Tender prices are rising less rapidly as new orders slow, while growth could fall below 1% this year, warn Peter Fordham and Máren Bauldauf of Davis Langdon
1) Executive summary
Tender price index
Building prices continued to rise in Greater London in the first quarter of 2008 but the rate of increase eased. A pipeline of workload and higher input costs are expected to drive prices up 4-7% in the next year. Some regions may show lower rates of inflation.
Building cost index
The building cost index rose by 4.3% over the year to the first quarter of 2008, the lowest figure for four years. Incoming materials price increases and a substantial summer wage award should push inflation above 5% by the second half of the year.
Retail prices index
The rate of increase in the retail prices index (RPI) has slipped below 4%. The government’s inflation measure, the consumer prices index, is up to 2.5%. Independent forecasters believe that the RPI should drop to 2.9% by the end of 2008.
2) Trends and forecast
Despite nine months of economic uncertainty, construction prices continued to rise in 2008. Tenders received indicate a 1% rise in the past three months, but that is slower than recent inflationary trends. The increase in prices in Greater London over the year to the first quarter of 2008 was 5.6%, but City offices suffered higher inflation.
Uncertainty about the extent of the UK economic crisis persists, and a number of surveys from across the sector indicate that the slowdown is getting worse.
The value of new-build construction output last year was 4.3% higher than in 2006. The commercial sector was the main driver for growth, rising 13%, with office-related construction up by a quarter. However, the flow of new orders started to ease in mid-2007: over the eight months to February 2008, the volume of new orders at constant prices was 5% lower than the previous eight months. Housing orders fell away sharply, and weakness in both commercial and industrial work is evident. Infrastructure work bucked the trend with a 19% increase in volume.
London has seen a much faster rate of growth over the past two years than elsewhere, as office development reached full swing. In 2006, the value of new orders in the capital leaped 47% (against 9% nationally), leading to output growth of 17.5% last year. New orders last year grew to just over £9bn, 50% of which was private commercial work, filling order books for 2008. However, the last quarter of 2007 saw the value of new orders fall to the lowest quarterly level since the fourth quarter of 2005, as private commercial orders fell away, showing how workload in 2009 may look somewhat different.
The private housing and commercial sectors are feeling the credit crunch most. Private housing output is now expected to decline more sharply this year and next than previously forecast. Last year’s orders for offices created a strong pipeline that should sustain near-term growth. However, new orders slowed dramatically at the end of last year, nationally down to an average £360m a month in the three months from December to February, compared with an average monthly spend of £600m during 2007 as a whole.
The retail and entertainment sectors rely on consumer confidence and spending, which are expected to be subdued in the next two years; activity in these sectors may stall.
Construction growth this year could be below the 1% forecast a few months ago. There are still few reports of projects being cancelled, but more instances of developers “reviewing” projects. Prelets or advance sales have become a requirement from funders. The industry will now rely more on the public sector to sustain growth. Most of the public capital expenditure is already committed and should go ahead, notably on schools, social housing and the Olympics.
While contractors in London remain buoyed by the pipeline of large projects, in some regions nervousness is creeping in. Contractors are no longer refusing to consider single-stage tenders. Already there are signs that one contractor may break ranks and submit a tender some way beneath the pack to secure workload.
In London there is no sign of contractors tightening margins, but elsewhere there are signs of preliminaries, profit and overheads beginning to soften. However, workload in Scotland, Wales, the North-west and the South-west is holding up and trading conditions appear unchanged.
Construction inflation remains difficult to call. Slower growth will ease price pressures but a sharp deterioration in prospects could mean lower tender price rises as tougher market conditions produce greater competition. Materials prices are likely to remain high, as demand from Asia underpins commodity prices and the weak pound makes imports more expensive. Overall, tender prices are still forecast to rise between 4% and 7% this year, with slower growth in 2009 moderating price rises to 3-6%.
