So, how has the industry fared since the tumultuous events of 11 September? Surprisingly well, in fact. Despite continuing uncertainty, Davis Langdon & Everest reports that tender prices are still on the up, new orders are holding up and the private commercial sector is still leading robust growth
The events of 11 September last year sent a severe shock-wave around the world that threatened to undermine global economic confidence. In the event, the UK construction industry enjoyed robust workload through to the end of 2001. Some investors froze on the spot, but most clients and developers took a deep breath and proceeded with caution. Some construction projects, particularly those associated with airlines, airports, hotels and other tourist activities, suffered cancellation or postponement, but they amounted to only a very small proportion of the total workload of the industry. On-site activity ensured most contractors and subcontractors remained busy until Christmas and, although there are still many uncertain signs for 2002, order books for most of them remain strong.
Analysis by Davis Langdon & Everest of tenders received between October and December shows a 0.5% increase in tender prices over the third quarter, leaving prices 4% higher than a year before. This represents a significant slowdown in the rate of construction price inflation, which has seen prices rise by 44% in the five years since the end of 1996.
The small increase in the last quarter hides a greater than usual variation in tender returns. This was because of the uncertain conditions under which contractors were being asked to bid for work: most were concerned about future workload and felt it prudent to sharpen prices to win work to ensure continuity in the months ahead. Others were sufficiently confident that they already had healthy enough order books to ride out any dip in enquiries, and continued to pass on cost increases that were being incurred, particularly for labour.
Similarly, there are signs of different market conditions emerging: at the small/medium end of the market, workload continues to increase but competition is still such that most cost increases are driven by higher labour rates rather than increased profit margins. At the top end of the market, consolidation of some of the larger players and the withdrawal
from competitive contracting in favour of higher margin PFI and partnering deals has reduced the pool of major contractors and subcontractors. This is giving rise to difficulties in compiling adequate tender lists and, as a consequence, obtaining genuinely competitive tenders. Pressure on cost plans for some of the industry's major projects is therefore more prevalent than for smaller schemes.
The stock market, which fell 12% in value after 11 September, had recovered all of the lost ground within three weeks. But the long-term trend since early 2000 has been downwards, and last year ended with the FTSE showing a fall for the second consecutive year, an event not witnessed since 1973-74. Yet most people feel that the UK economy is in fairly good shape, knowing that the events of 11 September could have triggered far worse economic free-fall.
Three interest rate reductions since September, following the four rate reductions thta had occurred earlier in the year, have taken rates to their lowest level for 37 years. However, there are now clear signs of a two-speed economy in the UK. There was no holding back consumer spending in the period leading up to Christmas and during the New Year sales. The Confederation of British Industry reported that retailers experienced the highest annual growth in sales in December for 14 years. John Lewis Partnership's figures in the last week of December were 17% higher than in 2000. Even before the Christmas spending spree, UK consumer borrowing leapt by a record £6.8bn during November. Some now believe that the next move by the Bank of England may be to increase interest rates to dampen consumer demand. Citibank now predicts that interest rates will have risen to 5.25% by the end of the year from their current 4%.
Chancellor Gordon Brown, in his pre-Budget statement, forecast growth this year in gross domestic product of 2-2.5%, compared with an estimated figure for 2001 of 2.25%. Not all commentators are so optimistic. Cambridge Econometrics (CE) expects GDP growth to slow to 1.5% during 2002. Most commentators believe that the US recession will be short-lived and that UK GDP growth will accelerate towards the end of 2002 and into 2003. In contrast, manufacturing output is still stuck in reverse gear: having been in decline since the beginning of last year, it is expected to contract further in 2002. But CE forecast that GDP growth will increase sharply in 2003 to 2.5-3%, in response to an expected recovery in activity, low interest rates and renewed confidence.
The FTSE 100 index ended the year at 5217, some 36% lower than its peak in spring 2000. All of the main investment houses are hopeful that a third year of decline is not about to happen. Most predict a fairly conservative improvement in the stock market, looking for the year to end on an index of 5500-6000, although Commerzbank expresses the view that the index could reach 6800, 30% above its current level.
Construction statistics from the DTI show that output in the third quarter of 2001 rose, after seasonal adjustment, for the fourth consecutive quarter. Output value in the third quarter exceeded £19bn, which, at constant prices, is greater than the peak quarterly value reached in 1990. DTI figures also show that construction employment has been rising steadily to cope with the increased workload: in the third quarter, 1,545,000 were employed in the construction industry, generating just less than £50,000 worth of work per employee per year. At the end of 1989, with 1,850,000 employed in the industry, each individual was producing less than £40,000 worth of work (at today's prices), showing how much productivity has increased over the past decade.
<B>Construction new orders</b>
Latest figures from the DTI show that new orders obtained by contractors have held up fairly well since September, but the total for the three months September to November shows a 7% fall from the level of new orders earlier in the year. The total for the year still looks set to exceed that of 2000 by about 4%, but orders for private housing and in the hard-hit private industrial sector will fall just below the previous year's levels.
Until November, 2001 construction had been led by strong growth in infrastructure orders. These were fuelled by contracts let for the Channel Tunnel Rail Link and strong expenditure on other railway work. Spending on road building was also more than maintained after the dearth in that sector between 1997 and 1999. Stephen Byers' decision to pull the plug on Railtrack brought a halt to new contract awards and a slump in the new orders statistics.
