黑洞社区

01 / executive summary

Tender Price Index

The sharp fall in the last quarter of 2008 was not repeated at the beginning of 2009 but construction prices still moved downwards for the third consecutive quarter. The rate of decline is expected to accelerate again.

黑洞社区 Cost Index

Year-on-year, the 黑洞社区 Cost Index still shows an increase but it is now falling as the drop in materials prices since late last year feeds into it. The index may start to rise in the summer, depending on industry wage negotiations.

Retail Prices Index

The Retail Prices Index has now fallen into negative territory for the first time since 1960. The year-on-year change in March was 鈥�0.4%, mirroring inflation in the US. The index is expected to remain negative for at least the next year.

02 / trends and forecast

Analysis of tenders in the first quarter of 2009 shows that prices fell again, but only by 1%, less than some may have feared given the big drop in the final quarter of last year. Nevertheless, prices in Greater London are 8.5% lower than their peak in the second quarter of 2008.

Market conditions have continued to deteriorate and construction output and orders obtained by contractors have declined sharply. But although some materials prices continued to fall (notably steel and reinforcement), suppliers of a number of other materials have forced through increases that contractors have not always been able to absorb fully, including items such as cement, bricks and plasterboard.

It is expected that the rate of decline in prices will again accelerate through 2009 as work presently on site is completed and contractors compete for a substantially reduced pool of new work. The latest Construction Purchasing Managers鈥� Index from CIPS/Markit reported the 13th consecutive month of declining activity with firms shedding jobs at a record pace in March. There are few signs yet of the bottom of this trend as developers have put many projects on hold for at least a year and others go through protracted preconstruction and feasibility periods.

The market is characterised by an increasing number of contractors actively hunting for work opportunities, often in new sectors. Clients are seeking to use the single-stage competitive tendering route as they realise this is likely to secure the cheapest entry price (although not necessarily the cheapest exit price). Contractors are willing to enter single-stage design-and-build competitions with as many as six bidders, which they would not have done 12 months ago.

Some contractors are at least partially protected by framework agreements secured in better times, but there is increasing evidence that clients are beginning to procure large projects 鈥渙ut of framework鈥� in order to secure a higher level of price competition and improve 鈥渧alue for money鈥�.

The result is that profits and overheads have tumbled from 6-8% at the peak of the market to about 2-4%. In some cases bids based on zero margin are being submitted, with the expectation of recovering one at a later date. Preliminaries costs have typically fallen 11-13% on a lower base cost.

The prices of some types of work have fallen even further. Concrete packages, particularly in the beleaguered London market, have declined by as much as 25-30%, although the halving or more of reinforcement prices is the most significant factor here. There has been a massive fall in the price of office fit-outs since early 2008. And the fall in residential schemes has sometimes been as much as double the average.

Packages of work that have seen less deflation include curtain walling, which is affected by the fall in the pound鈥揺uro exchange rate. M&E costs are falling but, with a relatively high proportion of imported components, the decline has so far been less than for building work.

Available work this year will be significantly lower than last, even if the government gets banks to free up credit. Next year is even more uncertain: commercial activity is likely to continue to fall away (London office rents are expected to fall until 2011). The public sector is perhaps the area of greatest concern, with the spending programmes on education, health, housing and infrastructure increasingly in doubt as public sector debt mounts.

It seems inevitable that construction prices will continue to fall in 2009 as contractors鈥� workload shrinks. Prices are predicted to fall by 6-9% over the next 12 months. During the following year, a further contraction may well occur, although it is hoped that the bottom may be reached by the end of that period. It is possible that some parts of the world economy will have turned the corner well before that time, in which case commodity prices could be back on the increase, but it is forecast that construction prices in the UK will decline 3-5% over the year to the first quarter of 2011.

Falling prices may be seen by some clients as a golden opportunity but they should be aware of the dangers of accepting tenders where contractors have seemingly offered to do the job for free. Those contractors will surely look for every opportunity to maximise payments for variations and claims. Although some contractors are keen to agree accounts and maintain cash flow, there are already examples of opportunistic claims. Clients should ensure that some of the construction savings achieved through lower tender prices are retained in the contingency fund to deal with claims and other sources of disruption, such as insolvencies.

03 / hot topic: the exchange rate

The pound has suffered a broad sell-off since the latter half of 2007. In 2008 it lost 23% of its value against the euro and 27% against the dollar, as investors were spooked by the difficulties in the British economy: in particular, they worried about the easing of monetary policy, the deterioration in public finances and worries about the UK鈥檚 dependence on the financial sector and direct investment from abroad.

The pound lost about 11% between mid-2007 and mid-2008, stabilised for a few months and then fell away at the end of last year as UK interest rates dropped rapidly.

