Despite the uncertainty of the pandemic, construction volumes in Latvia remained relatively unaffected. Total construction volume grew by 3% in 2020, but the first half of 2021 saw a slight decline of 1.5%, mainly due to unfavorable conditions for construction at the beginning of the year. Investors’ future plans show rising volumes of construction, but these will be tempered by a sharp, unexpected increase in construction costs.
Construction activities about to increase
The segment of apartments and private houses in Latvia is surprisingly active. The reasons for this are similar to those in other parts of the world – people are spending more time at home and are taking advantage of remote work opportunities. Therefore, they feel the need for additional space and choose to live further away from the workplace, in a more pleasant living environment. Despite growing uncertainty and declining incomes in some sectors, the desire to buy or build a new home is increasing.
During the Covid-19 crisis, higher-skilled and better-paid workers proved more protected against a fall in earnings because of the low availability of skilled workers. As a result, the purchasing power of those who could already afford a new home before the crisis remained – and they were even able to increase their savings, as spending on travel and leisure activities fell. However, for those who were less well off before the crisis, the situation worsened over the last year and a half.
From 2022 to 2023, more construction activity is expected across various business sectors. According to SEB Banka’s project pipeline, investors’ view of the office segment is surprisingly positive, despite the popularity of remote work.
The growth of office space in Riga is planned at 23% over two years. Warehouse construction is also expected to see a significant supply of 15% new space over the next few years. Retail space and the hospitality industry are sectors where less activity is expected. Retail space increased significantly from 2018 to 2020, and the stores now have to compete with the growing popularity of e-commerce.
The public sector will also contribute to a faster growth in construction from 2022. Some of the European Union funds and public money earmarked for pandemic mitigation and promoting a sustainable economy will result in new construction contracts. The extensive Rail Baltica project is already underway, and the construction of academic centres is set to continue.
Construction costs to continue to rise
Soaring construction costs will affect the plans of both commercial and private investors. While in recent years the construction cost inflation was driven mainly by labour cost increases of 6%-9% per year, this year has seen unusually fast and sharp price increases for a range of building materials.
The total cost of building materials in Latvia increased by 13% in August compared to a year ago, but for some materials the increase was significantly higher. The most noticeable price jump was for steel – around 60%. Prices doubled for some timber products.
There were several reasons for the jump in prices. This was caused by delays and overlaps in construction work. Work postponed in 2020 led to a surge in construction activity in many parts of the world this year. Price changes were also caused by disruptions in supply chains, both in production and logistics, which led to material shortages amid growing demand.
The production of building materials, in particular steel and cement, as well as glass and other materials, is energy-intensive, so the prices of materials will be driven upwards by soaring energy costs in the future.
However, it is not only direct energy costs that will drive up the production cost of building materials in the coming years. Emission reduction targets will place an additional burden on producers of building materials, as buildings and construction account for around 40% of total CO2 emissions. There will be increased demands to reduce emissions from production, but the transformation of the production process will impose additional costs on the end consumer.
Over the next six months to a year, prices of building materials will continue to rise, and the dynamics of growth may continue to be affected by disruptions in supply chains as the pandemic has not yet been overcome.
At the same time, there is continued pressure on labour costs. According to the statistics, the number of people employed in construction in the second quarter of this year was the highest since the financial crisis. Wages in construction will need to grow faster to meet the projected increase in construction output next year, given the already rising employment and average wage growth in the country. According to the Bank of Latvia economists’ estimates, wage growth in construction would need to exceed 10% per year to provide the additional workforce needed.
Cost increases to affect both ongoing and future projects
The successful and timely completion of ongoing construction projects is threatened by the rapid rise in construction costs already experienced and by inflation expected in the future. Construction companies will have to choose between completing construction projects with a loss or paying a penalty for stopping work if they fail to agree on price indexation according to the construction cost increases. Of course, the completion of construction work will also be impacted by the financial capacity of investors and the responsiveness of funders.
While this year’s price increases will largely be borne by construction companies, which may aim to close the year without losses, any future price increases will have to be funded by customers. This will require a review of planned construction projects, both to see whether they are still economically viable and to agree on more funding.