London's office developers are in hibernation and are likely to remain so for at least another year. This is dampening inflation in the capital – but in other areas, such as Wales and north-west England, the market is booming and costs are rising. Davis Langdon & Everest presents the big picture

The provisional figures for changes in tender prices for the fourth quarter of last year are now in. These show that tenders rose 4.5% in Britain compared with the final quarter of 2002.

Building tender prices in much of the country have risen by more than four times the consumer prices index, the Treasury's new measure of consumer inflation. The increase seems to be demand-led, as the DTI's figures show that the volume of construction output in Great Britain in the first three quarters of 2003 was 3.8% higher than in the same period of 2002.

At the end of last year, the DTI rebased its constant price construction output data to 2000 prices and, at the same time, revised a large number of figures, which changed the previously observed trends. In particular, it turns out that output growth of 8% in 2002 was in fact 4.8%. The year-on-year increase for 2001 has been reduced from 3.5% to 2.7%, but 2000 has been increased from 1.5% to 3.9%. Overall, the increase in output between 1999 and 2002 is shown to have been 11.8%, rather than 13.5%.
The revised data bears a stronger correlation with the increase in tender prices measured by Davis Langdon & Everest's indices. For the calendar year 2000, the DLE Tender Price Index rose by 8.8%, while in 2001, this slowed to 4.9%. In 2002, when the figures now show that output rose 4.8%, the DLE Tender Price Index rose 7.0%.

Greater London

Price movement in the capital over the past 12 months has been restrained. Tender prices in the fourth quarter of 2003 edged up 0.5% compared with the previous quarter. In the year as a whole, tender prices rose 3.1%. In the first three quarters, the value of output in London was 2% lower (at current prices) than in the corresponding period of 2002, and the value for new work fell 7%. This slippage needs to be seen in the context of year-on-year increases in new work output of 14% in 2002 and 25% in 2001, so on-site activity remains ahead of that in 1999 and 2000.

South-west

As well as Greater London, output fell in the South-west and the West Midlands in 2003. In the South-west, the DTI's figures show that the total value of construction output in the first three quarters of 2003 was 1% higher than during the equivalent period of 2002, but that the value of new work fell 6% (at current prices). This figure is distorted by the unusually high value of work in the region in 2002, which was a bumper year in all sectors but industrial. Infrastructure has a particularly heavy workload, but even without that, the value of new work was 19% higher than in 2001. Much of this was funded or jump-started by European funding, which continues to underpin much of the activity in the more remote parts of the region.

The contractor base in the area is relatively small and there have been difficulties in securing contractors for the additional work. Large value work or works carrying above-average risk are still proving difficult to procure and it is difficult to persuade regional or national contractors to expand their operations beyond the populous eastern part of the region. More resources will be swallowed up by the Ministry of Defence's south-west region prime contract, a £750m job for maintaining and building work at 300 MoD sites over a seven-year period, starting this year.

West Midlands

Construction in the West Midlands over the past three years has boomed. The symbol of this boom is the redevelopment of Birmingham's Bullring and the Birmingham relief toll road. Both projects have been finished (although repair work has started on the toll road). New work output in the first three quarters of 2003 was 2% less than in 2002 and new orders secured by contractors over the same period were down 17% (at current prices), suggesting that contractors operating in the region in the first half of 2004 are likely to be hungrier for work than they have been for some time. Competition appears to be most keen among small and medium-sized contractors.

North-west

This area experienced the biggest rise in construction activity in 2003. The value of new work output in the first three quarters was 20%, up on 2002. This is especially impressive when remembering that output grew 22%, at current prices, in 2002.
Growth in 2003 was dominated by the public sector, particularly health and education projects, and by private sector housing, notably at the luxury end of the market. There was even growth in private industrial work, bucking the trend of E E virtually every other region.

The additional workload has created problems in obtaining skilled labour, particularly plumbers, electricians and bricklayers. To specify brickwork in the Manchester area creates serious problems for tenderers, and brickwork rates are much higher than they were 12 months ago, up as much as 25%. Contractors' site staff are also in short supply and salaries now match those to be found in London.
Manchester's dominance is likely to be replaced by Liverpool. Being awarded European City of Culture for 2008 is bringing rewards. A large project in Liverpool would previously have been valued at £10-15m; now, the £400m Paradise Street redevelopment, Alsop's £140m Fourth Grace waterfront office and exhibition space development and the £100m Kings Waterfront scheme are all likely to get under way this year. Projects of this scale will draw the labour used to commuting down the M62 back to Liverpool – and further exacerbating supply shortages in the Manchester area.

Wales

Construction activity in Wales has shown strong growth in 2002 and 2003. The value of new work output in the first three quarters of 2003 was 22% up on the sharply increased level of 2002. The trend has been led by a 38% rise in the value of private housebuilding, a 37% increase in public non-housing work and a 24% rise in the private commercial sector (which includes PFI work). In Wales, too, private industrial work has shown a marked recovery.

