黑洞社区

01 / executive summary

Tender price index
The 18-month decline in tender prices came to a halt in the first quarter, but the short-term outlook seems very uncertain.

黑洞社区 cost index
The building cost index has shown a slow upward trajectory since the second quarter of last year, but movement over the next two quarters may depend on the outcome of wage negotiations.

Retail prices index
The annual change in this index soared to 4.4% in March following the reimposition of 17.5% VAT in January. It is expected to fall back to about 3% by the end of the year.

02 / trends and forecast

Following six consecutive quarters of falling prices in which the cost of construction dropped 17% from the price peak in the second quarter of 2008, the trend came to a halt in the first quarter of 2010 when average prices edged up a little. Analysis of tenders received by Davis Langdon in the first three months of 2010 shows that prices were 0.5% higher than in the last quarter of 2009.

This change in direction corresponds with the latest Chartered Institute of Purchasing & Supply (CIPS) construction market survey which, in March, reported an increase in construction activity for the first time in two years, led by housing but also supported by an uptick in commercial work.

Does this herald the end of the construction recession and mean that the low point for costs has passed? Probably not. More likely it means the start of a period of 鈥渂umping along the bottom鈥� and the probability that, as workload continues to decline this year, prices too will fall more before finally turning the corner when, and if, workload improves next year. The CIPS also warns that the sharp improvement in its index could prove short-lived.

However, there have been plenty of other encouraging signs in the wider economy. The Organisation for Economic Co-operation and Development considers that the UK economy reached the bottom last June and believes that our GDP grew at an annualised rate of 1.8% in the fourth quarter last year and will have grown by 2% and 3.1% in the first and second quarters this year, better than all the G7 economies except for Canada. To counter this view, one of the latest forecasts of GDP, from the Centre for Economics and Business Research (CEBR), suggests growth in 2010 will be no more than 1.2% with little change in 2012 and 2013.

The FTSE has recovered to its level of June 2008. Profit warnings by UK companies in the first three months of the year dropped to a 10-year low. Business insolvencies are at their lowest since June 2007, and the number of construction firms going bust in January was 27% lower than a year ago.

House prices continue to rise, recording increases in eight out of the past nine months to March, to show a rise of 9% over the year. UK industrial production showed a strong increase in February, but will it last?

Construction prices edged up in the first quarter as some materials prices 鈥� reinforcement, timber, aggregates 鈥� rose, and some contractors found it impossible not to pass on some of those increases, having trimmed their labour costs, their preliminaries and their overheads and profit so drastically over the past 18 months. However, if new construction orders continue to fall, then the tendering environment will become ever more competitive and 2010 will be a year when rising materials prices 鈥� particularly steel 鈥� will vie with the need to secure work to survive. Projects with a high degree of steel content 鈥� steel and concrete frames 鈥� may well see prices higher by the year end while others may secure still lower prices than the 2005 level we currently see.

There has been a definite easing of sentiment over the past three months, particularly in London and the South-east. Consultants and contractors are all feeling busier 鈥� most have slimmed down to a point where any new enquiries create pressure on resources. Many shelved schemes are being re-evaluated in the light of lower construction costs and a forecast of improving rents. The first developers off the line are looking to have schemes available to fill the shortage of space that is now forecast to happen as early as 2011. Credit availability may have improved, but funding remains a problem for many. London appears to be exhibiting the strongest green shoots while, elsewhere, work opportunities remain dormant and in those regions more reliant on public sector workload, the outlook may be more pessimistic.

There may also have been a rise in tendering activity in the first quarter as organisations sought to get projects committed before the end of the financial year. Some contractors鈥� estimating departments were over-stretched and had to decline tendering opportunities. In such circumstances, prices were bound to harden. That flurry of activity may now have passed and contractors may have to concentrate harder on winning work in the second quarter.

One sector where conditions have definitely improved is the London office fit-out market as tenants react to lease breaks and take the opportunity to relocate or demand improvements. This sector is busy after a particularly lean period, but overhead and profit levels remain as low as 1% and preliminaries little more than 3鈥�4%.

At the other end of the spectrum, with retail in the gloom, shopfitters are desperate for work and prices in this sector have never been keener.

Construction prices over the year ahead could be volatile, with prices on some schemes hardening while others continue to fall. There may be a battle between estimators having to reflect higher materials prices and directors trimming tenders to secure workload. Our forecast for the year ahead is that prices will move in the range of 鈥�3% to +2%, a wide range but indicative of the project specifics that may dictate how things change.

This forecast follows the pattern of construction activity indicated by forecasters 鈥� that a slow fall in public sector work is compensated by a rise in private sector projects. If there is a sudden withdrawal of new work opportunities post election, prices could suffer another more substantial fall.

Hopefully by 2011-12, private sector activity will have strengthened sufficiently to take up the slack of lower public investment, giving contractors the opportunity to recover some lost margin. However, this is not expected to be a seller鈥檚 market and price rises may be restricted to 3-4%.

