Tender prices and workload are to continue to grow in the country as a whole, despite the consequences of the invasion of Iraq. But, as we point out, the outlook is not so good in the capital, where an ailing office market has caused a slump in work output.

Gordon Brown, in his April Budget, reasserted the government's commitment to fulfil the investment plans outlined in the Comprehensive Spending Review. As the economic climate continues to worsen, this commitment becomes ever more vital to the health of the construction industry.

The UK and global economies have been in declining health for many months, hastened by the war in Iraq. However, the British construction industry continues to buck the trend. Workload in most sectors, with the notable exception of the London office market, has continued to rise.

Davis Langdon & Everest's Tender Price Index, focusing on the London market, has recorded a small increase (0.5%) in the first quarter of 2003. This reverses the trend in previous quarter, when prices actually fell, and the net effect is to bring them back to where they were in the early autumn. Looked at year-on-year, the first quarter 2003 is 6.3% than the first quarter of 2002.
In the regions, the rising trend of prices was maintained throughout the year such that the increase in prices over the 12 months to the first quarter 2003 was generally higher than in London (see graph).

Output and orders

Construction companies of all sizes remain busy. Small and medium-sized enterprises in particular report continued growth. The PKF SME Index survey for first quarter 2003 reported smaller construction firms experiencing further solid growth compared with the previous quarter, and expanding staffing levels to cope with demand.

Figures released by the DTI showed that the total volume of construction output in 2002 rose 8% compared with the previous year, with new work (as opposed to repair and maintenance work) 11% higher. At constant prices and seasonally adjusted, the figures were on a rising trend in the second half of the year.

Volume figures for new orders obtained by contractors released by the DTI show no sign of tailing off. In the 12 months to February 2003, new orders at constant prices rose 13% compared with the previous 12 months. In the three months to February 2003, the volume of new orders was 27% higher than in the same period 12 months earlier, and 15% higher than in the previous three-month period. These dramatic statistics were boosted by the letting of the Ministry of Defence's £1bn single living accommodation modernisation project. Construction work, involving the refurbishment and replacement of single-living quarters throughout the UK, began in April and will continue for five years.

Other big contracts include the BBC's £250m refurbishment of Broadcasting Housing. And to show that the London office market is not completely dead, Land Securities let its £200m Esso Glen contract at Victoria in January, providing 50,000 m2 of office accommodation and other ancillary space. The private commercial figure for that month was further boosted by the £187m pre-let Bishops Square development at Spitalfields Market on the eastern edge of the City.

In spite of these awards – and the massive developments at Heathrow Terminal 5 and Wembley Stadium – London is generally experiencing a slowdown. This was demonstrated by the construction output statistics for the fourth quarter of 2002, which showed a 3.6% fall in output in London (at current prices), compared with a 3.1% increase for Great Britain as a whole. Scotland was the only other area to show a fall but, with a drop of just £3m in its quarterly total, this can be regarded as stable output and at a level nearly 9% higher (at current prices) than during the first half of the year.

All work output in London in the fourth quarter fell by £127m – the total figure was still 4.4% higher than the quarterly average in the first half of the year, but inflation will have more than swallowed up that difference. The DTI statistics were confirmed by the latest RICS Construction Survey, which covered the first quarter of 2003. This showed slower growth in London and the South-east. Countrywide, 16% more chartered surveyors reported a rise in workloads for the first quarter 2003 than a decline, with strength particularly evident in the Midlands, Eastern, Northern and South-western regions. PKF's SME Index concurred by showing the strongest increases in output for small and medium sized contractors in northern England and the South-west, although survey respondents in the Midlands reported a slight weakening in activity.

The national picture

North-east England has seen an expanding construction industry over the past 18 months. The value of all work output in 2002 was 22% higher than in 2001 (before inflation) compared with 12% for Great Britain as a whole. The value of new orders in the second half of last year was 65% higher than in the same period of 2001, enabling workload at the beginning of 2003 to achieve record-breaking high levels.

Every sector, except the traditionally important private industrial sector, experienced significant improvements in new orders last year. There was a sharp jumps in new orders for private housing in the second half of 2002 – 128% higher than in 2001, in response to demand that has seen new house prices in the region rise at the fastest rate in the country.

The Halifax reported that house prices in northern England rose 8% in the first quarter and 30% over the year, and predicts that this trend will continue throughout the year.

Private commercial activity in northern England has grown considerably in recent years; last year, it made up 35% of the value of all new work, up from 29% in 1999. Some landmark schemes have revamped the region's image and attracted investment and demand for commercial space and upmarket apartment blocks.

With increasing demand for building services, requests by contractors are struggling to meet demand, and requests for extended tendering periods are becoming commonplace. In common with many other regions, preliminaries costs have risen, partly in response to increased insurance premiums. And in response to skills shortages, the pay of traditional trades such as bricklayers and carpenters has risen by as much as 20-25% over the past year. At the same time, lead times for materials are generally lengthening.

The increase in construction output in Yorkshire and Humberside in 2002 was only slightly less than in north-east England, but new orders in the second half of the year were not as high as in the first half. Skilled trades are still in short supply but the larger, non-PFI, projects are being keenly contested as speculative office development has slowed. However, medium-term confidence is high as the European Union's Objective 1 funding programme kicks in. This includes a £1.8bn investment programme to restructure South Yorkshire's economy; all funds must be committed by the end of 2006 and spent by the end of 2008. The programme is forecast to generate an extra £912m to the area and a significant proportion of that sum is likely to be spent on the built environment, including redeveloping the town centres of Barnsley, Doncaster, Rotherham and Sheffield.