3) Round-up of recent industry surveys
RICS housing market survey, March 2008
• The proportion of chartered surveyors reporting house price falls rather than rises increased to a historic level in March
• 78.5% more reported a fall than a rise, the lowest figure since the survey began in 1978
• The East Midlands was the worst performer, with 89% more reporting a fall than a rise
• Scotland was the only UK region with a net balance reporting a rise in prices
Chartered Institute of Purchasing & Supply/NTC Economics purchasing managers’ index – report on construction, April 2008
• Construction activity shrank in March for the first time in over six years
• New orders declined for the first time since October 1998
• Residential and commercial activity fell at the sharpest rate in the survey’s history
• Civil engineering activity rose robustly
RICS UK construction market survey, 1Q08
• Workload growth slowed sharply in the first quarter
• Just 1% more chartered surveyors reported a rise in workload than a fall, the weakest result since 1996
• The worst-hit sector was private housing, with workload growth negative for the first time since 1999
• The North was the weakest region, with workloads falling
• Scotland was the strongest
Construction Products Association/Ernst & Young construction activity barometer 1Q08
• The construction products industry experienced its slowest quarter for sales in two years
• The survey recorded a score of 51, just above the 50 “no change” mark and much lower than the 69 of the fourth quarter of 2007
• Heavyside sales declined, but lightside sales held up
• Some modest growth in sales is expected this quarter
4) Input costs
At the end of June, directly employed building operatives will see basic wage rates rise 6%, as part of an agreement set in May 2006. This considerably exceeds the 3.5% and 4.3% rises set for the previous two years.
Since 2004, labour shortages have been largely resolved by the influx of eastern European workers. This has kept a lid on wage rates, and labour cost inflation has not been much of an issue in the past three years.
There is evidence that some of these workers are returning to their countries of origin, as wages in eastern Europe have grown sharply. At the same time, the pound has weakened, making the prospect of working in the UK far less compelling. If there is a significant outflow of immigrant labour that is not replenished from elsewhere, labour cost inflation could return to the UK construction market.
Between 1996 and 2003, inflation in construction materials ran at about 1.5% per year. Since 2004, it has averaged over 6%, including a rise of 6.3% last year. This has been largely driven by rises in world commodity prices.
The beginning of 2008 has seen some significant price rises in materials such as sand, gravel, roadstone, cement and concrete.
Materials prices are expected to rise in 2008 well ahead of their 10-year average rise of 3.5%. In spite of fears for the world economy, commodity prices are soaring: steel has risen steeply so far in 2008 but is expected to peak in the summer; at the beginning of March, copper prices reached a new 12-month high. In contrast, timber prices seem to have stabilised.
Fabricated steel prices rose 9% last year, a figure likely to be exceeded in 2008. Suppliers have been hit by large rises in the price of raw materials – iron ore, coal and scrap. Corus introduced a rise of £60 per tonne on its list prices for structural steel sections and plate from 30 March 2008. A further rise is expected over the next three months in response to raw materials cost increases and global demand.
Reinforcement prices fell in the second half of last year but rose sharply at the beginning of 2008. Suppliers have implemented several price increases since the turn of the year, over £200 per tonne in total, following a surge in world scrap prices and continuing demand. However, prices are now expected to have peaked and are likely to start falling again through to the end of the year.
Tender rates in London were £900-1,000 per tonne during the second half of 2007. Rates have now reached £1,050-1,150 per tonne, but contractors should be able to anticipate lower purchase prices in the months ahead.
Non-ferrous metals also took off in 2004 as global demand increased. Aluminium prices doubled between 2004 and 2006, while copper trebled and zinc quadrupled. Most peaked in the second half of 2006, but aluminium and copper prices are now back close to record high prices. Zinc and nickel prices remained lower. Continuing global demand seems likely to ensure that metals prices remain high. Copper is forecast to surpass previous highs owing to energy shortages in Chile.
The price of oil has risen from $10 (£6) a barrel in 1999 to $115 (£58) today, doubling over the past 14 months. This has also driven vast increases in gas and electricity prices. Fuel costs have been responsible for increases in manufacturing costs that have driven many materials price rises in the past four years.
