UK

In the UK, there are various reasons why it now costs more to deliver development projects: supply chain issues caused by Brexit and/or the pandemic; labour shortages resulting in increased wages; and delivery delays to name but a few. Increased inflation is both a symptom and a cause of this.  It reflects cost increases, such as those linked to Russia’s invasion of Ukraine, and drives up prices in other areas.

Planning problems

Increases in inflation, and in particular the indices by which it is measured, have specific knock-on consequences in the planning sphere.

Almost all developments are subject to community infrastructure levy (CIL), and many developers will also be required to pay contributions under s106 agreements. All of these payments are subject to indexation. So, as the value of indices climbs, so do these CIL and contribution costs, with no additional benefit to the developer. Despite the hope that this will be offset by greater receipts in the future, this doesn’t diminish the appreciable impact on upfront costs when getting development underway.

The position is further compounded for housing schemes with affordable housing requirements. Many affordable housing requirements are subject to review mechanisms based on viability considerations. This means that when developers make higher profits than originally anticipated, this benefit is shared with local planning authorities, in the form of an increased affordable housing requirement.

But this doesn’t cut both ways – in the vast majority of cases, original affordable housing requirements are not reduced as a result of viability reviews. Even if costs skyrocket without an increase in receipts, the developer must provide the same affordable housing. Schemes which were once marginal, or even profitable, can suddenly find themselves unviable.

Often there is limited sympathy for the plight of developers, and there are few political points to be scored by lowering mitigation expectations to increase profits, but the situation is more complex than it may appear. Unviable development is much less likely to happen either because the developer won’t take the risk or because it knows that if it waits, market conditions will eventually shift, leaving it in a much stronger financial position. The real losers when these pressures bite are those needing the homes which are delayed when developers pause or stop schemes because they cannot absorb the extra costs.  These developers find themselves stuck between a rock and a hard place and they are often the SME developers who the government is keen to see increasing market share.

Where a scheme is financially precarious, a developer can try to renegotiate its mitigation with the local planning authority, which could result in smaller contributions and lower affordable housing requirements. However, often developers will be at the mercy of the authority in agreeing to this, and securing reductions can be unpredictable and slow. There is also no discretion around CIL – once there is a liability that cost is fixed, albeit subject to indexation!

Time for government intervention?

There are steps the government could consider to help.

In the depths of the pandemic, when CIL was identified as a barrier to schemes progressing,  measures were introduced to delay liability in certain cases. Although the cost remained the same, the delay helped mitigate the position on upfront costs.

The issues currently facing developers in many ways reflect those following the 2008 financial downturn. At that time, the government took clear action. As well as introducing a streamlined process for making non-material changes to permissions, making them more deliverable, the government also introduced a temporary ability to “extend” permissions, through the grant of new consents. Accordingly, where a scheme could not proceed in the short term, the time and cost of securing planning permission was not necessarily wasted.

Perhaps more interesting were the rights temporarily included in the Town and Country Planning Act 1990. This created a time-limited right to apply to revise affordable housing requirements in certain cases. Where it could be demonstrated that existing affordable housing requirements rendered a scheme unviable, the local planning authority had a statutory duty to revise these. A developer wouldn’t necessarily get the exact change it wanted, but there was the comfort of knowing that things would move in the right direction. Even without a formal application, the backdrop to discussions round affordable housing shifted, making it politically easier for a local planning authority to entertain the idea of reduced requirements.

This doesn’t mean to say that the same approach is the right one now, but it serves as a useful reminder that when the government wants to ensure housing doesn’t stall, it has options. Clearly, though, the government has a significant, long term planning agenda, and may not appreciate the distraction – to it or the public – of temporary measures. However, irrespective of long term aspirations, many in the industry will feel that to avoid an impact on housing delivery, we need action now.