03 / HOT TOPIC blue, yellow or red?

Which of the parties鈥� manifestos holds out the best hope for construction? In truth, none of them give much clue as to where cuts may fall, and as such which construction sectors could suffer. Here are some likely areas:

Housing

For all the government鈥檚 targets and commissioned reports, their achievement in delivering affordable housing has been dismal. Some 31,000 social housing units were completed last year, up from 23,000 in 2005 but still only a fraction of the numbers widely acknowledged as required to house the number of people never likely to be able to afford to buy a house in the private sector. The Homes and Communities Agency鈥檚 Kickstart programme has had some success in unlocking stalled private sector schemes. The Public Land Initiative is also starting to deliver results but the programme to deliver 1,250 homes by March 2012 is hardly revolutionising the face of housing delivery. Both the Tories and Liberal Democrats plan to abolish the Homes and Communities Agency.

Experian anticipates a significant reduction in funding for public housing going forwards.

Health

Construction spending on the health estate peaked in 2008 and fell back by about 15% last year. In the last Budget, Labour confirmed its intention to raise health funding by 5% a year for the next two years. Both Labour and the Tories have committed to protecting health spending overall but have provided no guarantee that capital spending is safe.

The Tories and Lib Dems have attacked the PFI models that provided so many of our hospitals in recent years but both support Lift and the model for delivery of smaller GP surgeries and health centres.

It seems safe to suggest that, whoever gets in, new large-scale hospitals will not be on the agenda.

Education

It has felt for a while now that the only thing keeping the construction industry going is the commitment to refurbish or new build the country鈥檚 entire stock of primary and secondary schools. Just under 拢9bn was spent on education projects last year, 16% of the whole new-build industry. (In 2002, education construction accounted for 9% of new-build work). However the end of last year saw a marked reduction in new orders.

The government鈥檚 programme of modernisation and rebuilding extends for many years into the future (the primary school programme has a 14-year span). However, whichever party holds sway after May, resources will be fewer, education projects will come under increased scrutiny and the number of project starts will fall. Labour has not guaranteed to maintain its previously set out programme or to maintain previously projected levels of investment.

There is little clarity from the Tories regarding future commitments to school rebuilding. They seem less than keen on 黑洞社区 Schools for the Future and its bureaucracy and whatever reforms are introduced will be funded from within the BSF budget. Any schemes that have not reached financial close are thought to be at risk.

The Lib Dems have expressed support for BSF and have committed themselves to continue investment in new school buildings. They have criticised the Tories, who they claim are planning to cut school building by 拢500m a year.

Transport

Both Labour and the Tories have expressed their commitment to a new high-speed rail link between London and the North. However, given that this is such a long-term goal, both parties can safely promise this without any serious short-term financial commitment.

The UK鈥檚 crumbling infrastructure has long been a problem avoided by government. With such a huge budget deficit, will this now be another excuse to avoid long-overdue investment?

Roadbuilding has come and gone like a fashion statement, depending which side of the green argument has won the day. Spending on roads last year was at its highest since 2002 as major schemes such as the M25 widening were allowed to go ahead. The Tories maintain they will build new roads only where it is 鈥渃onsistent with a responsible approach to the public finances鈥� which sounds like little new roadbuilding can be expected if they gain power. The Lib Dems, too, would erect various green barriers for any projects to have to leap through and have indicated plans to transfer 拢3bn of capital spending from roads to rail.

Rail investment is expected to grow strongly over the next two years. Network Rail鈥檚 plans include 拢19bn of renewal and enhancement works from 2009 to 2014. Crossrail is moving ahead with Labour committed to completing it by 2017 and the Conservatives 鈥渟upporting鈥� it. However the construction programme could easily slip.

If spending on transport is maintained, there is a feeling that it will only be because of the forthcoming Olympics and the need to try to improve some of our infrastructure before it is inspected by the rest of the world.

The number of public sector projects being cancelled has already risen sharply. Contractors are increasingly reluctant to commit to large upfront bid costs for schemes for which they see a very real possibility of subsequent deferment or cancellation. Without knowing which party will hold the spending reins after May, both Experian Business Strategies and the Construction Products Association have built substantial reductions in public sector construction into their latest forecasts (see overleaf). However both expect 2010 will confirm a further rise in public sector construction spending and that the drop in 2011 will be confined to a fall of about 6%. 2012 will be the year when construction really suffers from government cuts (down 15-20%) by which time it will be imperative that the private sector is once again calling on the industry鈥檚 services.

04 / activity indicators

The Office for National Statistics (ONS) is no longer going to produce monthly data on new orders obtained by contractors and instead will publish quarterly data only. Conversely the quarterly data on construction output will be replaced by a monthly business survey. The latest available data relates to December 2009 (new orders) and fourth quarter 2009 (output). The new procedures mean that there will be a six-month hiatus in information as no data will be published until mid-July. Meanwhile we must swim in the dark, hoping that the new data sets will show an improvement in business conditions in the first half of the year although forecasts suggest this may be unlikely.

