In the first of our country-specific economic profiles, we look at Germany, where the market has grown for the first time in 10 years. Meinhard Rudolph and John Atkins of EC Harris report

01 German economy recovers

After years of moderate growth, the German economy is finally changing. In 2006 GDP grew by 2.5%, after four years of growth ranging from –0.2% to 1.2%.

This is largely owing to an unexpectedly substantial increase in consumer spending – up 1.8% in 2006 – while inflation remained relatively low at 1.7%. Growth was assisted by a boost in exports, in which Germany had a record year, with a 14% increase compared with 2005.

Growth rate expectations for 2007 are more modest, although there are fears that the 3% increase in VAT on 1 January (to 19%) could have brought spending forward into 2006. Early figures, however, indicate that turnover in January 2007 remained steady.

One of the big winners of the economic rebound has been the jobs market – Germany’s problem in the recent past. Unemployment, which was close to 13% in 2005 fell to 10.8%. A further decrease is expected in 2007.

02 Real estate sector

German real estate was booming in 2006. In the first half of the year, ¤17bn (£11.6bn) was invested. By the end of the year that rose to ¤50bn (£34bn). Most of the growth took place in the hotel sector (190%), in shopping centres (72%) and in distribution centres (34%).

About two-thirds of this money came from foreign investors, confirming Germany’s favoured status.

Experts predict that real estate is heading for a long and steady rise in 2007. The advent of G-REITS (German real estate investment trusts) in 2007 is also expected to play an important role.

The impact of these developments on construction is uncertain, although a positive effect is expected, particularly in the refurbishment sector, where recent growth rates are expected to be sustained.

03 Construction companies feel relief, but ...

Despite a severe decline, which started in the 1990s and lasted well over 10 years, the construction industry retains a prominent place in Germany. It receives about half of all investments made in the country and employs about 2 million people.

After 10 years of decline, and with a further fall expected, the industry showed a growth in 2006 of 2.5%, according to the Expert Council for Evaluation of Overall Economic Development, or of 3.6%, according to official figures. Leading the charge was the industrial building sector, which had an average growth of 4.4%, and the residential sector, where permits increased 30%. However, the increase in residential buildings is unlikely to continue beyond 1 January 2007, when VAT increased and the Eigenheimzulage für Neufälle – a form of state benefit for owners of private residential buildings – was abolished.

The outlook for the construction industry in 2007 is positive, with a further 1.7% increase in growth forecast and investment in construction expected to reach more than *220bn (£149bn) – the highest figure for five years.

However, despite full order books and an overall positive business climate, there are still many worries, not the least being a steady decline in the number of permits for new building during 2006. Some think that last year’s figures raised undue optimism.

After years of declining incoming orders and shrinking order backlogs, the 2006 figures are encouraging, but German construction companies are not yet in the mood to celebrate.

Increasing turnover does not immediately translate into increasing profit as contractors have been asking “dumping” prices for a while. But at least the order backlog should ensure full capacity for a year. Low price levels have become less of a problem since the second half of 2006.

04 Remarkable increase of construction costs

According to official figures, construction costs increased 4% in 2005 and unofficial figures put construction inflation for 2006 at 10-20%. M&E installations prices have risen by 15-20%.

The high inflation can be put down to:

  • The high rate of bankruptcy in the past few year (Phillip Holzmann and Walther Bau are two of the biggest) leading to a decrease in supply
  • Increased demand , particularly for the construction and refurbishment of industrial and public buildings, resulting from the economic recovery and the real estate investment boom
  • A massive rise of some material costs following the boom in commodity markets
  • An increase of subsidiary costs (for example, for transport) owing to increasing demand and increasing costs of fuel and labour.

05 Material and labour

Costs for concrete were stable but other materials showed steep increases in 2006, led by steel prices, which were up 15-20%. Timber prices rose 12%, glass 60%, technical installations 15% and bituminous products 30%.

The expansion of the construction industry is already bearing fruit and the number of employed construction workers increased in 2006 for the first time since 1993.

Because of high social security contributions in Germany, on-costs add 80% to the actual hourly rates. This means that labour costs represent about 40% of construction turnover.

Considering the rate of retail price inflation (2% in 2005 and 1.7% in 2006), wages have been stable over the past couple of years.

At the time of writing, the first round of bargaining between unions and employers was taking place for the 2007 wage award. Although modest by UK standards, the 5.5% being claimed by the union has not yet been countered by employers. It is thought the settlement will not be far short of that figure.

06 The future of the German market

A number of reasons have been put forward for the resurgence of Germany over the past year. The most likely explanation is a combination of the reforms brought in by former chancellor Gerhard Schröder, the politics of the coalition government of chancellor Angela Merkel, positive global economic development, and the much discussed feelgood factor unleashed by the enormous positive feedback from the World Cup in summer 2006

Whatever the reasons, after years of disappointing growth, the German economy and one of its main pillars – the construction industry – are finally back on track. However recovery is in no way assured. There are a lot of positive indicators, but some doubts about sustained recovery over the next couple of years.