The US Energy Information Administration forecasts that the oil price will remain above $100 a barrel this year in spite of the global slowdown. Over the next decade it could rise much further, as peak production levels are reached but demand continues to rise. Russian oil production may have already peaked and Chinese oil imports are 25% higher than this time last year.
Inflation in materials prices will be exacerbated by the decline in the value of the pound. Against the euro, it recently dropped to its lowest ever level and has lost 15% of its value since last summer.
Imported building materials and components were worth £12.3bn last year, headed by electrical wiring, timber and air-conditioning equipment. The cost of construction materials now compared with nine months ago will be 3% greater, based on currency deflation alone, if the same materials continue to be imported.
Hot topic: The economy and the credit crunch, continued - Things can only get worse
Since February’s examination of the economy and the credit crunch, economic sentiment has worsened. Chancellor Alistair Darling recently described the world’s major economies as having to deal with “the biggest economic shock since the Great Depression”, echoing a statement from the International Monetary Fund (IMF) in its latest World Economic Outlook report.
The IMF forecast that the US economy would slip into a “mild recession” this year with growth of 0.5%. Economic growth in the UK is expected to rise by only 1.6% in each of the next two years. The chancellor, however, is sticking to his Budget forecast of growth of about 1.75-2.25% this year and 2.25-2.75% the next. Most independent forecasters are more pessimistic and the average forecast at the beginning of April was almost exactly in line with IMF forecasts.
The Bank of England’s credit conditions survey in the first quarter confirmed that corporate credit availability had reduced over the past three months; a further reduction in credit availability was predicted over the next three. Specifically, credit availability to the commercial property sector was reported to have fallen. At the same time, demand from this sector fell. Terms and conditions have also tightened – maximum credit lines have been reduced and loan covenants are stricter – with further tightening expected.
The gap between the London inter-bank lending rate and the base rate disappeared briefly in January but has since widened, illustrating the banks’ continued reluctance to lend to each other.
In March, the latest financial services survey from the CBI and Pricewaterhouse Coopers revealed that companies expected the credit squeeze
to get worse in the next six months. Capital investment plans were shown to be weak, with investment intentions for land and buildings the lowest since 1992.
Wall Street firms are estimated to have cut more than 34,000 jobs since the credit crunch began, and many believe a lot more will follow. The Centre for Economics and Business Research predicts 11,000 City job losses this year and a further 8,200 in 2009. If this happens, the purge will be greater than after the dotcom crash in 2001, with clear knock-on effects for occupiers’ property needs.
There has been a sharp increase in profit warnings, according to Ernst & Young – the highest number to occur in a first quarter since 2001. Retailers were particularly hard hit, despite anecdotal evidence that the consumer downturn is yet to bite.
In February, only 73,000 new mortgages were approved, the lowest figure since July 1995. With higher rates and smaller loan-to-value percentages available, new buyers will find it even harder to get on the property ladder, which will affect the whole housing market. The Council of Mortgage Lenders has warned that mortgage lending could halve this year.
Halifax reported that average house prices fell in March by 2.5%, the sharpest decline since January 1992, bringing the year-on-year rate of increase down to 1%. Housebuilders have reacted by restricting development.
Figures from the Investment Property Database show that returns from property fell by 3.4% over the past three months, with the retail, office and industrial sectors all performing similarly. Industrial returns over the past six months have fallen 10.5%, while office returns have slipped 12.3%. Against this background, the flow of new orders for commercial and industrial projects has dwindled in recent months.
The share prices of most property firms have continued to fall – the average reduction over the past year is close to 40%. However, they have not fared as badly as housebuilders, which have seen their company values typically fall by almost 60% over the past 12 months.
The pound continues to slide against the euro. It has fallen 16% over the past nine months and most commentators do not see any likelihood of a change in direction any time soon. The effect has been higher prices for imported goods, not least construction materials.
Manufacturing costs rose almost 3% in March and recorded an annual rise of 20.6%, the highest since records began in 1986. The fall in the value of the pound against most currencies has led to higher import costs, though more than half the annual increase was down to the price of oil, which continues to rise.