Despite a dip in orders at the end of last year, the sector is back on track with new workload spurred by generous infrastructure spending, reports Davis Langdon & Everest – but resourcing problems may undermine the sector's attempts to sustain current levels of output

Analysis of competitive tenders received in the second quarter of 2002 shows that building prices rose by 1.0%, compared with the first quarter. DL&E's Tender Price Index for the first quarter of 2002 has been firmed up at 398 – two points higher than the provisional figure reported in the May tender price forecast. The provisional index for the second quarter 2002 stands at 402, reflecting the steady increase of the last year: building prices have risen by 1-1.5% each quarter and tender prices are now 5% higher than this time last year.
Over this period, the Building Cost Index has risen by 4.6% and the Retail Prices Index by 1.2%. The annual increase of national building costs over the last six years has been overtaken by building tender prices. Since the second quarter of 1996, building costs have risen by 28%, but tender prices have gone up almost twice as much in that time to 53%, at an average of 7.3% a year. Retail prices over this period have risen by 15%.

<B>Construction output</b>
The price increases continue to be sustained by rising workload. The total volume of construction output last year was the highest for 50 years, and this trend carried into 2002. DTI statistics show that construction output in the first quarter of this year was worth over £19.6bn – 7.6% higher at constant prices than the previous year. This figure represents a workload volume nearly 5% higher than the record quarterly figure registered at the peak of the late 1980s building boom in the first quarter of 1990.
While repair and maintenance work has increased over the last two years, the workload bonanza has been principally down to new work. R&M last year was worth 5% more than in 1996, but the new-build market leapt by 18% in that period and continued to rise at an even faster pace in the first quarter of this year, across every sector except private industrial work, registering significantly higher figures than in 2001.
The most improved sector last year was infrastructure spending, which grew 8.6% – significantly more than expected. Expenditure fell away a little at the end of last year, but the figures have registered a volume of work in the first quarter not seen since the first quarter of 1993, when the Channel Tunnel was still under construction.
The public non-housing sector also performed better than expected. There was particularly strong growth in spending at the end of last year, which continued into the first quarter of this year – proof that government spending plans are being brought to fruition.
Finally, against expectations, the private commercial sector continues to return ever-increasing figures. Expenditure on privately funded health and education schemes is now allocated to this sector, so output in public non-housing was actually slightly lower last year than in 1993. However, taken together, the two sectors have still grown by 66% since then.
Most forecasts predict continued growth for construction output. This is confirmed by Construction Forecasting and Research and the Construction Products Association, both of which have recently published their summer 2002 forecasts of construction output up to 2004. Each has significantly lifted their forecast of output volumes for 2002 above those made at the turn of the year. And each predicts growth in total work output this year of 3.7-3.8% over 2001. This would be the highest growth in a single year since 1989. As well as seeing the highest construction workload of a lifetime, such additional demand could exacerbate existing resource problems – something that numerous commentators have underlined in the debate over whether the government's ambitious building plans for infrastructure, health and education can be met.
In a reversal of last year's forecasts, new work growth is now expected to outstrip growth in R&M work. New work is expected to rise by 4.1-4.6% this year but, excluding infrastructure, this mollifies to between 3.1 and 3.3% – still an increase in excess of £1bn worth of extra work.

<B>New orders</b>
Strong construction workload for 2002 seems well on course, judging by the latest data from the DTI on new orders obtained by contractors. The fourth quarter last year saw a dip in the number of orders taken, as projects were put on hold in the uncertainty following 11 September. As such, many projects planned to start at the end of the year were not begun until the first quarter of 2002. The total volume of new orders in the first quarter was the highest quarterly total since 1989. However, this boost was mainly due to infrastructure works, with large new orders for road building, railway works (after the lull in the fourth quarter last year, following the demise of Railtrack) and water expenditure.
The strong trend for new orders continued into April and May, generating a 13% headline growth in orders in the three months to May, compared to the same period a year earlier. Infrastructure orders fell back to below trend levels, but the overall high totals were maintained by increased orders in the public non-housing sector and private housing. Public non-housing orders in the first five months of this year are running 14% higher than last year, indicating that the government's public spending initiatives are taking off.

<B>Aggregates and concrete</b>
The principal driver behind this quarter's price rise has been the aggregates levy, in effect since 1 April. The anticipated tax revenue was estimated to be in the order of £385m. Overall, this equates to a 0.5% tax on all construction work, but the percentage will work out higher on new-build work and much higher on infrastructure works.
The tax is charged at £1.60 per tonne of aggregate, which has fed through into concrete prices, bitumen macadam, precast concrete goods and all types of fill. Concrete prices have generally risen about £5/m3 over the last 12 months and are now in the order of £85-90/m3 in London, £80-85/m3 in the South-east and £71-77/m3 in East Anglia.
Concrete rates have risen over the last two years in excess of general tender price inflation, particularly on large schemes where national subcontractors, who are in short supply, are needed. Over the last four years, concrete work has risen in price by approximately 35%. In contrast, steelwork rates remain extremely competitive and erected fabricated steelwork rates have changed barely at all over that period. However, the collapse of the UK's only rebar manufacturer ASW in mid-July has forced reinforcement prices up by £50-80 per tonne in the short term, as fabricators compete for reduced supply. A substantial wage rise in April for steel erectors and an expected increase in steel prices in September will also partially reverse the trend.
Following the lull at the end of last year, there are still some reports of spare capacity within some medium-sized contractors, but the majority seem to be working at full stretch. However, demolition tenders on larger schemes have recently become more competitive as resources have been released from completing major central London projects.

