Is Milan’s property development boom over?
In contrast to much of Italy, the city of Milan has experienced an 8 year long growth, reflected in a strong property market. This growth has been challenged recently by rising finance and construction costs. Just at the time when the property markets should be looking for a recovery, the City of Milan is introducing changes to the planning regime. Together, these factors will make some projects unviable, especially those in the early stages of planning, and force a repricing of land.
8 YEARS OF GROWTH
In the final two months of 2023 two major property development deals in Milan were completed, marking a clear demonstration of local and international confidence in the city. In November, Coima & Redo with backing from Intesa San Paolo, acquired the residential and Life sciences component of Milano Sesto, totalling around 1 million square metres, from Hines and Cale Street. In December, Hines was part of the consortium with Prelios and Unicredit which was awarded the purchase of Scalo Farini & Scalo San Cristoforo developments, for around 620,000 sq.m of mixed-use development. Hines also released further details in November of its plans for the 130,000 ex Trotto site in the north-west of the city.
Since Expo 2015, the city of Milan appears to have followed a limitless climb, expanding rapidly. It has benefited from substantial upgrades in infrastructure, such as the new eastern motorway relief road, two new metro lines and better connections to the city’s airports. The city’s strengths in design and fashion makes it ideally placed to capitalise on a world-wide boom in conspicuous consumption.
Over the last 10 years, it has also pulled away economically from the rest of Italy. As at October 2023, Milan recorded an increase in GDP since the pre-pandemic of 6%, higher than cities such as Berlin, New York and Amsterdam (source, Assolombarda). Meanwhile, although Italy’s GDP has broadly recovered since 2019, it is still 7% lower than what it was in 2014. (source WorldBank data, US $ current). Between 2014 and 2023, the city’s resident population grew by a modest 2.4%. However, the population of Italy as a whole fell over the same period by 2.5%, which in absolute terms is broadly the same as losing the entire population of the city of Milan.
The growth in Milan has been fuelled by cheap development finance and equity, much of it from abroad. It has also been assisted by a favourable planning regime that offered enormous flexibility to developers, in for both use and scale.
However, a number of factors have occurred at broadly as similar time to challenge the growth of Milan’s property development market, principally the office sector but also to an extent all other sectors, including residential. None of these issues are unique to Milan. If anything, the Milan property market has much more in common with other leading European markets than it did in the past.
CONSTRUCTION COST INFLATION
ISTAT records construction cost inflation for the residential sector averaged 11.9% over 2022 (https://www.milomb.camcom.it/indici-istat-costo-di-costruzione); anecdotal evidence suggests the increase might have been much higher, or at least that contractors are pricing in higher levels of contingency into contracts to guard against loss.
Build costs have been driven higher by the price of raw materials, particularly cement (+59% between 2021 and 2022; GAD Studio, 2022). But generally there has also been a squeeze related and indirect costs, including labour, transport and site security, partially as a result of increased demand across the sector. It is no coincidence that in 2022 the construction sector was 2nd ranked in Italy for business failures, after wholesale retail.
In addition to cost inflation is the impact on cost of measures for decarbonisation and improved technical performance, whether required by the Alphabet of different building performance standards (BREEAM, LEED, Wellness etc) or legislation for higher Indoor Air Quality in commercial buildings.
Construction cost inflation has impacted on the financial viability of property development projects and we have seen this reflected in stalled developments or attempts by land holders to sell out before starting construction.
DEBT FINANCE - SCARCE AND COSTLY
As everywhere, finance terms on development loans have deteriorated significantly over the past 18 months. Yet the Italian market as a whole continues to price all real estate, explicitly or implicitly, on the assumption that finance is readily available at optimum terms from high street lenders, at all-in costs of 4% p.a or less.
But the Italian market has always suffered from a limited number of institutional lenders in property, and the number has declined further in recent years following consolidation and regulation. There are only a handful of active lenders in the market (Intesa San Paolo, Unicredit, BPER Banca and Banco BPM to a lesser extent), plus some presence of French Banks; German banks have almost entirely withdrawn from the market.
A lack of lenders means that loans are dependent on existing relationships and there is no appetite from lenders to consider non-core opportunities. Whilst there are some alternative lenders in the market, very few developers and investors are familiar with these lenders, or able or willing to finance projects on interest rates of 8% plus.
CHANGES TO THE PLANNING REGIME
Through the application of a relatively relaxed planning regime, the Comune of Milan has been a key player in facilitating and promoting the regeneration of the city. However, the Comune has flagged the challenge of achieving sustainable development and meeting its affordable housing targets and has made changes and is proposing changes.
Planning Taxes Increased
The first significant change has been to the regime governing planning taxes in the city. These are ostensibly made up of 3 elements; primary and secondary planning charges or oneri (rated on a square metre or cubic metre rate depending on use) and a construction levy (contributo di costo costruzione), calculated on the approximate project cost.
The Administration has made some radical changes to this, significantly increasing the Oneri. The city is now divided into an inner and outer zone. The boundary is the circonvollazione esterna.
Instead of a single, city wide rate for oneri, there are now different rates for the inner zone (red in the image above) and the outer zone. The table below shows the sum of primary and secondary oneri for each major use class. Industrial use charges include also the “imposte smaltimento rifiuti”.
Primary and Secondary Oneri for Milan
| Residential | Office / retail | Hospitality | Industrial | |
|---|---|---|---|---|
| City wide (old rate) | €61.93 / m3 | €346.40 / m2 | €225.94 / m2 | €186.08 / m2 |
| Inner zone (new rate) | €132 / m3 | €738 / m2 | €481 / m2 | €362 / m2 |
| Outer zone (new rate | €68 / m3 | €381 / m2 | €249 / m2 | €217 / m2 |
To complicate matters further, the rates are linked to prevailing property prices and are subject to change on a monthly basis. For the first time, there is also an extraordinary charge calculated on the development profit, for certain instances of new development on designated “abandoned” sites.
Calculation of oneri and the contributi di costruzione, is not a straightforward exercise and will require the services of a professional.
Affordable Housing Provision to be increased
In May of 2023, the comune of Milan published its briefing note on revisions to the City Development Plan (PGT) which is due to be approved in the summer of 2024. There are changes proposed for incentivising the move to net zero, a more strategic approach to urban regeneration and a push towards promoting Milan’s global status.
But the one topic which has generated the most comment in the property world are the proposed revisions to the Social Housing (Edilizia Residenziale Sociale – ERS) component in residential development. Currently, for any development project greater than 10,000 sq.m with not less than 2,000 sq.m residential area, at least 40% of the residential component must be social housing.
The city authorities have made it very clear that they are unhappy with the volume of affordable housing that has been delivered. Rumours suggest that the city administration is seeking to lower the threshold to projects to 5,000 sq.m and possibly even less.
The effect of this, particularly in view of recent development cost rises, has been to put a stop to almost all significant residential projects in Milan, other than those which are already under construction or where the planning is confirmed.
CONCLUSION
Property developers in Milan have to contend not only with substantial cost increases and more expensive and scarce development finance, but also new and impending changes to planning charges and requirements. This has collectively added substantial cost and risk to developments. The true price of land has fallen in Milan. Projects which are still in the planning stage are particularly at risk. Not all owners are willing or able to accept this. Development projects are still being offered for sale sometimes on the basis of only preliminary contracts, at prices higher than were agreed just a few months ago.
For those owners who have patient capital, they can perhaps afford to sit on paper losses today. Others will not be so fortunate.
Olmo Real Estate Advisers uses its expertise and knowledge of the Milan market to assist property developers in securing new sources of capital and also identifies off-market opportunities for investors looking to invest in the city.