The performance is going to continue in 2004 as contractors' new orders in the first three quarters of 2003 were worth about 20% more than in 2002, led by the same sectors. As a consequence, good construction firms are at full stretch and it is proving difficult to compile tender lists. Contractors are able to improve margins and so prices have risen. Tender prices are expected to continue to rise rather faster than general inflationary trends.

General trends

Most regions have little spare capacity, and most contractors of note are now able to be selective, with the result that the benefits of partnering and securing work by negotiation are clearly visible on their bottom lines. Hence the popularity of two-stage tendering, which puts less strain on head office resources. It also enables work package procurement to proceed with less commercial pressure, and allows clients to benefit from earlier contractor involvement.

If the market eases off contractors will once again be willing to bid for traditional lump-sum projects and there may be signs of this in some areas of the South-east, where perceptions at least are that workload is starting to decline.

Forecast

The two principal construction output forecasting bodies, the Construction Products Association and Construction Forecasting & Research (now part of Experian's Business Strategies Division) have both recently published forecasts of construction activity through to 2006.

Both are generally optimistic about workload continuing to rise through 2004, and predict a rise of between 2.1% and 2.2% in new work output (excluding infrastructure) this year. In 2005, the bodies forecast that workload will continue to rise at a much more modest level of 0.3 to 0.6%. Both also warn that their predicted continued rises in construction output are dependent on ongoing government funding for health, education, infrastructure and social housing as the private sector is not expected to recover before 2006.

Wages and labour

With industry working close to capacity in most regions, inflationary pressures remain just below the surface. All of the main wage-fixing bodies in the industry have agreed wage awards for 2004 and most for 2005, with the lowest annual award (for heating and ventilating operatives later this year) at 4.5% and the highest (for building craft and general operatives) at 9.5% in June 2005. These figures are built into the Building, Mechanical and Electrical Cost Indices but, because of bonus and incentive arrangements, not all operatives are likely to benefit by these percentages in full.

On many large construction sites, non-English-speaking operatives have become commonplace, sometimes leading to practical difficulties and inefficiencies; however the influx of operatives from Eastern Europe, Asia and South America have also been used to contain inflation. From May this year, when 10 new Eastern European countries accede to full membership of the European Union, a large and legal labour pool will be available, and it is thought that many thousands will travel to the UK to seek work. It is expected that many of these migrants will find their way into the construction industry, and that this will tend to dampen wage inflation.

Nevertheless it is anticipated that tender prices over the year ahead will, in some regions, once again reach 5%, and that the national average increase will be in the region of 4%. With inflation of such magnitude occurring in unit rates for particular items of work such as brickwork and wet finishings, building clients and their consultants will seek ways to improve the efficiency of their buildings and their construction to minimise its effect on the total cost of the product.

The construction output forecasts made by the CPA and Experian relate to Great Britain as a whole. It seems certain that the trend in London and probably parts of the South-east will not be so positive. Output in London declined last year. Contractors' new orders figures for the first three quarters of 2003 show a 9% fall in value compared with 2002. Excluding infrastructure, the decline in new orders was about 23%, which is worth about £300m a quarter. Orders in the private commercial sector fell 30%. Office rents are expected to continue to fall for the next two years as nearly half of office space currently under construction has yet to be let. Recovery is not expected before 2006, but when it does begin, it is expected to move quickly, as there are a large number of substantial schemes with planning permission ready to go as soon as developers smell spring on the wind.
In spite of the current decline in office building and the likelihood of a continued lack of orders, most contractors have been able to extend their activity into other areas, such as education and other public sector projects where demand remains strong. However, tenders for structural steelwork, curtain walling and office fit-outs remain highly competitive.

New orders statistics imply a reduction in workload in the short-term, but there is a number of forthcoming high value projects that will soak up large quantities of resources. Arsenal Football Club's £400m stadium is back up and running, now the funding difficulties appear to have been resolved; in East London, Bart's and the London NHS Trust have appointed a preferred bidder for £800m of healthcare construction; this is expected to start on site towards the end of this year, and the national stadium at Wembley will attract one of Britain's biggest ever urban regeneration projects.

Tender price inflation over the next year, however, is expected to be subdued and a range of 2% to 3.5% is forecast. Until the private commercial sector picks up in earnest, inflation is likely to remain at this level, and so a rise of 2.5% to 4% is forecast between the fourth quarter of 2004 and the fourth quarter of 2005. Should a number of developers all decree at the same time that they want to take their projects to market, they should be aware that a sudden leap in prices cannot be ruled out as contractors and subcontractors will have moved their finite resources into other areas.