The two regions with the strongest growth in construction output in 2002 were the East Midlands and the South-west (up 25% and 24% respectively on 2001). The value of new orders was up 16% and 26% respectively, the South-west benefiting particularly from a boost in new housing work, infrastructure and public sector work. The increase in workload has put pressure on the local building industry: two-thirds of building firms in the region were working at full or near-full capacity for most of last year. Skill shortages have forced labour rates for traditional trades up 10-20% this past year.

Commercial activity accounted for only 22% of new orders in the South-west in 2002 compared with 31% nationally, providing a degree of insulation against any downturn in that sector.

As elsewhere, framework agreements and negotiated tendering arrangements are preferred by contractors to the competitive marketplace – when sufficient work availability permits.

The South-west has also benefited from the Objective 1 funding granted to Cornwall and the Isles of Scilly. The programme is reckoned to be worth about £800m to Cornwall when the European funding and Public–Private Match Funding are added.
Objective 2 funding, sourced from the European Regional Development Fund and the European Social Fund for areas with particular structural problems, is available up until 2006 to an area covering north Devon, Torridge, west Devon and South Hams as well as parts of Plymouth, Torbay, west Somerset and Bristol. These two sources of finance should help to bolster the region's construction industry for the next few years.

London

In contrast, the past six months has seen a tightening of the construction market in the Greater London area. Sizeable, straightforward schemes have attracted prices below previous expectations, as firms have become jittery over order books in the light of the fall of the London office market. The volume of new orders obtained by contractors in the fourth quarter last year gives cause for concern. DTI figures show that the value of orders for all new work the fourth quarter slumped 40% from the unusually high figure recorded in the third quarter, but were also 20% lower than the average of the previous three quarters.

Orders in the private commercial sector were 38% down on this period and housing orders, public and private, recorded a figure 30% lower. The market was saved, however, by a continuing growth in public sector orders, which in the second half of 2002 were worth 84% more than in the same period of 2001.

Labour rates have so far held up. Bricklayers still command rates of £130-150 per day, up from £120-140 per day a year ago. Carpenters rates follow closely behind.

Running against the general trend of rising prices, piling, curtain walling and M&E contractors are holding prices or cutting margins in an attempt to bolster forward order books. In the current climate, negotiations can be rewarding for building clients. The 0.5% increase in tender prices identified in the first quarter can be largely attributable to the congestion charge.

Forecast

Gordon Brown's optimistic view of economic growth in the UK over the next few years is supported by few commentators. The Treasury forecasts that GDP is expected to grow 2-2.5% this year but, anticipating reduced global uncertainty and stronger world recovery, it forecasts growth of 3-3.5% in both 2004 and 2005. The International Monetary Fund has forecast UK growth in 2004 of 2.5%, echoed by the 2.4% average forecast of independent forecasters compiled by the Treasury. The Bank of England is predicting just over 2%. Many believe that by 2004, spending plans will have to be reduced or taxes raised.

Business investment continues to fall, creating reduced demand for commercial property. Consumer spending at last shows signs of a slowdown, leading to a fall in demand for retail premises, starting in London. Most construction forecasters have already factored in reduced commercial sector investment. The Construction Products Association and Construction Forecasting and Research predict small increases in output in the private commercial sector in 2003 (1.3% and 2% respectively) but a fall in 2004 (-2.1% and -5%). Both, however, predict that output will continue to rise (3.7% and 4.5% respectively in 2003 and 0.6% and 2.5% in 2004), fuelled predominantly by health, education, infrastructure and social housing refurbishment.

Cost pressures are another factor. The underlying rate of inflation, now 3%, is at its highest level for almost five years. Input costs have been driven higher by oil prices which rose substantially ahead of the war in Iraq but have now fallen back to a mid range figure of $25 a barrel. For construction, labour costs are likely to remain the most significant input cost. The Construction Industry Joint Council recently agreed its latest three-year deal for building workers, increasing basic hourly rates 5% in June this year, 7% next year and 9.5% in 2005. However, site rates will be just as much influenced by market conditions as national labour rates which effectively represent a minimum level of earnings for directly employed labour.

As a result of the slowdown in commercial activity in London, tender prices are forecast to rise by 2-4% over the next 12 months, with a similar level of rise the following year. With less reliance on the commercial sector, workloads should continue to rise in most other regions, exerting stronger upward pressure on prices, which are likely to increase by a percentage point or two (see graph).

The ups and downs at a glance

Current trends
↑Volume of orders up 13% year on year, and 27% quarter on quarter
↑UK output in 2002 rose 8% on the previous year and 3.1% in 4Q02
↑Private housing orders in North-east increased 128% in second half of 2002 compared with the previous year
↓Value of all new work orders in London fell 40% in the fourth quarter, down on unusually high figure in 3Q02

Forecast
↑Tender prices to increase by 2-4% over the next year
↓The Construction Products Association and Construction Forecasting and Research predict that commercial output will increase 1.3% and 2% respectively in 2003 but to fall from –2.1% and –5% respectively in 2004