Both Experian Business Strategies and the Construction Products Association have issued spring updates for their construction output forecasts. Experian is slightly more optimistic regarding 2011 but has reduced its growth in 2012 to negligible with private commercial work rebounding at a slightly slower rate than previously anticipated. The CPA is slightly more optimistic throughout, with 2011 showing a stronger recovery on the back of better than previously expected private commercial activity. In total CPA remains more negative about construction work this year, forecasting a further 3.3% fall in new work (compared with Experian鈥檚 鈥�1.5%) but both anticipate a similar 2.3 to 2.5% pick-up in 2011. Both foresee the momentum in 2012 being maintained but only just (0.2% Experian, 0.9% CPA).

The final ONS quarterly construction output data showed that 2009 suffered the worst contraction in activity on record, down 11.5% in real terms from 2008. New work fell even more, down by 12.6%. However, in context, the value of new construction work last year (拢55.5bn) was bettered only in 2003鈥�08. Last year鈥檚 total was still 6% higher in real terms than the peak of the last boom in 1989.

The value of new orders obtained by contractors peaked in 2007. Last year鈥檚 total was more than 30% lower in real terms. The table (below left) shows that north-east England has suffered the sharpest percentage fall in new orders over the period, as both private housing and private commercial sectors have been decimated. The east and south-east of England have survived the best: both have benefited from strong infrastructure spending.

05 / building cost index

The building cost index bottomed out in the second quarter last year after just three consecutive quarterly falls. Since then, the index has risen by 1.3% over the ensuing three quarters, entirely the result of increases in materials prices.

Labour

Directly employed building and civil engineering operatives have had their pay frozen since June 2008. Workers employed under the 黑洞社区 and Allied Trades Joint Industrial Council agreement, generally working for smaller builders under the umbrella of the Federation of Master Builders, have secured a 2% wage deal that will come into effect in September this year. It is anticipated that operatives working for larger companies under the Construction Industry Joint Council working rule agreement will secure a similar deal though negotiations have only just begun.

Materials

Figures from the ONS show construction materials prices have risen 4.3% since last July (to February). Many materials prices have not moved but the price of imported softwood and plywood has risen sharply, partly because of the weak pound but also because of increased demand from around the world and mothballing of processing plants.

The price of coated roadstone has also increased substantially, illustrating the effect of the rise in oil prices, which have increased steadily by 75% over the last year, on affected materials prices.

Although some suppliers of aggregates, cement and ready-mixed concrete announced price rises at the beginning of the year, there appears to have been little impact in the market, though some increases were not due to come in until April.

Steel

World steel prices started to rise last December though prices in Europe have been more sluggish. Corus announced a 拢25 a tonne price increase on plates and sections last October but any small movement in the market soon dissolved as increased demand failed to materialise. 2010 however seems set to experience a more significant upward movement in steel prices. Steelmakers around the world are having to contend with large hikes in the cost of raw materials. The principal ingredients of steelmaking are iron ore, coking coal and steel scrap, all of which have seen huge price rises this year.

For the past 40 years prices paid by steelmakers for iron ore and coking coal were agreed on an annual basis, providing a large degree of price stability and certainty for manufacturers. The three main mining companies, Vale, BHP Billiton and Rio Tinto, who between them control almost 70% of the sea-born iron ore market, have moved away from annual benchmark contracts to a quarterly pricing mechanism based on the previous quarter鈥檚 spot price. This means that, for the current quarter, coking coal prices are 55% higher than last year鈥檚 price and iron ore prices approximately double in response to growing demand, particularly from China. This translates into a rise in steel production costs of about 拢60-80 per tonne of steel.

Current spot prices for iron ore and coking coal suggest that steelmakers will be paying even more for these raw materials next quarter, increases which could translate into a further 拢50 per tonne of manufactured steel.

Corus announced a price increase of 拢50 a tonne on structural sections 鈥渂asis prices鈥� from 1 March and have followed it up with another 拢60 a tonne rise from 2 May. These increases would just about cover the increased manufacturing costs from these two raw material price hikes. The question is whether Corus and other steel manufacturers will be able to fully recover these price increases while demand for steel remains subdued.

Scrap is the main ingredient of the electric arc furnace method of steel manufacture, which is more normally associated with the production of reinforcing steel. Scrap prices have always been volatile but, after collapsing from record highs in mid 2008, have resumed an upward trend since the end of last year. Since last November they have risen nearly 50%, which translates into an extra production cost of about 拢100 per tonne of steel. Prices of rebar have been following suit and recently quoted prices are as much as 拢150 per tonne higher than at the beginning of the year. Prices are expected to peak in late summer.

What seems certain is that, for the moment, subcontractors will be reluctant to agree to fixed price contracts for structural steelwork or reinforcement until the market calms down.