The year 2022 has confirmed the turmoil in the property and bank lending markets, slowdowns in prices and ever-higher borrowing rates, and against this backdrop developers large and small will face a number of challenges. Unsurprisingly, it will be the smaller structures that will suffer the most from the consequences of inflation, whether structural – we looked at the direct consequences of rising borrowing rates in a previous blog – or cyclical, with materials imported directly from war-torn Ukraine.
Prices of flats under construction still on the rise
We are looking here at developers building homes (rather than buildings for commercial or industrial use, etc), and although the property market is slowing down overall, VEFA “vente en état futur d’achèvement” (sale in future state of completion) sales rose by 5.7% in the last six months. This figure needs to be qualified, however, as it is due to a shift in a greater proportion of sales to towns where the price per m2 is higher.
You might therefore say that sales of new homes will enable developers to get by thanks to this increase (by making more money), but in reality this is not the case.
The reason for this is relatively simple to see, and it is here that the impact is most significant for smaller structures. This is because a large property development company can afford to take the risk of building a building without first having sold the homes, it may have the necessary resources, and it may also find it easier to obtain financing because of the size of its structure. On the other hand, the smallest developer has to “sell off the plan” in order for the project to go ahead. Without this, there is no financing, because there is no guarantee that the banker will accept it. We could even discuss the proportion of off-plan housing sold to constitute this guarantee (70% in practice at present), which could increase as access to loans becomes more difficult.
We can therefore understand that if prices per m2 are rising, and access to loans for households is more difficult (interest rates are forcing households to scale down their plans or give up), then it will tend to be much more difficult for a small developer to sell its homes on the basis of the plan. As a result, the number of projects being financed should logically fall. We are talking about an overall decline in the order book of 0.6 months in the 3rd quarter of 2022.
Building materials and passing on costs
The sale price of new buildings or homes must automatically increase because there is a construction index that ensures that the cost of raw materials and building materials is passed on to the sale price. In other words, if my materials cost me 15% more, I increase my price by 15%. That’s the theory, but in practice, can developers really pass on these costs? The question is not at all straightforward, because not only are costs rising, but there are also outright shortages.
In reality, it is once again the small developers who suffer the most damage, as they have no control over any part of the chain. The largest development companies (including those in Luxembourg) have secured their supplies of raw materials and materials by acquiring the entities that supplied them. This does not entirely resolve the issue of the cost of materials, but it does make it much easier to deal with small developers whose suppliers impose prices. In this context, it is doubtful that smaller developers will be able to pass on all their costs in terms of materials, not to mention the rising cost of energy (and therefore indirectly of transport), and the inevitable delays to construction due to shortages.
Loans and equity
We mentioned above the issue of financing for small-scale developers who have to sell off-plan. The question of down payments is also directly related. When we talk about investments, we are talking about 30% down payments. You need to finance 30% of your development project from your own funds.
You can see why investors and lenders are wary. Especially as this 30% rate means that the higher the cost of construction, the higher the amount of the down payment, and therefore the less likely you are to get a loan. Large developers with a solid cash position are less affected by this. Overall, banks are likely to grant 25% fewer loans in this area.
It should also be noted that the fewer projects there are, the more housing will be in short supply, and so flat prices will continue to rise. It’s a vicious circle, and here we return to the first point raised in this blog.
Other considerations common to large developers
Inflation and financing problems therefore affect smaller developers more than larger ones. But that’s not to say that the situation in Luxembourg is not very favourable to larger structures. There are, in fact, more common problems, particularly with regard to building permits and the development of PAPs (special development plans).
By way of explanation, the PAPs implement and specify the use of each zone of the general development plan (PAG) at commune level. Anyone can submit an application for a PAP. For example, I have land that can be built on (under the PAG), and I would like to have this zone specified on the commune’s PAP in order to carry out my project. Planning permission is also required for any construction, conversion or demolition of a building.
Jusqu’ici, rien de problématique, le souci concerne les délais afin que ces démarches aboutissent. Dans certaines situations et communes, rien ne se passe avant moins de deux années. On constate aussi régulièrement des défaillances dans les équipes techniques à l’appui des communes notamment dans l’élaboration des PAP. Il existe même des possibilités de moratoire afin de geler des projets/demandes d’autorisation si un nouveau PAG est à l’étude (à ce titre, regardez l’article 20 de la loi du 19 juillet 2004 concernant l’aménagement communal et le développement urbain).