the reconstruction of their country. A way of solving this could be to recruit workers from Central Asia,” he suggests. “Refugees have also helped to fill some of the labour gaps, such as for finishing and fit-out work. A lot of refugees are women and recently I’ve twice seen all-female teams doing painting and gypsum work,” observes Jakub Jędrys of Savills.

Supressed demand for homes

A more serious situation for construction is the downturn in the residential market, not just due to inflation itself but also the measures taken to combat it. “The huge demand for housing in 2021 has fallen off due to the interest rate hikes. Sales have been down by 40 pct over the last two months,” admits Bartłomiej Sosna. As he goes on to add: “These have reduced the availability of mortgages. Half a year ago in Poland you could take out loans of PLN 500,000, but now banks are only lending about half that figure – so apartments are now unaffordable for the average Polish home buyer.” Jakub Jędrys concurs with this view: “The housing market, due to the high inflation and interest rates, is facing acute problems – and this has also had a huge impact on construction. The number of dwellings for which construction has started fell by close to 25 pct between January and September 2022 compared to the same period last year. The costs of taking out mortgages has shot up and sales have plunged. As a result, this is the part of the industry that has suffered the most. So until inflation and interest rates begin to fall, there’s not much chance of a recovery in this segment,” he believes. He also points out that high interest rates affect construction in another way, by reducing the availability of financing for commercial projects, which in turn has an impact on speculative development activity. “We can already see this in the logistics real estate sector, which is also being impacted by the rise in the price of materials and the labour shortages,” notes Jakub Jędrys. Interest rates, however, can go down as well as up – and the expectation is that they will have to go down eventually, enabling the demand for housing that clearly existed prior to the present downturn to recover. “We expect interest rates to start to go down in H2 2023, bringing some stability back to consumers. And we have to remember that the number of owned homes per 1,000 inhabitants in Poland is among the lowest in the EU, while the influx of refugees from the war has doubled the need for housing. So the demand on the residential market will return. Market players need to be patient – this is a temporary slowdown, not a major recession,” advises Bartłomiej Sosna.

Residential projects make up a large chunk of orders, but the other main pillar of the construction sector is civil engineering and infrastructure – and in Poland there are also issues in this area, since many of these projects are dependent on EU funding, which is currently being withheld due to the Polish government’s ongoing disputes with the European Commission. How likely are these to be resolved any time soon? “EU funds are currently frozen, but, with the 2023 parliamentary election coming up, I can’t imagine a party going into this without having resolved this issue with the EU Commission. When it comes to civil engineering projects, 50 pct of the funding comes from the EU – so it is a huge recipient. There are still some delays with payments from the EU’s seven-year fund (2021–2017), but the main problem is with accessing the EU pandemic recovery fund. However, we expect that this will be just a temporary issue,” believes Bartłomiej Sosna.

The light at the end of the (railway) tunnel

Demand for construction will also eventually come from other sectors. The war has also pushed the need for energy transformation up the agenda – and this will involve the construction of both nuclear power plants and offshore wind farms. And it is likely to prompt more investment in military facilities, although this could also divert state funding away from civil engineering and infrastructure. Aside from the war, there is also the ongoing need for railway construction in Poland, which has been brought into sharper focus by the project to build the New Central Polish Airport, otherwise known as the Solidarity Transport Hub, between Warsaw and Łódź, which should be completed by the end of 2027. “The first tranches of EU infrastructure funds generally went into road-building, but with the development of the Solidarity Transport Hub more railway infrastructure will be required,” points out Bartłomiej Sosna of Spectis, who adds: “In the last few months, as this project finally enters the construction phase, we’ve seen the signing of the first design and construction tenders for projects related to the Hub including for a railway tunnel in Łódź.”

As he concludes: “So the number of projects going forward looks bright – the only worry concerns the ability to finance them given the high inflation and interest rates and the issue with frozen EU funds,” – problems that he expects to be resolved in 2023. This view is echoed by Jakub Jędrys of Savills, who puts it this way: “What the pandemic has shown us is that it’s the insecurity caused by these events and these issues that has to be overcome. So the question now for the construction sector is how long inflation and interest rates are going to be so high. But we saw with the pandemic that once the initial uncertainty passed, we could move forward again.”