A decrease in interest rates, combined with economic growth and high expectations upon accession to the EU initiated a steady growth in both commercial and residential real estate, inducing construction industry development.
According to data provided by the Latvian Statistical Bureau, construction volume in Latvia reached 1.2 million euros in 2005, a 15.5 percent increase compared to 2004. During the first six months of 2006, construction volume in the country has reached 571 million euros. Construction of new projects reached 123.4 million euros in 2005, which is a 27.8 percent increase in comparison with the previous period. Since 2002, annual construction volume growth has surpassed the 10 percent benchmark and is well above average GDP growth in the country. Is such growth in the construction industry sustainable?
One of the major causes of rapid construction volume development is the fast expansion of civil engineering, including the renovation of infrastructure, which includes roads, railways, and ports. Such abrupt development became possible, particularly, due to substantial resources generated from EU funds and direct EU assistance which has been allocated through the state budget.
In addition, there is huge demand for housing due to the income level of the population growing and the easy availability of cheap mortgage credit. Dynamic development is also observed in other real estate segments, including office and retail, as demonstrated in ambitious projects such as projects on Skanstes, Mukusalas and Duntes streets.
Unprecedented real estate demand resulted in a fast increase in construction costs as well. In 2005 construction costs grew by 9.6 percent, which was the highest increase since 1995. In the 3rd quarter of 2006 compared with the 3rd quarter of 2005, construction costs in Latvia rose on average by 26.5 percent. After 1995 this is the steepest rise in construction costs during a single year, and these indicators well surpass the increase in official inflation in the country.
When examining the causes for such an abrupt cost increase, the most significant factors in 2005 were: salary increases (16.10 percent), equipment exploitation and maintenance cost increases (13.80 percent), and construction materials cost increases (9.30 percent).
Due to the increased labor out emigration after EU accession, labor availability and labor costs became a key issue for all market players. The average reported salary for the top 10 companies is about 500-600 lats (717-861 euros) gross which is a realistic indicator of current market trends. At the same time, companies tend to increase the share of the "white", or official salary, in employee remuneration schemes in order to retain existing workers. The stringent legal environment forces the companies to reduce the use of unregistered labor. It is expected that almost all the companies will try to solve their labor shortage problems by importing skilled and unskilled labor from Eastern Europe countries, e.g. Belarus, Ukraine, and Bulgaria and Romania (after they join the EU in 2007). But still labor import opportunities are considered to be limited.
Another trend of the fast construction industry expansion is the necessity to increase the share of construction done by a company's own workforce. It is difficult for companies to win large tenders if you cannot demonstrate sufficient workforce resources. Top market players are showing the tendency to increase their work force, while simultaneously increasing punctuality and quality. In 2005, the average ratio for construction work done by a company's own workforce for market leaders was 65 percent, while for medium size companies (top 40) the figure was 48 percent. In order to preserve the quality level of the work and meet promised deadlines, these numbers are expected to increase for the industry leaders.
Serious technological innovations in the construction industry are planned to grow along with the construction industry. It is expected that less labor intensive technologies in construction will be applied. For instance, recently Lithuania faced labor shortages in construction as well, and as a result the usage of ferroconcrete has increased significantly. This particular technology gives the opportunity to minimize labor costs by reducing the number of people needed on the building site while at the same time increasing quality by producing concrete in a controllable environment. This and similar technologies may create a long term possibility that will make current growth sustainable, taking into account the difficulties associated with importing new workers.
Kristine Kolosovska is head analyst at Bridge Capital