As a result, growth last year continued to be led by the private commercial sector. The total value of new orders for the year will not be as high as in 1998, but they will almost certainly exceed £10bn and be 6% higher than in 2000. Higher private investment in schools and universities is included in this figure, though this was partly offset last year by the reduced value of new orders for privately funded health work.
The figure for offices was boosted by some large orders in the first quarter last year, but the rest of the year continued to generate a steady stream of orders to satisfy occupier demand and, at least until September last year, a degree of speculative building.
The entertainment sector continued to fall away: lottery money has now been largely diverted away from capital projects; hotel development had already been hit by a fall-off in tourism as a result of the foot-and-mouth epidemic before the industry became a major casualty after 11 September. But the retail sector bounced back last year after a couple of years of decline. New orders for shop development may well end up 15% higher (at current prices) in 2001 than in 2000, as major players such as J Sainsbury and Asda once again work their way into the construction industry's top 10 clients. Retailers were able to continue investing since the retail sector generally bucked the trend of the stock market and was one of the best performers over the past 12 months. While interest rates remain low, consumer spending looks set to continue.
The events of 11 September undoubtedly drove the USA deeper into recession, whereas the effects on this side of the Atlantic have happily not seen the economy thrown into turmoil. But there is a greater degree of uncertainty about the future as a result of 11 September. The latest expectation is that the US economy is at the bottom of its trough and will recover strongly in the second half of 2002. If it does, Britain will undoubtedly benefit too – hence the Treasury's and CE's bullish predictions for next year.
The Construction Products Association released its latest forecasts for the industry at the beginning of the year. Their forecasts of total construction output have been reduced from their forecasts made in summer 2001, but still paint a continuing pattern of growth for the industry. Total workload is predicted to increase by 1.8% this year, 3.5% in 2003 and 3.8% in 2004. If these figures prove correct, there will be an additional £6.75bn of work being undertaken in 2004 compared to last year, at current prices. On today's manpower figures, this will require an additional 140,000 new recruits to be brought into the industry.
Despite the demise of Railtrack and the continuing uncertainty over investment and contracts, much of the additional growth is expected to be in the infrastructure sector. The ongoing Channel Tunnel Rail Link and work on the Birmingham Northern Relief Road will provide the backbone of activity during the current year, but the government's 10-year transport plan should also help to boost workload in the sector in subsequent years.
The Strategic Rail Authority published a new 10-year plan on January 14, which included an additional £4.5bn for the railways over the next 10 years, bringing the amount of money committed to the railways under the 2010 Transport Plan to £33.5bn. The go-ahead for Heathrow's fifth terminal will also call on substantial resources within that quadrant of the South-east from next year onwards.
The growth forecasts also depend on funding coming through from the government's 2000 Comprehensive Spending Review, since the private commercial sector is expected to decline slowly over the next three years. The private new housing market is still not expected to increase this year, but repair and maintenance of private housing should continue to show strong growth, thus ensuring buoyant workloads for small builders, the brown economy and DIY stores.
The bulk of additional work this year may come from infrastructure and repair and maintenance, but the new-build building market looks relatively stable. There has been a slowdown in business park and out-of-town office development, but additional PFI health and education work should offset a fall-off in office schemes, while the retailers continue to overcome planning constraints.
Until the new-build housing market picks up, demand for labour such as bricklayers may level off this year, but the repair and maintenance sector will still provide plenty of alternative work opportunities for traditional tradesmen. Directly employed labour tied to the Construction Confederation's wage agreement will enjoy a substantial hike in wages this summer, as basic pay rates are due to go up by 8.9% at the end of June. Self-employed and agency labour rates will only be affected by supply and demand.
If no further disasters strike and the US economy recovers quickly, the UK economy should end the year ahead in at least as good a condition as it now appears to be in: the private sector may decline slightly, but should remain generally robust; public sector funding of infrastructure, health, education and social housing should enable the construction industry to continue to grow. Further growth will create capacity problems in certain labour categories and for some specialist subcontractors.
The main threat to materials prices will be the aggregates tax, which comes into force on 1 April this year. The tax levied will be £1.60 per tonne on primary aggregates, which will rebound on the price of readymix concrete, precast concrete products and plaster. Otherwise, materials price movements should remain benign. Over the next 12 months, tender prices are now expected to rise by 2.5 to 4.5%, and the following year, if government funding continues to flow, prices paid by clients could be forced to rise by 4 to 6%.
The ups and downs at a glanceCurrent trends
- Tender prices up 0.5% for the third quarter.
- The stock market has recovered from 11 September but the long-term trend has been down.
- Consumer spending is high, with borrowing leaping by a record £6.8bn in November.
- Manufacturing output is stuck in reverse.
- FTSE 100 index ended the year 36% lower than its spring 2000 peak.
- New orders are generally holding up well and most sectors look set to improve on 2000.
- Strong construction performance was led by a 6% increase in private commercial orders.
- The leisure sector continues to languish, hit by foot-and-mouth and 11 September.
- Over the next 12 months, tender prices are expected to rise by 2.5-4.5%.
- Total workload is expected to increase by 1.8% this year.
- The infrastructure sector will lead growth, with the Channel Tunnel Rail Link and the Birmingham Northern Relief Road providing the backbone of continuing activity.
- The new-build building market looks relatively stable.
- PFI health and education schemes should offset a fall-off in office schemes.