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When Rates Rise: Softening Demand Threatens European Homebuilders Amid Climbing Costs

Homebuilders across Europe are braced for a bumpy ride as a host of external factors threaten to hit their margins in the next 12-18 months, says S&P Global Ratings. Rising interest rates and inflation could depress sales volumes given that the market relies heavily on mortgage loans and, to a lower extent, households' savings. Furthermore, the Russia-Ukraine conflict and worldwide supply chain issues are raising homebuilders' costs and shortages, which will likely delay projects. In our view, moderate leverage, cost optimization plans, and sound liquidity cushions will enable them to maintain ratings at their current levels.

Rising Interest Rates Should Pressure Demand For New Homes, Unless Governments Act As Catalyst

Soaring interest rates will likely dampen demand for newbuild homes, given that more than 70% of homebuilders' sales are paid through mortgage loans in Europe. Moreover, most banks are tightening mortgage conditions. While some markets are still experiencing a final sales rush ahead of potential further interest rates hikes, the current economic uncertainty may also lead some households to put off buying a new home. Demand from the build-to-rent segment may be particularly stunted, as expected returns for investors (internal rate of return or yields) may decrease with higher construction and funding costs.

It remains to be seen whether governments will continue to stimulate demand either through bulk purchases as seen during the COVID-19 pandemic, subsidized loans, or tax incentives on home purchases. In the U.K. and France, it is unclear whether help-to-buy and Pinel schemes will continue into 2023. On the contrary, recently announced caps on rent indexations to limit the effect of rising prices on households' purchasing power could further depress build-to-rent investment decisions.

Chart 1


House Prices Are Unlikely To Fall, But The Rate Of Growth Should Cool

The housing shortage in most European countries, which will intensify given there are fewer new homes hitting the market, should continue to support sales prices. In Spain for example, the absorption of the existing housing stock stemming from the last real estate crisis--coupled with limited new supply and increasing demand from individuals--has driven up prices to pre-financial recession levels in cities like Madrid. Strong household balance sheets and savings accumulated during the pandemic should also support sales prices in 2022-2023 in most European markets, but growth will likely lose pace as reserves diminish and real estate purchasing power weakens (see chart 2, data from "European Housing Markets: Soft Landing Ahead," July 13, 2022).

Chart 2


Chart 3


Developers Will Struggle To Pass All Rising Costs On To Buyers

The surge in developers' raw material prices and labor costs since the beginning of 2022 will likely depress their margins in the coming year. Property developers and their sub-contractors are notably exposed to steel, plaster, and cement prices, which have increased significantly since the Russia-Ukraine crisis began. Energy represents a lower share of property developers' costs of goods sold (5%-10%), but its current price expansion is exacerbating inflationary pressure. Energy prices affect developers indirectly as they determine the cost of building materials and transportation that they use or sub-contract.

Fewer people will be able to afford new homes as prices continue to increase faster than wages and interest rates are rising. Homebuilders will struggle to cut prices because sales volumes are already under pressure. Therefore, we anticipate that margins may squeeze, but mostly in 2023 because most costs with contractors are already secured for 2022 and the hit should be delayed toward next year.

Property Supply Remains Constrained By Shortages And Administrative Hurdles

In our view, a few external factors will continue to drag on European developers' capacity to deliver residential real estate in the coming year and possibly weaken their contractors' margins. These could ultimately affect developers' cash collection and exacerbate swings in working capital. Receivable impairments may also affect EBITDA generation.

Supply chain bottlenecks and raw material and labor shortages are slowing construction and are likely to delay the delivery of certain projects, thus eroding developers' sales volumes in 2022-2023. However, these issues may ease over time. Such shortages result from the confrontation of high demand and lower import capacity due to the ongoing Ukraine-Russia conflict and past pandemic-related supply chain bottlenecks.

We understand developers in some European markets are also still facing diverse administrative and political hurdles to source land, obtain building permits, and clear recourses. In France, obtaining building permits from local administrations is still very difficult given land scarcity and political considerations. In Spain, the recovery of the residential real estate development sector in the aftermath of the great financial recession has dried up the stock of fully permitted land. This, coupled with the local and municipal administrations' reluctancy to handle new permits, has resulted in land scarcity weighing on future production, further elevating prices.

Chart 4


Growing Environmental And Safety Requirements Support Demand For Newly Homes, But Can Also Cause Delays And Costs

Increasing environmental and safety requirements are positive for residential developers as they encourage demand for new builds that are typically more energy efficient and safer than ageing or low-energy efficient second-hand residentials. However, these requirements may also delay the execution of projects and pile on costs to developers. In France, for example, the new RE 2020 set of environmental norms, which took effect in January of 2022, adds technical constraints and limitations to developers seeking to obtain building approvals. In May 2022, the U.K. government introduced the Building Safety Levy Pledge. This is a wide-ranging homebuilder commitment to implement stricter guidance on building fire safety and fix life-critical defects on all buildings over 11 meters tall that homebuilders or their subsidiaries had a role in developing or refurbishing in the past 30 years.

Margin Pressures And Liquidity Needs Should Be Manageable For Rated Issuers In 2022-2023

Developers' liquidity needs will be largely covered by sales and cash advances for the next 12 months, but the cushion could narrow toward the end of 2023 as result of lower sales growth.

In attempt to optimize costs and limit margin erosion, we think developers may re-think their chain of sub-contractors, with a more pro-active management of suppliers and lower use of master contracts.

As a result, and given strong cash flow generations in 2021-2022, we expect the developers that we rate to maintain credit ratios within our current ratings expectations for the next 12-24 months (see table 1).


Related Research:

This report does not constitute a rating action.

Primary Credit Analyst:Franck Delage, Paris + 33 14 420 6778;
Secondary Contact:Luis Peiro-camaro, CFA, Madrid +34 91 423 31 97;

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