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Analysis of tenders received in the third quarter 2003 indicates that prices for competitively procured construction rose 1.5% from the second quarter. Davis Langdon & Everest鈥檚 Tender Price Index for the third quarter stands provisionally at 430, up from the second quarter figure of 424. The index measures price movement of construction in the Greater London area and shows that building prices have risen just 1.7% over the year as falling demand, particularly in the London office market, has had a dampening effect on inflationary trends. Between 3Q02 and 3Q03, national average tender prices have risen only 2.5%. This is in sharp contrast to the year before, when, in the year 3Q01 to 3Q02, tender prices rose 9% in London and 7% across the UK.
There was record growth in the industry last year, with total output increasing 8%. Output in 2003 has continued to grow from this high base but, in the first six months of 2003, at a more sustainable 2.7%. Construction output in Greater London, however, has slipped, with figures in the first six months of 2003 2% lower (in current price terms) than during 2002.

Procurement

There is a clear preference on the part of contractors for negotiation or two-stage tendering; if more than three are tendering in open competition, many contractors will now decline to bid. In competition, contractors still cannot expect profit margins of more than 1.5-2.5%; when projects are negotiated, profit levels of 4-5% are more likely to be achieved. Gleeson is the latest contractor to announce that it has withdrawn from the competitively bid construction market.

However, there are signs that two-stage tendering may have peaked, with clients reverting to design-and-build or even, in the case of medium and smaller-sized projects, to traditional procurement routes as they decide that the benefits of the two-stage route may be outweighed by the financial penalty.

PFI and prime contracting are accounting for a large proportion of the public sector work, which is now dominating the industry. This is in the hands of the major contractors, resulting in more turnover going to fewer contractors. As a result, in some areas, small to medium-sized contractors are finding it hard to increase or even maintain turnover, enabling prices to remain competitive.

Labour costs

The price increase in the third quarter is largely the result of a rise in labour costs. 黑洞社区 operatives whose pay is tied in to the Construction Industry Joint Council鈥檚 Working Rule Agreement received a 5.1% increase in basic hourly rates from 30 June. Large numbers of operatives are not tied in to formal wage structures, whether self-employed or agency workers, and increases in their pay are purely market led. Labour shortages continue to be a headache for the industry and are often cited as the reason for holding back investment.

Construction output trends

Construction output has continued to grow through 2003. In the first six months, DTI statistics show that the total volume of output in Great Britain was 2.7% higher than in 2002.

However, this growth has been very dependent on two sectors, housing (both public and private) and public non-housing. Private housing output in the first half of 2003 was 12% higher than last year. Public housing grew 10% after 16% growth in 2002. The public non-housing sector has increased 13% in the first half of this year after rising a massive 25.5% in 2002, as the government鈥檚 spending plans on health and education continue to bear fruit. However, the volume of output in the private commercial sector declined 3% in the first half of 2003, representing its first fall in 10 years. Privately funded health and education schemes are allocated to this sector so the decline in office construction in particular has been much more dramatic.

New orders

Construction activity this year is still benefiting from the large increase in the volume of new orders obtained by contractors in 2002. However new orders in the first eight months of 2003 are now some 5% lower than last year. The monthly total for August was the lowest monthly figure since December 2000. New orders for housing are running ahead of last year but every other sector is showing a decrease. Even new orders in the public non-housing sector are running beneath last year鈥檚 level. Orders in the private commercial sector are running 9% lower than last year and, in August, contractors obtained orders worth just 拢644m throughout Great Britain, which again represents the lowest monthly figure for almost three years.

The national picture

Strongest construction growth in the first half of 2003 was experienced in the North-west and Wales, with the value of output running 11% higher at current prices than during 2002. Some retrenchment has occurred in London and the West Midlands, where output in both regions has declined by 2% in the first half of 2003.

The North-west is forecast to have the strongest growth in construction output of any UK region over the next two years. Construction output grew 16% in 2002 (at current prices) and the value of new orders obtained by contractors for new work in the first half of 2003 was some 26% higher again. This has generated construction price inflation higher than in most other regions of the UK Most small and medium-sized contractors in the region appear to have fairly full order books.

However, in the burgeoning education sector, larger contractors are eager to bid for projects as low as 拢1m in value in order to better position themselves in readiness for the spending bonanza anticipated through the Schools for the Future initiative.
Liverpool鈥檚 status as European Capital of Culture for 2008 has boosted optimism and jump-started regeneration and revitalisation projects. Paradise Street, a proposed 拢400m shopping, leisure and housing mixed use development on a 17 ha site, is expected to be the biggest regeneration project in Europe.

Manchester and Salford will shortly undergo one of the biggest housing regeneration projects in Britain for 30 years, the first of nine government pathfinder projects under a 拢500m housing market renewal strategy for the North of England (see pages 48-50).

Increased government spending on health and education projects, a relatively buoyant commercial market, a number of large-scale infrastructure projects and increased private housebuilding should ensure a healthy market in the region, both this year and next.

