With a war looming, shares prices plummeting and the office market in London freezing, it's all but impossible to know what will happen next. But building tender prices and workload are still likely to continue their steady rise
A new year's eve editorial in The Times sympathised with the plight of economic forecasters attempting to predict the size and direction of financial trends in 2003. The pattern of movement of building tender prices looks equally hard to foresee. Possible war with Iraq, tumbling stock markets and world economic uncertainty are, as you may have suspected, the factors underpinning the problem of prediction.
Tender prices in the fourth quarter 2002 in Greater London experienced a drop of just under 1% after 13 consecutive quarterly rises, whereas prices in most other regions rose. Over the 12 months, however, Davis Langdon & Everest's tender price index shows a rise of about 7%, with little variation between regions (click here for the table).
Output and orders
DTI statistics for output show that the national volume of work over the year to the third quarter of 2002 was 8% higher than the previous year. New work (excluding repair and maintenance) was 10% higher in real terms.
Contractors continued to post strong order books throughout 2002. For the 11 months to November 2002, the volume of orders was 5% higher than during the previous year. In fact, the trend rose during 2002: the volume of orders received between June and November, at constant prices and seasonally adjusted, was 4% higher than it was in the previous six months. New orders last year grew in every sector except industrial.
The strongest improvement came in public sector orders – 18% higher in the first 11 months of 2002 compared with the same period of 2001 – and the latest months' figures are still rising. The volume of public orders for schools and colleges fell but this was more than cancelled out by increases in orders for universities, healthcare facilities, offices and privately funded schools.
London commercial market
In London, office development activity has virtually come to a halt. Most regional centres are still short of office space, and development continues, but there are fears of a ripple effect from the centre. On site, work continues to keep contractors busy but, with development at a standstill, it is the workload of six to nine months' time that concerns contractors and subcontractors. Early trades, such as demolition and piling, are anxious for any work that arises. Curtain walling, which on most large City office developments using bespoke systems has a long gestation, is now attracting much more competitive prices than nine months ago. M&E contractors, although not at the beginning of the construction programme, are anxiously looking at their forward order books.
The DTI figures show that the value of construction output in the first three quarters of 2002 in London was 16% higher, at current prices, than in the same period of 2001, greater than the 12% increase in the national figures. But in London private commercial work accounted for 31% of total work, encompassing new work and repair and maintenance (and half of new work only), compared with only 18% of total work nationally (and one-third of new work). Nationally, offices account for 41% by value of the private commercial sector, and probably more in London – hence the sharp effect on the construction scene in London of a sudden drop-off in office building. About 51% of contractors' new orders in London in the first three quarters of 2002 related to private commercial work, with the same percentage holding true even in the third quarter. The fourth quarter data, when it becomes available, is likely to show a sharp fall.
The national picture
The latest available market report, The Chartered Institute of Purchasing and Supply's Construction Purchasing Managers' Index for January, found that robust construction growth was sustained in January, though at a slightly lower rate of expansion. Growth was still reported in all sectors, including commercial work. Respondents to the survey maintained a buoyant optimism that activity levels would rise over the next year, with confidence boosted by planned expansions and an anticipated strengthening of demand.
Planned expansion, and to a lesser extent public investment, look more and more fragile as the days go by. The performance of the UK stock market in January, including the record run of 11 consecutive daily falls, has not assisted business confidence. The FTSE100 fell to half of its level at the end of 1999. At the end of January, 10% had been knocked off the value of companies since the start of the year. As a result of this stock market collapse, not only are pension funds running out of money but companies have neither the confidence nor the funds to expand. Similarly the government's budget deficit grows wider. The Strategic Rail Authority has warned that some of the rail spending plans may have to be postponed or abandoned.
Construction Forecasting and Research, in its winter 2002/3 outlook, released at the beginning of January, substantially increased its expected output for 2002 following stronger than expected performance in the latter half of the year. But for 2003 it also marked up its output forecast, predicting further growth of 4.5%, led primarily by public non-housing work (up 13%) and infrastructure (up 12%). The forecast is based on the assumption that the government's capital expenditure programmes is maintained at promised levels.
Construction forecasts released by the Construction Products Association, also in January, are slightly less bullish, but still forecast an increase in total workload of 3.7%. Output is forecast to continue to grow in 2004 but at 0.6%. The CPA warns that slower progress in realising the government's spending plans and a greater deterioration in business confidence and consumer expenditure in response to a weakening world economy could threaten its forecast. It estimates that a global slump could cut construction growth this year to 2.5% and cause a drop in output in 2004.
The growth forecasts for 2003 represent an additional £3.5bn worth of work (at today's prices) for the industry compared with last year. Both forecasters include small increases in private commercial output this year (up 1.3 to 2.0%). This is based on the assumption that increased spending in the entertainment sector and PFI education and health work more than compensates for the fall in office activity.
Even if the private commercial sector performs worse than forecasters expected – for example, there may be sharper falls in investment in the retail and entertainment sectors as well as offices – there would have to be a fall of about 25% in output to wipe out the total anticipated growth in 2003.