Germany

In Germany, the Annual Tax Act 2022 increases the straight-line depreciation of residential buildings from 2% to 3% from 1 January 2023. Furthermore, the special depreciation for new rental housing was extended. The special depreciation of 5% per year can be claimed over a total period of four years in addition to regular depreciation.

Back at the beginning of 2022 the various ministries issued decrees for federal construction projects which allow special arrangements to be agreed for public contracts (such as special material price escalator clauses). This is intended to mitigate the adverse effects of Russia’s invasion of Ukraine for construction companies, such as supply bottlenecks and price increases for key construction materials. The possibility of contract adjustments was also created for existing contracts.

Decrees of this type also often serve as guidance to the private sector on how they can or should handle certain situations and unforeseen events.

In addition, the German Federal Ministry of Housing, Urban Development and Construction has set up an Alliance for Affordable Housing, which includes a wide variety of representatives from the federal and state governments, leading municipal associations, the housing and construction industries, and civil society.

With a catalogue of measures agreed on 12 October 2022, which the members of the alliance must implement within a certain period, new affordable housing is to be created.

Measures included:

• the establishment of independent funding for new construction;
• consideration of the interests of the construction sector in the federal government's strategy for securing raw materials (domestic and renewable building materials and raw materials, imports, recycling);
• the development of legal regulations in the building code to strengthen the preservation of existing buildings and the reuse of components/building materials in residential construction;
• the expansion of support for building capacity for serial and modular new construction; and
• the anchoring of regulations in all state building codes so that type approvals already issued are also valid nationwide, provided that no state law aspects (such as wind, snow or earthquake loads, regulations on barrier-free access) contradict this.

Hungary

Inflation in Hungary in the first couple of months of 2022 was already rising mainly as a result of increasing demand on the market following the COVID years which caused increasing inflation all around the world. The increase in inflation was further precipitated by the actions of the Hungarian Government preparing for the elections in April 2022 and Russia’s invasion of Ukraine in February 2022.

Devaluation of the national currency has also been an important factor affecting inflation, which has been fuelled by debates between Hungary and the EU. The increase of the inflation rate was specifically intense in the case of fuel, energy and food prices in the last 12 months, and the Hungarian Government and National Bank are in a difficult situation to cope with this in parallel with the Hungarian economy slowing down. As a result, Hungary is among the countries having the highest inflation rate in Europe with a general increased rate of 22.5% in November 2022 on a yearly basis.

It is expected that inflation will continue to increase in the coming months, before it starts decreasing possibly towards the middle of 2023. It can be expected though that the uncertainties in connection with the inflation rate will remain with us in 2023 as well. While market players will continue to adapt to the circumstances, the main focus will be on energy prices and the general state of the Hungarian economy, which are expected to continue to affect the inflation rate in Hungary, rather than new development.

France

Although it is probably too early to understand the full impact of inflation, the French real estate market clearly shows signs of its impact. One key example is construction agreements which previously were regularly entered into for a fixed or a maximum guaranteed price with no possible revision, that are now including indexation clauses to take into account the rapid increase of the price of raw materials. We also see attempts of renegotiation of some existing construction agreements, even when they were entered into with a guaranteed maximum price or on a fixed price. The increasing price of fluids (gas, electricity and now water) will just be adding to the already high (and rising) material costs.

The impact of inflation on the transactional real estate market is also being reflected in the pricing of the assets; prices are renegotiated downwards by investors and some transactions are even being aborted. Transactions unquestionably slowed down in the second half of 2022.

It remains to be seen what the French government will do to try and counter the effect of inflation on the real estate market in the next few months. As of now, the most significant measure for the real estate sector is the limitation to a maximum of 3.5% of the indexation of rent based either on the variation of the index on commercial rents and of the index on residential rents. This limitation has not yet been imposed on the construction cost index.

Authored by Hannah Quarterman, Sabine Reimann, Kerstin Schoening, Christopher Noblet, Laszlo Partos, Margot Derumaux, Alice Houdart, Stella Bliss, and Ingrid Stables.