Construction activity in Wales was stagnant or in decline between 1998 and 2001, unlike England and Scotland, where strong economic growth boosted construction activity. Last year saw a 17% surge in construction output in Wales, up from 拢2.5bn to 拢2.9bn in value, led largely by public sector non-housing and repair and maintenance work. The trend has continued into 2003 with further public sector investment and private sector housebuilders sharply increasing production. New orders in the first half of 2003 are 10% higher than last year, giving contractors security of workload over the next year.

Most of the investment is in South Wales. The 拢48m Welsh assembly building has begun on site at Cardiff Bay and revitalisation is epitomised by the 拢104m Wales Millennium Centre. Due to open in November 2004, it is currently midway through construction. To help fund the building, members of the public can 鈥渁dopt a slate鈥�.

London

In London, the first half of 2003 has seen a decline in construction activity for the first time since 1993, led almost entirely by the slump in private commercial work. This trend is set to continue for the immediate future as contractors鈥� new orders for private commercial work in the first half of the year were 26% lower than in 2002.

As a result, tenders going to the market for demolition work and cladding and curtain walling are attracting keen rates. The larger curtain walling contractors are European and, until this year, the buoyant UK market, and London in particular, was a valuable outlet at a time when most European construction markets were in the doldrums.

However, the London construction industry is far from in despair: total work output slipped slightly in the first half of 2003 but new orders overall, in spite of the collapse of commercial work, have risen by 5% in the first half, driven mainly by new infrastructure work but also by housing activity.

The capital鈥檚 industry remains sufficiently buoyant for the government recently to have delayed for up to a year two major PFI hospitals in London, worth 拢1.1bn, because of fears that contractors cannot cope with all the work.

The new Wembley Stadium, Heathrow Terminal 5 development and the recent 拢575m contract to rebuild the White City shopping centre in West London underpin the capital鈥檚 workload.

黑洞社区 and engineering services costs

The 黑洞社区 Cost Index rose 4.5% over the year to the third quarter 2003 and is projected to increase 5.4% and 6.2% over the next two years. DTI figures show that construction materials rose 2.1% over the year to August 2003, including increases of 8% for ready mixed concrete and 5% for bituminous products. The year ahead could see a slightly higher rate of increase as oil prices stay at post-Iraqi war highs and base metal prices have risen to their highest level for many years.

For the last six years labour has been the biggest cost driver of the cost index. A three-year wage agreement for building operatives began at the end of June, lifting basic wage rates 5.1% initially. In June 2004 rates will rise 7.2% and in June 2005 a further 9.5%. These rates apply to directly employed operatives tied in to the Working Rule Agreement of the Construction Industry Joint Council. In practice, because of bonuses and incentive payments, total take-home pay may not increase as much as these figures (unless market conditions dictate otherwise).

The Mechanical Cost Index and the Electrical Cost Index increased 9% and 4.9% respectively over the year to the third quarter 2003, both figures again dominated by labour cost increases. In October last year, heating and ventilating operatives received an increase in basic wage rates of 16.2%, including some consolidation of travelling allowances and overtime arrangements. A wage deal has just been agreed, lifting wage rates 3.5% from 3 November.

Electricians are midway through a three-year wage agreement that started in January 2002. Operatives with transport received wage rises of 5% outside of London and 6% in London in January this year. In January 2004, the national rates will increase 7.2% and by 8.2% in London.

Tender price forecast

In its summer 2003 forecast, the Construction Products Association anticipated that construction output this year would be 1.9% higher than last year and would be followed by further small increases of 1% and 1.1% in 2004 and 2005, with expansion continuing to come from the public sector to offset contraction in the private. Although public sector construction has increased significantly over the past two years, the CPA has been critical of the government in failing to meet many of its own targets.
Construction Forecasting and Research in its summer 2003 forecasts was generally more optimistic than CPA throughout, predicting 4.7% growth this year, followed by further increases of 2.2% and 2.9%. With the benefit of more recent data, these forecast growth figures now look over-optimistic.

However, there are promising signs. In the third quarter of 2003, Great Britain鈥檚 GDP grew by 0.6%, a similar rate of growth to the second quarter, meaning that Gordon Brown鈥檚 projected growth rate for the year is likely to be achieved. A global economic recovery is now reckoned to be under way, with the US economy at last showing robust growth.

With the probable exceptions of the northern regions, market conditions over the next two years seem unlikely to drive construction prices to the inflationary levels experienced between 2000 and 2002. Nevertheless there will be inflationary influences in the form of underlying labour and material cost increases. In London, tender prices are forecast to rise between 2.5% and 4% over the next year and 2.5-4.5% over the year to 3Q05. 黑洞社区 clients should be aware that the London construction market may currently be flat without real cost inflation but, should developers all return to the market at the same time with projects currently in the pipeline, significant price rises could quickly ensue.