黑洞社区

01 / Executive summary

Tender price index 鈻�
Tender prices increased in Q3 2016 by 7.1% provisionally versus the same time a year earlier. Risks to the outlook are now clearly to the downside through 2017 and into 2018.

黑洞社区 cost index 鈻�
黑洞社区 materials cost inflation is picking up, increasing over 2% in the year. Devaluation of sterling exchange rates is the primary reason for the materials price changes.

Retail prices index 鈻�
The annual rate of change was 2% in Q3 2016. Domestic inflationary risks are increasing quickly.

02 / Trends and forecasts

Like the extended summer this year, UK construction activity confounded many, especially post-EU referendum, and maintained its steady momentum well into the autumn. This residual activity is expected to continue over the near term, although likely to post ongoing moderate growth rates. This assumes the absence of any major fiscal stimulus from the government.

Now that we know the EU referendum outcome did not knock construction off its course 鈥� or the UK economy for that matter, which had too much underlying momentum 鈥� the bigger, looming question is what happens over the medium term to economic growth.

Underestimations of momentum, or bias even, possibly meant that it did not rank highly enough in assessments of immediate future paths to output. This is not to say there will not be any Brexit-related impacts: it will take a number of years for the direct effects of the UK leaving the European Union (EU) to be felt.

With clearly split views on Brexit 鈥� a Marmite choice almost 鈥� the type of Brexit and its effects dominating current discussions, there is still no definitive picture yet about what the EU referendum outcome will mean.

Inevitably, the vacuum generates speculation and market movements, sometimes wild swings. This also ignores the ongoing changes and revisions to global growth prospects, the government鈥檚 unfinished business on eliminating the budget deficit and the inevitability of economic cycles.

Any realistic answer to what Brexit will mean is not necessarily becoming any clearer. Of the various types of risk in this unique situation, political risk is possibly the greatest near-term hurdle to overcome. Often investment decisions rely on the signals and actions of governments, and it is these that are likely to alter the trend of construction output over the medium term. As soon as the referendum result was known, uncertainty became a perennial issue.

Brexit has created split views on confidence 鈥� housebuilders鈥� perspectives on housing, for example. Generally there remains plenty of talk of possible future projects, but prevailing uncertainty is resulting in some hiatus in decision-making. Consequently, the timescales for prospective pipeline projects turning into live projects is longer in some cases. The risk of this approach to clients is that construction tender prices are still rising, albeit more slowly than recent years.

Do clients with a definite scheme then wait for what they believe to be an approaching better pricing window? Or press ahead now and secure current price levels?

Delays are not all the result of the Brexit vote: some projects have been hit hard by weakening values at a time of coincidental pressure on construction prices. Schemes have therefore been subject to reviews to optimise design economy.

A / Aecom Indices

Fundamentals still point to a strong development market if it were not for Brexit-related uncertainty. Some tenants have carried on taking space, which provides confidence that the market is not losing velocity quickly. Site acquisitions have continued but how much of this activity transfers into actual starts on site will be closely observed. The twin risks of faltering global economic growth and Brexit-related uncertainty are now joined by risks arising from expected benign UK economic output and rising domestic inflation. Escalating domestic inflation will have an impact on construction prices 鈥� even if it鈥檚 offsetting softer market-driven construction pricing. There was a high probability that the UK was set for an economic rerun of 2010-2013 anyway 鈥� the EU referendum outcome was not the whole story in the last Market Forecast.

Nevertheless, an increasingly mixed view in the industry is emerging. Optimism mostly still trumps pessimism for now. Some large commercial projects have stalled or been put on hold. That said, some that were held after the referendum outcome have re-started. Housing, fit-out and industrial sectors meanwhile have posted good levels of recent activity. Anecdotal evidence of the main contractor market slowing is becoming easier to find though, with just a little more anxiety around. This is most evident in having more main contractors bid for work on a competitive single-stage basis. This was almost impossible six to 12 months ago. That said, commercial negotiations already further down the line are not yet always reflecting this emerging change in market conditions. Trades, meanwhile, do not report the same loss of speed, many often still able to select their workload, with evidence of this creating project delivery issues. There is some relief in the intensity of workload for trades at the front-end of the construction project cycle. However, follow-on trades later in the construction cycle continue to be very busy.

