How will construction costs evolve in Spain in 2023?
Construction costs in Spain have increased considerably since January 2021, a rise that was prompted by the strong recovery in global demand as the economy reopened after the pandemic but was further aggravated by the outbreak of war in Ukraine. In recent months, however, the price of industrial metals on international markets has fallen sharply and the futures markets point to prices stabilising to some extent. Given this situation, the cost of construction materials in Spain is expected to moderate in 2023.
2022 was a particularly volatile year for commodities. A series of events affected commodity prices, including industrial metals, to a greater or lesser extent throughout the year, such as the war in Ukraine and the energy crisis, as well as the strong appreciation of the dollar, China’s recent slowdown in growth and the prospect of a worldwide economic slump. A glance at some of the benchmark metal indices on the international markets endorses this scenario. For example, the London Metal Exchange (LME) index, commonly used as an international benchmark, rose by 53% between January 2021 and April 2022 following the outbreak of war in Ukraine. Since then its value has fallen although it is still 28% above its pre-pandemic level.23
- 23. Other benchmark indicators also performed similarly. For example, between January and April 2022 the JP Morgan metals index rose by 20% and, despite its recent decline, is still 59% above its pre-pandemic level. These same figures for the Rogers metals index were 18% and 26%, respectively.
The outbreak of war in Ukraine accentuated the upward trend in commodity prices. Since the summer, prices have fallen and futures suggest they will stabilise at current levels.
These fluctuations are due to several factors. First, Russia is one of the world’s major suppliers and exporters of commodities, including metals and other materials used in construction. In addition, the war in Ukraine led to negative expectations among investors who anticipated higher energy costs and therefore a fall in the supply of metals (whose production is highly energy intensive). However, these same expectations took a drastic turn when the worst fears of commodity shortages due to the conflict did not materialise and, later on, due to the deterioration of the growth prospects in developed economies. At the same time, another important factor in the recent decline in metal prices is the trend in China’s demand for commodities. During 2022, the Asian giant introduced severe restrictions on travel due to COVID-19. This resulted in a paralysis of its economic activity. In paralel, the country’s real estate sector is in a delicate position because of the impact of policies adopted to curb its real estate bubble.24 Finally, the dollar’s appreciation (a direct consequence of the Fed’s monetary policy) has pushed down commodity prices even further as they are traded in dollars on international markets. Given this downward pressure on international industrial metal prices, a logical question would be whether this will this have an impact on construction costs in Spain. And, if so, when will we see it?
- 24. See the Focus «China’s real estate sector (part II): emergency landing or low-altitude flight?» in the March 2022 Monthly Report.
To shed more light on this issue, we have developed a time-series econometric model that allows us to determine how industrial metal prices in international markets affect construction costs in Spain. But before going into detail regarding the results of this model, it is worth reviewing the recent trends in Spain’s construction costs.
In Spain, construction materials have become significantly more expensive and a reversal of this trend is still unlikely in the short term.
According to data from Spain’s Ministry of Transport, Mobility and Urban Agenda, in September 2022 the cost of residential construction materials was 26.7% higher than in January 2019 (slightly lower than the peak growth of 27.6% reached in June 2022). In our analysis, we focus on cement, concrete, steel and wood as representative materials in construction. The chart below shows that, in September 2022 cement and concrete were approximately 20% more expensive than at the beginning of 2019 while the price of wood was 28% more higher. We can also observe the extreme case of steel, which became 84% more expensive and whose price in September was still 61% higher than in January 2019.
In order to project how construction costs in Spain may evolve in 2023, we use the prices from the LME futures market.25 According to the mid-November futures curve, investors expect metals to fall slightly in December and remain stable in 2023. In line with the evolution of LME futures, our model26 predicts that steel, concrete, wood and cement prices will also decrease in 2023 (see the chart below), a decline which would be moderate for wood (2%) and more significant for steel (23%), according to our estimates. The difference between the drop in steel and wood is due to the fact that the former correlates more closely with the real estate market cycle, which is currently in a moderating phase. Likewise, steel rebounded much more, partly due to its greater exposure to the Ukraine conflict (Russia is one of the largest steel exporters). Wood, on the other hand, does not suffer from such exposure.
- 25. We have used synthetic futures, calculated via a weighted mean between global aluminium and copper futures. The LME has a 97% correlation with the linear combination of these two futures. The aluminium and copper futures used are from 17/11/2022.
- 26. For each construction material, we’ve created an autoregressive model with an explanatory factor, the LME Index.
Next we have looked the effect this trend in price of the different commodities would have on the total cost of residential construction. To do so, we have used a time-series model that captures the persistence of construction costs27 and the trends in the price of cement, concrete, steel and wood, together with their projections obtained from the LME futures. In parallel, and for illustrative purposes, we have simulated two alternative scenarios with construction costs moving in opposite directions. On the one hand, we have constructed a scenario that assumes another shock in which commodity prices would stay at the level reached in August 2022, remaining at that level throughout 2023 (e.g. as a consequence of an escalation in the Ukraine conflict with global consequences). On the other hand, we simulate the trend in construction costs in a scenario in which commodity prices converge in mid-2024 at their 2019 average, the pre-pandemic level (e.g. as a consequence of China’s economy cooling down more than expected or a severe correction in real estate markets). The results of this exercise can be seen in the charts below.
- 27. A persistent series is one where the value of the variables at a certain date is closely related to the previous value.
As we can see, the model based on international metal futures leads us to a scenario in which a substantial drop in construction costs in Spain would begin in December. In 2023, the year-on-year change would moderate, reaching negative values as of April. On average, residential construction costs in 2023 would be 3% lower compared with 2022, although in December 2023 they would still be 15% higher than in January 2019.
Despite the expected decline, in 2023 residential construction costs in Spain would still be higher than their pre-pandemic level.
On the other hand, in a scenario of high prices, construction costs would remain at high levels in 2023, with 1% year-on-year growth. Finally, the results of the model assuming lower prices (a return to 2019 levels by mid-2024) show a similar trend to that of the central scenario but with a somewhat sharper decline. In this case, negative year-on-year changes would be posted from March 2023 and, on average in 2023, prices would be 7% below their 2022 level.
Numerous geopolitical and economic occurrences in Ukraine and China, along with the dollar appreciation, have led to increased commodity volatility. Among these, the price of industrial metals rose sharply during the first few months of 2022, followed by a drop that seems to have left the previous peak behind. Based on investors’ expectations for industrial metal prices in international markets, we estimate that construction costs in Spain could decline in 2023 although they would converge at prices that are still 15% higher than the pre-crisis values. All in all, the economic and geopolitical situation is uncertain, and there are numerous upside and downside risks that could materialise depending on the China’s recovery path, the evolution of its real estate market and other geopolitical factors related to the war in Ukraine.