RKAS currently has several major public sector real estate development projects underway, including the construction of state high schools, Viljandi's new hospital-health center complex as well as various objects involved in ensuring the country's internal security.

According to Kusmin, the likelihood of these projects being completed on time and within budget has decreased dramatically in the past few weeks. Labor and material costs had already started to grow steadily during the COVID pandemic, but in connection with the war in Ukraine, the construction sector has now also been hit with construction material supply difficulties, sharp increases in fuel costs and worsening labor shortages.

RKAS is monitoring the construction price index, which is based on the results of public procurement tenders. In the fourth quarter of 2021, construction prices for a sample of public procurements went up 30.8 percent on year. This means that the average public procurement-based construction price of an office building reached €2,206 per square meter, exclusive of VAT.

The duration of construction contracts signed based on public procurements was also extended by four to six months, as the availability of construction materials has worsened.

According to Kusmin, RKAS' partners in the construction sector have informed the company that the situation will become even more challenging in the near future, and there are no good, quick solutions for altering supply chains or for Estonian construction companies resolving cross-border issues.

"Rising energy prices and labor shortages at construction sites, where many construction workers with Ukrainian backgrounds have returned to Ukraine to defend their homeland, as well as the availability of materials are further exacerbating an already tense situation," she explained. "Much of the metal, bitumen or lumber used in construction had previously been supplied by Ukraine, Belarus or Russia."

Risk of EU funding recovery

The RKAS CEO noted that in standard practice for public procurements, changes to contracts, including to deadlines or prices, are strictly regulated. And even if contracts aren't altered, showing understanding to contractors that have run into difficulties has proven highly problematic in the past.

"Namely, there have been cases where recoveries have been requested on projects funded by EU structural funds purely because granting a contractor additional time for fulfilling their obligations or failure to issue a contractor a contractual penalty has been interpreted as an unauthorized modification of a contract," she explained.

According to Kusmin, in these current exceptional circumstances, all of this could lead to the disruption of work on many significant construction projects, as a result of which many buildings may end up sitting unfinished.

"It would be possible to conduct new public procurements for the completion of these construction works, but that would mean that project costs would increase as a result of the changed market situation, the incorporation of the cost of unforeseen future risks into the price as well as the risks of taking over a property from another contractor," she said.

"Deadlines for project implementation would likewise be delayed as well," she continued. "The chance that a similar pattern caused by unpredictable price increases or supply difficulties may repeat itself with new procurement contracts cannot be ruled out either, as there is a great deal of uncertainty on the market."

The eligibility period of most projects funded via EU structural funds ends at the end of 2023. According to the RKAS chief, the completion of several ongoing projects by the end of the eligibility period seems highly implausible due to the aforementioned risks.

"Which in turn increases the risk for the Estonian state of recovery on projects funded from European structural funds," she explained. "Of projects being led by RKAS, properties being built as part of the state high schools program and the hospital and health center in Viljandi are among high-risk projects. We can expect that local governments and other public sector customers have similar projects funded by structural funds as well, regarding which RKAS does not have detailed info."

Four proposals for alleviating the situation

Kusmin has provided four proposals which could help bring clarity and security to the construction sector, state customers as well as the government amid current uncertain circumstances.

First, the state government urgently needs to start discussing the increased risks involved in using funding from European structural funds, and, if necessary, launch a broader dialogue on the European level in order to find a solution for extending the eligibility period for structural funds by a couple of years from the current 2023.

Second, in order to fulfill procurement contracts currently in progress as well as provide security for the organization of new public procurements, it is necessary for the state, via the Ministry of Finance, to provide general written guidelines regarding opportunities for making changes to procurement contracts, both in the case of rising costs as well as the extension of deadlines.

Third, resources must be drawn up and allocated in the state budget as well as the state budget strategy process for the completion of projects already underway, including taking into account the need to make changes to own contributions to projects funded from structural funds.

Fourth, changes linked to the extraordinary market situation to planned and previously confirmed investments and schedules for implementation must be taken into consideration during the state budget strategy process.

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