In general, most firms remain busy and earning respectable margins. Order books for the next six to nine months are generally deemed good. However, more construction firms are stepping up the active chasing of future opportunities. Clients and their consultants can expect contact from main contractors in coming months.

Relationships have been continually highlighted by Aecom contractor surveys in recent years as a key theme for the supply chain. Enhancing and developing relationships (whether client, main contractor or supply chain) will become increasingly important over the near and medium term. The impact of the EU referendum on the construction industry is likely to increase the focus on indirect aspects of construction activity too. The type of work sought, the transfer of risk and actively managing cost overheads to streamline businesses will all receive greater attention.

03 / Activity indicators

Initial estimates from the Office for National Statistics (ONS) construction output data record a modest fall of 1.1% in Q3 2016 compared with the previous quarter.

Although all new work increased by 0.3%, repair and maintenance declined by 3.6%, which contributed to the headline change. Over the past year, all work output increased marginally by 0.1% compared with Q3 2015.

The private housing sector contributed by far the best yearly growth figures, up 10.8% on the same period a year earlier.

Private commercial was the other sector to record positive yearly change on a three-month basis.

Public new work also posted 3.1% yearly growth. However, this sector has been the laggard for the past five years 鈥� slight changes now do not necessarily indicate a radical transformation in its fortunes.

ONS data for new orders confirms that the industry continued to expand in Q2 2016. New orders for construction were 7% higher than the same quarter a year earlier.

Again, there is variation by sector, with housing acting as the mainstay of activity.

Private commercial work contributed a sizeable change in new orders over the year at 28% but the sector鈥檚 2016 data has remained broadly flat.

General economic indicators and business sentiment mostly all record a bounce back from dips posted immediately after the Brexit vote. Consumer confidence also held up.

Investment intentions are softer though, which reflect more the medium to longer term nature of business investment strategies.

The flatlining of overall current construction output is likely to be compounded by present delayed decision-making. The effects of this will follow on into output figures in about 18 months鈥� time. Positive intervention from the government in the approaching Autumn Statement would inject some optimism and positivity for the outlook.

Action here would support the chancellor鈥檚 earlier statements about government intentions of 鈥渞esetting鈥� its fiscal policy and being ready to 鈥渂orrow and invest鈥�, all of which would benefit construction.

Contractors generally remain bullish about workload, which is reflected in no material changes to delivery and lead times. Some trade contractors state that further increases to workload and therefore lead times are expected over the near term but the number of these firms is reducing.

The fears of what Brexit may bring have been overtaken by subsequent events, and this has brought back some confidence in future work pipelines. Order books provide further insight to the activity picture: demolition works have become more scarce; piling jobs were beginning to run out at the end of this year, bringing an expected three- to six-month lull; concrete frame contractors have offered some lower prices recently, perhaps signalling more anxiety around future workload.

The RICS released its Q3 2016 market survey, which pointed to a modest increase in sentiment and workload growth. This reflects current workload and also expectations about future activity for surveyors.

Although themes of capacity constraints and skills shortages are common across the UK, the RICS survey highlights some nuancing to the construction story in UK regions.

Good present activity levels were also recorded in the CIPS Markit construction PMI, which improved to 52.6 from 52.3 in September.

In almost all the recent surveys, the residential sector bolsters the results. This may be no surprise given that mortgage approvals improved slightly in Q3 after a lull during the summer.

Record low mortgage rates are also helping to support the property market and give housebuilders the confidence to continue building at a fair pace.