This decline has made imported goods more expensive. This is particularly important for construction, where about 25% of materials and components have been imported in recent years. Last year, 拢12.6bn of building materials and components were imported. The decline in overall prices that has occurred since the middle of last year would have been considerably greater had the pound remained stable. Over the 18 months between July 2007 and January 2009, the pound lost 27% of its value against the basket of currencies representing the UK鈥檚 trading partners. This effectively means that construction materials increased by nearly 7% because of the exchange rate.

This is part of the reason why European curtain walling and M&E services installations have not seen the sort of price reduction experienced elsewhere, even though workload has taken a similar hit.

Since the turn of the year, the pound has been more stable, perhaps because interest rates now have no further to fall, but its future direction remains uncertain. The forces of appreciation are:

• Deteriorating prospects in other economies 鈥� particularly highly leveraged eastern European members of the EU
• Investors鈥� perception of the safety of US markets, with a rapidly rising public debt and increase in the supply of government bonds
• The stabilisation of the global banking system should reduce risk aversion and reduce demand for the dollar as a safe haven
• Return of confidence in the UK economic model as it benefits from globalisation and the financial activities that go with it.

The forces of depreciation are:

• Further instability in the British banking sector
• Quantitative easing by the Bank of England
• The rapid build-up of public sector debt
• Appetite for the dollar, which could be whetted by the US government鈥檚 latest attempt to fix the US banking system.

Most commentators expect sterling to strengthen a little this year, with the average forecasting a rise of about 4% by the end of the year followed by a further 4% rise in 2010. This would help to bring construction prices down lower and further improve affordability.

04 / Tender prices vs building costs

Although tender prices show a decline of 8% over the past year, the 黑洞社区 Cost Index (BCI) shows a rise of 5.5% over the same period. The BCI is a notional measure of labour and materials costs only and excludes most items relating to market conditions such as overheads and profits (OHP) and preliminaries costs. The fall in prices in the fourth quarter last year was driven largely by a cut in OHP levels and a trimming of allowances for preliminaries .

The BCI allows for changes in the minimum cost to employ labour under the national wage agreement for operatives but does not take account of changes in bonus payments nor of the cost of self-employed labour or agency workers, which now comprise a significant proportion of the labour force.

The year-on-year percentage change in the BCI reflects the 6% increase in the minimum basic wage rate afforded to directly employed operatives last June. In contrast, official figures show that average construction earnings (including bonuses) in the year to February fell 0.5%. Rates for self-employed and agency workers fell by considerably more, particularly towards the end of last year, as more labour competed for less work.

The BCI is a measure of latent cost pressures and has proven itself to be a useful benchmark against which to judge the Tender Price Index (TPI): in boom times, the TPI will rise at a faster rate than the BCI and in hard times, the reverse will be true. It is the TPI that is the true reflection of prices paid by building clients in good times and bad.

The left-hand chart plots the differing trends since 1976 of the TPI and the BCI. It shows that in the early nineties, when tender prices fell by more than 30% between the end of 1989 and the beginning of 1993, the BCI continued to rise by more than 15%. This time it is different; the BCI fell in the first quarter of 2009 in response to materials prices, which have been in decline since the end of last year. Tender prices will probably fall throughout this year but the BCI may rise again if a new national wage agreement comes in this summer.

The right-hand chart plots the market conditions element, defined as the annual percentage change of the TPI less the annual percentage change of the BCI. It clearly shows the historical cycle and the boom conditions that existed in the early seventies, the end of that decade and the late eighties, and the slumps that followed each event. Although tender prices rose more than 6% a year between 2006 and 2008, the chart displays no significant spike, indicating that prices were largely cost driven. The past two quarters have seen the line fall sharply; it remains to be seen whether it will fall as far as it did in 1991 or 1975.

Materials

Materials prices have been falling since last November, driven by the collapse of steel prices. Fabricated structural steel prices fell 24% between September and February; reinforcement prices fell 29% from their peak last July. Both have since continued to decline owing to the collapse in worldwide demand. However, there have been numerous examples of manufacturers and suppliers introducing price increases since the beginning of the year, notably cement, aggregates, bricks and plasterboard. Some of these appear to have stuck.

Labour

A new wage agreement for building and civil engineering operatives, due to come into effect at the end of June, is under negotiation. It is possible that there could be a pay freeze (as put forward by the employers). There has only been one previous freeze, which occurred towards the end of the last construction recession in 1993. In the early part of it, retail inflation was still running at 8%, making it difficult to deny a wage award. With inflation currently below zero, that argument does not apply. However with electricians, plumbers and steel erectors all in receipt of awards of 4-6% this year, it still may be difficult for employers to deny any increase for builders.