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01 / Executive summary

Tender Price Index
The decline in tender prices accelerated in the third quarter with a 5% drop over the second quarter, leaving prices 15% lower than a year ago.

ºÚ¶´ÉçÇø Cost Index
The ºÚ¶´ÉçÇø Cost Index shows a 1.3% drop over the last year, the first time the index has recorded a year-on-year fall since it began 40 years ago.

Retail Prices Index
This has been rising since April but shows a fall of 1.4% over the year. The consumer prices index is still positive, but at 1.1% for the year to September it is at its lowest for five years. Both indices will climb steeply at the beginning of next year with the end of the VAT cut.

A / Price indices

See attached graphic below.

02 / Trends and forecast

The downward movement of building prices accelerated in the third quarter. There was a new level of price cutting in the summer, and tenders received since June have had a sharper edge. Prices in the second quarter fell 3% compared with the first, and provisional results from tenders received in the third quarter show prices 5% lower again. Average prices received for work between July and September were 15% lower than the year before and 16% below the peak in the second quarter of last year.

In some circumstances clients have been able to secure greater reductions. Tenders for steelwork are 40% lower than a year ago, in large part due to the collapse of world steel prices, but also because steelwork contractors find themselves with huge holes in their order books, and many have had to mothball fabrication plants. Reinforcement prices have suffered a similar collapse over the past year and, with concrete rates down 25%, frames and groundworks tenders are even more competitively priced than the general market.

Allowances for preliminaries continue to fall as contractors’ staff numbers are trimmed and salaries cut. Overheads and profit remain at 2-4%, although in the highly competitive fit-out market, they are typically below 1%, with preliminaries allowances no higher than 5%.

Clients are taking the opportunity to retender projects that may have been postponed or delayed using a single-stage competitive approach to obtain the lowest price.

Can prices drop much lower? As new orders continue to fall, competition for what work there is becomes fiercer throughout the supply chain. The volume of new orders in the first quarter was 40% lower than those received in 2007, a reduction of £5bn in one quarter. However, the volume of orders in the second quarter rose 25%, largely as a result of schools and college work, but also because of a pick up in infrastructure work as we entered the new financial year. This improved level was maintained into July and August and included a notable increase in social housing activity as promised government funding came through.

New work output for the whole of 2009 is expected to be 14% down on last year, a loss of around £10bn to the industry. Activity in 2010 is expected to be similar but with infrastructure and some growth in housing offsetting further decline in private commercial work.

GDP surprised most by falling further in the third quarter but other news items hold out more hope. House prices are rising, business surveys show improvements in confidence, retail sales are up, unemployment figures have not grown as quickly as feared, the FTSE 100 has jumped 50% since March and commercial property has returned to positive capital growth.

But private sector construction is not expected to make a swift comeback. Surveys reveal that investment intentions remain weak. Occupancy of warehouses, office space and retail units is expected to continue falling in the short term, although DTZ forecasts an 8% increase in office rents in the City of London next year.

Although there is some evidence that credit availability generally is improving, banks remain reluctant to increase their exposure to commercial property or construction and funding for development projects is expected to remain hard to come by unless a pre-let has been signed.

Next year will be difficult for all in the industry but there are signs of hibernating developers and estate owners beginning to stir, realising that construction prices are approaching their low point and that demand for their product may be in place by the time development plans are completed. Residential projects will probably resume and infrastructure work should maintain its upward trend. But many contractors will find a lack of new work on their books to replace projects coming to an end this year, which will increase competitiveness throughout 2010.

As the year progresses, the industry, sadly, is likely to experience increased insolvencies and consolidation. At the same time, as the global economy recovers, price pressures will return to commodities. These factors are likely to place a floor under construction prices by the end of 2010 by which time they may have fallen by as much as 25% since their 2008 peak.

Prices are expected to continue falling in the next 12 months as order books become thinner and more clients return to competitive tendering. Prices are forecast to decline 5-8% over the year but are then likely to stabilise. The challenge between declining public sector spending and rising private sector activity will determine whether a double dip recession can be avoided in 2011/12.

03 / Hot topic: Whither the public sector?

When the Labour government came to power in 1997, it vowed to maintain the spending plans established by the outgoing Conservative administration.

For the first five years of power, new-build public sector construction accounted for about a quarter of the industry’s output. From 2002 to 2007 increased government expenditure on health and education propelled the public sector’s proportion of construction spending (including PPP spending) to 31%.

Last year, as the private sector retreated, this proportion increased to 35% and, in the first half of 2009, with private sector activity sharply down, public work accounted for 41% of new-build output. In total, public sector construction spending totalled about £42bn last year, of which some 55% was on new-build construction.

With a huge deficit in the public accounts, it seems certain that there will be significant cutbacks in government spending whichever party wins next year’s election. A recent Pricewaterhouse Coopers report estimates that, without higher taxes, public spending will have to be cut by 17% in the three years to 2013-14. Public sector construction, which has grown 70% in real terms since Labour came to power, must be at risk. Some of Labour’s intentions may become clearer in November’s pre-Budget report.