B / Aecom tender price inflation - Yearly run rate and forecasts

04 / 黑洞社区 costs and prices

Construction prices continued to rise year-on-year at Q3 2016, according to Aecom鈥檚 tender price index, which uses Greater London as a base location. Price inflation of 7.1% was recorded in the year at Q3 2016. This robust figure maintains the well-above-average rates of tender price inflation posted for the past 18 months. Now, however, the yearly rate of change is beginning to slow as expected 鈥� which was always the baseline forecast before the recent falls in sterling.

Increasing uncertainty throughout the construction industry introduces further questions to the direction of market pricing. The anticipated slowdown in output will have a bearing on the changes to tender pricing into 2017 and 2018. While some lower pricing, particularly at trade level, may emerge in coming quarters, the reasons should be understood and not extrapolated as being applicable to all other scenarios.

Construction price inflation was driven predominantly by market fundamentals for a long time. Demand outstripped supply for construction services. Now, however, prices are seeing pressure from rising input costs, which are increasing at their fastest rate since 2011. Changes to sterling against its major currency pairs comprise a primary contributory factor, and these have been material in size. Weaker sterling increases the probability of imported inflation and therefore higher rates of domestic inflation. There is an argument that sterling was over-valued for some time prior to the EU referendum.

Higher labour wage awards for 2016 and 2017 will also feed through into additional pricing pressure for the supply chain. Additionally, materials price rises also picked up speed in Q3 2016, whether because of currency impacts, suppliers seeing a market opportunity or a combination of both.

If construction prices are forecast to slow or turn negative, are all the conditions in place for that outcome? Assuming output does not fall precipitously, obstacles remain to significant price falls. A smaller industry 鈥� number of firms and people 鈥� restricts price adjustments driven from the supply-side.

Construction is typically a low-margin industry and a reversal or negative trend in output prices will lead to commercial colds. Thin margins also limit the ability to easily absorb significant changes to input costs, which in this case are due to foreign exchange rate movements. On the flip side, demand-related factors to pricing are softening as UK construction output continues to flatline.

Rising input costs resulting from the devaluation of sterling and any recovery in oil prices also will not help construction firms鈥� operations. Potentially there remain too many upward cost pressures approaching to propel or sustain a material downward trend in prices. This assumes build specifications for a given project are not value engineered. If this is not the case, construction businesses will suffer compressed margins and financial discomfort. In a post-contract environment, margin compression from general inflationary pressures may also lead to project delivery issues.

Clearly, the exposure of any sector or project and its construction components to foreign exchange rate adjustments will be different, with changes to these corresponding percentages. But risk modelling offers some insight into the effect of foreign exchange changes on construction costs. So too, cost planning accounting for higher currency-related risks.

Elevated risks from exchange rate fluctuations and imported materials and components will change attitudes to offering and achieving cost certainty. Fixing lump sum contracts with contractors may see clients needing to pay for this benefit.

Should sterling volatility continue for an extended period, will price adjustment formulae return again? The direct effects of foreign exchange changes to costs and prices are resulting in heavily caveated bids and proposals from trade contractors and specialists. Although this is a hot theme, there is not a uniform pass through of price adjustments arising from the devaluation of sterling by all trade contractors and specialists yet.

Risk registers may benefit from items addressing the indirect effects of foreign exchange changes. Ultimately, suppliers seek to pass on higher costs and clients and their advisers challenge price increases.

Aecom鈥檚 baseline forecasts for tender price inflation are 2.2% from Q3 2016 to Q3 2017, and 2.3% from Q3 2017 to Q3 2018. Downside risks are more likely across both forecast periods. However, slim positive yearly change is the baseline forecast and there is a slightly higher possibility of negative annual price changes over the forecast periods than last time. Headline forecasts seek to make a picture; the fan charts tell more of the story by indicating the majority of possible outcomes and where they might be.

The price forecasts are based on key assumptions: construction output flatlines; Brexit-related events continue to confound pessimistic forecasts of an immediate and sustained downturn; order books do not collapse even though uncertainty is increasing; prevailing trends in government capital expenditure are not substantially changed; and despite material adjustments recently, sterling strengthens moderately.