EU construction sector faces year of decline but green shoots appear

Marginal construction output growth in 2023
EU production volumes increased marginally, by 0.1%, in 2023 due to a very strong first quarter. Yet, in the third and fourth quarters of the year, EU construction production decreased by 0.3% and 0.2%, respectively. High interest rates and a weak economy made home buyers and firms reluctant to invest in new buildings. In contrast, renovation works in the building sector and the civil engineering sector kept up pretty well due to sustainability works and investments in (digital) infrastructure.

Small decline expected in 2024
For 2024, we expect a small decline in production volumes (-0.5%). Due to long lead times, new residential and non-residential building volumes will decline further as a result of the reluctance of home buyers and firms to invest in new premises in the past. However, the renovation subsector (including sustainability works) is seeing structural growth in demand. We also expect that investments in infrastructure will continue to grow. The main drivers for this continual growth will derive from the EU Recovery funds, investments in digital infrastructure, extensions of the power grid and the energy transition.

Some room for optimism for 2025
For 2025, we expect that the above-mentioned growth trends in the renovation and infrastructure sector will continue. We also expect the new building sector to slowly improve due to the recovering housing market. However, this will take some time as they are limited by the declining amount of issued building permits in the short run.

The stock of contractor work has remained remarkably stable for the past two years. At the beginning of 2024, EU construction firms had 9.1 months of work in their portfolios - similar to the same period a year earlier when it was at a peak. Compared to the developments during the financial crisis in 2008 and 2009, currently, there is no visible decrease. There may be various reasons for this:

• The economic downturn during the financial crisis was more widespread than the economic downturn now;
• Order books of contractors consist not only of new construction but also of renovation and sustainability. The growth in these latter sub-sectors (renovation & sustainability) is more stable and higher, which also increases their share in the construction sector;
• Projects have become more complex to execute in recent years, resulting in more work and a longer duration.

In many EU countries, house prices have started to increase again, after a period of decline. Structural housing tightness, especially in cities, supports demand. Increasing wages makes it possible for house buyers to borrow more albeit at higher interest rates, thus driving up house prices. For instance, Spanish house prices went up by more than 4% in 2023 and we expect a further, but lower increase in 2024. Only in Germany, where the economy is more sluggish, are house prices still declining.

Higher prices of existing houses are good for new residential building volumes, although it will take some time to materialise. Sale prices of new houses are closely related to prices of existing houses as they are often substitutes for consumers who are in the market for a new home. Therefore, price developments of the two can’t and won’t diverge too much in the medium and long run. So, when house prices of existing houses increase again, this also gives the opportunity for project developers, although it won’t always be easy, to increase the sales price of newly built houses. This is also what we see happening. Prices of new houses are increasing in most EU countries. In France, they remain more or less stable as house prices of existing houses do. Only in Germany are residential project developers being forced to decrease sales prices as house prices of existing homes are also still declining.

Pass through of higher building costs
Higher sales prices of residential properties gives contractors the opportunity to pass through the higher building material costs which have increased enormously in the last couple of years. Yet, building material prices have stabilised in 2023, although each specific material follows its own price path.

The number of approved permits has decreased over the last two years. Project developers and residential builders have been hesitant because of the challenging market. In the third quarter of 2023, there was a decline of 14% in issued permits for residential buildings compared to the same period a year earlier. Recent data doesn’t show any improvement yet. The demand for new-build houses seems, as we indicated above, to have improved somewhat. Now however, it is the supply side that will become the main bottleneck in many countries due to a shortage of building land, financial issues, complex project development and/or legal delays. It will take some time before project developers start new projects and apply for new permits. We, therefore, expect a further decline in the new residential sector in 2024, before recovering in 2025. Huge housing shortages in many European cities will also ensure sufficient demand in the residential sector in the long run.

Highest decreases in Austria & Germany
Austria & Germany have seen the sharpest decline in the number of issued permits for new houses, which have declined by approximately 40% in the last two years. For Austria, this is due to the end of housing subsidies for new housing construction, as well as higher interest rates and building costs. In Germany, the sluggishness of the economy plays a role. Belgium, the Netherlands and France all saw a drop in issued permits of between 20% and 30% in the same period.

Huge permit growth in Spain
Spain is the outlier, with the number of residential building permits skyrocketing over the last couple of years. In the first three months of this year, these were more than 2.5 times higher than two years earlier. Higher house prices in Spain make it possible to increase prices of newly built houses as well, which compensates for higher building costs.

Permit issuing for non-residential buildings starts to drop
The non-residential sector seemed to be resilient to the sluggish European economic developments in 2022 and 2023. There was hardly any decline in issued permits. This was mainly due to a rise in e-commerce, which increased the demand for new logistics centres and consequently the number of issued permits. Public spending on buildings for education and health also stabilised demand. However, the slowdown of economic growth, higher interest rates and both geopolitical and economic uncertainty are making companies in other sectors more and more hesitant towards investment in new premises. Therefore, we now see a sharp decline in the last data available. Permit issuing for new offices has come under particular pressure. Working from home and high vacancy rates make current investments in new offices a risky proposition.

The infrastructure sector is more resilient to the economic cycle as investment mainly comes from local or central governments. The EU infrastructure volumes have shown moderate growth in 2022 (2.4%) and 2023 (3.2%) which supports total construction volumes. The subsector benefits from needed investments in the energy transition, especially for new power grids and investments in digital infrastructure such as fibre to the home. Challenges also arise in the field of drinking water, as population growth and climate change lead to more frequent dry periods in many places.

Stimulus from EU funds bolsters growth of the infrastructure sector
In Spain, civil engineering is benefiting from the Next Generation EU funds, leading to the launch of numerous ready-to-go infrastructure projects long delayed by resource constraints.
In Poland, substantial investments in road infrastructure have bolstered growth. Additionally, several previously delayed railway projects are anticipated to begin in the coming years, further driving progress. The execution of numerous projects in the planning will be fostered by removing the access restrictions by the European Commission that blocked the utilisation of allocated EU funds. Yet, it will take some time before some of these projects materialise.