<B>Trends</b>
The latest RICS construction market survey confirms DTI data of a rebound in activity in the first quarter of 2002 and a further increase in workload in the second, pinpointing the private housing and private commercial sectors as the areas of highest growth. Further confirmation of industry buoyancy was provided by the Chartered Institute of Purchasing and Supply's Construction Index for June, which indicated expansion of activity for the 41st consecutive month, with housing the fastest-growing sector. Latest figures released by the Office of the Deputy Prime Minister show that the number of housing starts was 12% higher in the three months to May 2002 than in 2001, as housebuilders crank up production to benefit from spiralling house prices, despite their complaints of planning constraints. National House Building Council figures show that UK applications to build new houses increased by 26% this May compared to May last year, and have doubled in the South-east.
Demand from all sectors of the building industry means that labourers – bricklayers in particular – continue to be in short supply.
The industry has been looking for ways to circumvent this long-term problem, one example being Redrow's recent announcement of a joint venture with Corus to provide steel frames for its housing development programme. The sector is also showing a greater interest in modular construction.

<B>Forecast</b>
The UK's underlying rate of inflation last month fell to its lowest since records began 27 years ago. Most pundits expect consumer inflation to have reached 2.5% by this time next year, and it seems certain that construction price inflation will be considerably higher.
CFR and CPA's construction output forecasts of 3.7-3.8% growth this year are followed by predictions of further growth of 3.2-3.6% in 2003 and an additional 2.2-2.9% in 2004. On CPA's slightly more bullish expectation, the total volume of construction output in two years' time will be worth £8.5bn (at today's prices) more than work completed last year.
These figures were compiled before significant additional expenditure was allocated to public services in Gordon Brown's 2002 spending review, above what was announced in the comprehensive spending review and in the Budget. Spending on public services is set to rise by 5% a year after inflation, providing an additional £24bn in 2003/4, which rises to an extra £61bn in 2005/6, 64% of which is earmarked for health and education. Before this announcement, the go-ahead was given for a new tranche of 13 PFI hospitals, worth £2.4bn, intended to go to the market over the next six months as part of the promise to build 100 new hospitals by 2010.
Under the new review, transport spending is programmed to grow by a further 12% a year in real terms over the next three years, in order to boost delivery of the government's £180bn 10-year transport plan. The focus of this additional expenditure will be the rail and underground networks, including £1bn a year to fund the first three years of the London Tube renewal.
On top of that, an additional £1bn a year is set aside until 2005/6 for investment in affordable housing, reforming the planning system and bringing social housing up to an acceptable standard. The planning system reforms are aimed at facilitating more housebuilding in the South-east to meet spiralling demand.
Significant increases in public housing R&M work are also forecast for 2003/4, as housing association investment in transferred local authority stock begins to take root. This reverses the drop in expenditure over the last six years because the large-scale voluntary transfer programme of moving existing local authority stock into housing association ownership had fallen behind schedule.
At the beginning of April, Glasgow's 80,000 tenants voted in favour of transferring the city's entire stock to the new Glasgow Housing Association in what was the largest stock transfer to date. The association has promised to invest £1.9bn over the next decade into home improvements and modernisation. This massive investment could be a boon to Glasgow's smaller builders and tradesmen. However, a proposed stock transfer of 85,000 homes in Birmingham was rejected by tenants only days later, so the West Midlands builders' anticipated housing-improvement bonanza is now on hold. Other schemes in Yorkshire should provide a sustained period of repair and refurbishment work for local contractors in the North-east.
Even before the 2002 spending review, the CPA in June pronounced the "best construction prospects for 40 years" on the grounds of plans for public-sector investment at the time. But the recent turmoil in financial markets, prompted by the accountancy scandals in the US, have led commentators to question whether an economic downturn would prevent the government fulfilling its pledges without further politically difficult tax rises. At the same time, the falling stock markets may have a dampening effect on private sector investment.
With clear evidence of government investment promises being delivered, the outlook for construction continues to be bright. The only downside is its ability to deliver further output without fuelling inflation. Nevertheless, to achieve higher output, a rise in prices seems inevitable and tender prices are forecast to rise by 4–6% over the next year, and by 3.5–5% over the year to the second quarter 2004.

The ups and downs at a glance

Current trends
UP - Tender prices rose 5% over the past year, the lowest increase for six years
UP - Output was 7.6% higher than last year and 5% higher than 1990’s record figure
UP - The total volume of new orders in the first quarter was the highest since 1989
UP - The government’s spending initiatives pushed public non-housing building work up 14%
UP - The aggregates levy pushed building prices up 1% in the second quarter of 2002 Forecasts
UP - Output growth is predicted at 3.2-3.6% in 2003 and by an additional 2.2-2.9% in 2004
UP - Spending on public services is set to rise by £24bn in 2003/4 and £61bn in 2005/6
UP - Transport spending is programmed to grow 12% a year over the next three years
UP - Tender prices are forecast to rise by 4-6% over the next year