New orders in the public sector have mostly held up in 2009. Public housing orders this year are actually 11% higher in cash terms compared with last year (private housing, by contrast, has fallen 23%). Education orders are 13% up, but health building orders are 15% down.

The star is infrastructure, where new orders on the public sector side are running 100% higher than last year.

But for how long will these numbers be maintained? Health spending last year was particularly strong and orders are now expected to tail off. Education spending last year was also at a record high and the programmes of primary and secondary school replacement and refurbishment in place suggest that last year’s figure can be improved upon for at least the next three years. However, there must now be a risk to those programmes and it is to be hoped that this year’s Learning and Skills Council’s funding fiasco for further education colleges, when more than 100 projects were shelved, is not repeated in other areas.

In spite of fears of what may happen to government spending immediately after the next election, 2009 and 2010 are expected to show strong growth in the infrastructure and public non-housing sectors over what was already a resoundingly strong 2008.

Experian and the Construction Products Association have broadly similar views as to what will happen to public non-housing work over the next three years, but differ somewhat on infrastructure. Experian is more bullish, assuming that Crossrail goes ahead fully as planned. Both major political parties have pledged their support for the scheme, but it would not be a surprise if the programme slips. The CPA has factored in falls in roads output and expects to see cuts in spending after 2010.

Both organisations forecast strong growth for public non-housing work this year as the schools programme continues to feed through and the sector is boosted by activity on the Olympics 2012 site. Both of these programmes are expected to maintain their momentum through 2010. Work will begin to tail off in 2011 but will still maintain historically high levels of activity. In 2012 and 2013 the CPA predicts falls in workload of between 10% and 15%. However, the volume of work would still be at a higher level than in 2007 and the sector could be worth about £10bn.

With the probability of public sector work tailing off in 2011, it must be hoped that private sector activity will fill the void. At the moment total workload next year is expected to be about the same as this year’s sharply lower figure with a small improvement in 2011, founded on housing and infrastructure.

If public non-housing work falls away more quickly, without private activity to take its place, contractors could find the world a still tougher place in two years’ time.

04 / ºÚ¶´ÉçÇø cost index

In contrast to the Tender Price Index, the decline in the ºÚ¶´ÉçÇø Cost Index halted in the third quarter and even recorded a tiny (0.1%) rise. However, over the year, the index dropped 1.3%, the first year-on-year decline ever recorded. Although materials prices have fallen over this period, the major influence has been the freeze in labour rates: only the second time in 40 years that this has happened.

Labour

ºÚ¶´ÉçÇø and civil engineering operatives expected a wage increase at the end of June, but pay levels have been frozen. There was hope of resuming negotiations in the autumn, but there seems little likelihood of any increase in rates this year. Asphalt workers’ wage rates were also frozen in June. In Northern Ireland, a 6% pay rise that was to have come into effect in August has been postponed until next January.

Meanwhile heating and ventilating operatives will have to wait until October 2010, when their rates will rise 2%.

Plumbers’ rates rose 5% in January and will not increase in 2010, while rates in 2011 will be limited to changes in the Retail Prices Index.

Engineering construction workers may be more fortunate: employers and unions agreed a 2% wage increase from 1 January 2010 but employees rejected the offer in a ballot and the deal is now in limbo.

Materials

Figures from the Office for National Statistics show that materials prices rose in July and August after eight continuous months of decline. Prices fell by more than 5% between October 2008 and June 2009 before recovering by 1% over the following two months. The recovery has been led by the cost of imported materials, which rose by 2.5% between July and September as the value of the pound began to slip again.

ONS figures show that the price of fabricated structural steel fell by 34% over the year to August 2009. But world steel prices have been moving cautiously upwards since June, rising 14% in the EU between July and September. The increase has been stronger in flat products, but long products such as structural members and rebar are beginning to follow suit. Corus announced a price increase of £25 a tonne on structural sections and £30 a tonne on plates from 4 October. Hollow sections increased by a similar amount. These represent increases of only about 2% on list prices but further rises of £50-60 a tonne have been mooted for 2010.

However, some mothballed capacity has been brought back on line in anticipation of improved demand and the increased production has already led to price increases being reversed as higher demand has failed to materialise.

Electrical materials prices have been rising since the spring. This is largely in response to the surge in copper (and other metals) prices since the turn of the year. Copper prices more than doubled between January and September, but have stabilised or even slipped a little since then. Nickel prices have followed suit. Aluminium prices peaked in August after rising 60% from the end of February. Zinc prices have climbed 85% since then and are still moving upwards.

Increases in metal prices have been attributed to government stimulus packages around the world and restocking of run-down inventories. Over the next year, analysts predict increases of 20% for copper and 10% for aluminium.

Sterling

After the pound dropped 30% against the euro to €1.02 in December 2008, a recovery was staged in the first six months of this year.

The pound was up to €1.18 in June and most analysts anticipated further recovery as the year progressed. But it slipped back to €1.07 in mid-October with pessimists anticipating a figure close to parity before long.

This is significant as 25% of construction products and components are typically imported, the majority from the EU, though this percentage can rise as high as 40% for European-sourced curtain walled highly serviced offices. Further falls in the value of the pound will reignite inflationary pressures for such buildings.