Just as big a danger to the growth forecasts is the continuation of spending by the government. Government voices maintain that there is no prospect of cutting back on the promised capital investment in health, education and infrastructure. As noted earlier, construction output and new orders figures have been boosted by health and education work but an Office of National Statistics report on public sector finances reveals that of the £28bn gross capital expenditure promised this year, only half had been committed in the first nine months. Chancellor Gordon Brown is also under pressure from the European Commission, which has condemned the government's investment plans because they are likely to push public sector borrowing above the eurozone limit of 3% of GDP.
Tender price forecast
If the forecasters' growth predictions are correct, there will continue to be pressure on prices nationally, although the fear of a reduction in work in London has brought price rises to a halt in the capital.
Some cost increases are in the pipeline. National Insurance contributions will rise 1% in April: this will result in a construction price increase of at least 0.5%. Then there is the hike in insurance premiums. Main contract and trade package preliminaries have increased over the past few months as contractors have included insurance costs in them, and this trend will continue unless the government and the insurance industry come up with a swift solution. In London the congestion charge comes into effect in February and it has been estimated that this will add at least 0.5% to construction costs in the capital. On the labour side there are likely to be substantial wage demands to be met (see 'Percentage change to tender prices' table).
In Greater London there will be underlying cost increases, but it seems likely that there will a reduction in total workload in the capital, despite the commencement of Heathrow's Terminal 5 development. With the uncertainties regarding the global economy, war and the availability of investment funds in both the private and public sectors, tender prices in Greater London over the 12 months are expected to rise 2% to 4%; in most other regions, the fall-off in private commercial work is likely to be less marked, and inflation is expected to be a point or so higher than in the capital. The following year output is expected to level off, but it will still be at unprecedentedly high levels: in Greater London price rises are expected to continue at the same level of 2% to 4% and in the regions may ease back to a similar level of increase.
Building Cost Index
The Building Cost Index rose 7.4% in the year to the fourth quarter 2002, driven by a 9.5% rise in labour costs in mid year. Basic wage rates for craftsmen and general operatives under the main union agreement rose 9% at the end of June as the third and final part of an agreement made in June 2000. From 2 December, plumbers' basic wages increase 13%, partly offset by reduced overtime and frozen travelling allowances.
Negotiations have begun on a pay deal for building operatives to replace the current arrangement, which runs out in June. The unions' opening salvo is a demand for £12 an hour, which is a 60% increase in the basic rate. Nobody expects this to be the rate on the finishing line, but negotiators on both sides will be aware of the deal struck on Terminal 5, where craftsmen will receive £13.50 an hour, as well as generous performance-related bonuses.
Construction materials costs rose by 4.2% over the past 12 months, the highest rate of increase for many years. It was driven mainly by the effects of the Aggregates Tax. Materials price increases should ease this year as these effects pass through. Underlying factory gate inflation is driven solely by higher oil prices.
The Building Cost Index is forecast to rise 3.2% over the year to the fourth quarter 2003.
M&E cost indices
The Mechanical Cost Index rose 7.5% over the year to the fourth quarter 2002 and the Electrical Cost Index rose 5.3% over the same period. The MCI was mostly influenced by labour costs; the third and final part of a three-year wage deal for heating and ventilating operatives came into effect in October last year. This increased the basic hourly wage for all grades by 16.2%, partly offset by reductions in travelling allowances.
Electricians received a 6% increase in London and 5% in the rest of the country in January 2002. This was the first part of a three-year deal; the second part came into effect on 6 January this year, lifting rates a further 6% and 5% respectively. The wage deal struck on Terminal 5 by Laing O'Rourke led to fresh demands by electricians' union Amicus, which has now agreed a major projects premium of £3 an hour.
Unaffected by the aggregates tax, mechanical engineering materials over the past 12 months have risen 1.4% and electrical engineering materials by 0.2%.
The MCI is expected to rise 2.9% and the ECI 5.7% over the next 12 months.
Republic of Ireland
The Irish industry enjoyed continuous growth from 1994 to 2001. However, that came to a sudden halt in 2002, when construction output declined 2%. Housing continued to grow, as did civil engineering. Private investment in general construction plunged.
The projections for 2003 are even less encouraging. General construction will continue to decline, as will civil engineering. Housing may also show a decline. The net effect may be an 8% reduction in new construction this year.
The Irish construction industry has been dealt two body blows by the recent Budget at a time when the industry is in decline: a 1% increase in the VAT rate applicable to construction and the removal of tax breaks for new construction.
After a number of years of rampant inflation the cost of building subsided in 2002. The input costs of labour and materials rose 4%. However, tender levels declined 2% in the year. A similar trend is expected in 2003. Tenders will continue to reduce as contractors fight for the declining number of new projects. Average tender levels in 2003 are expected to decrease by 4% to 5%.
The ups and downs at a glanceCurrent trends
↑The volume of orders rose about 5% in 2002
↑Output was 8% higher in the first three quarters of 2002 compared with the previous year
↑Public sector orders rose 18% in first 11 months of 2002
↓Office development has almost stopped in London
↑The Construction Products Association predicts workload growth of 3.7% in 2003 and 0.4% in 2004
↑Construction Forecasting and Research predicts workload growth of 4.5% in 2003 and 2.5% in 2004
↑Tender prices in Greater London over the 12 months are expected to rise by between 2% and 4%
The above is an extract from the Davis Langdon PKS' Annual Review 2003. Davis Langdon PKS has offices in Dublin, Galway and Limerick.