London is feeling the pinch as the office market dries up, but prospects are good in many of the regions. The first quarter's decline in output does not spell doom and gloom, but housebuilders and the public sector will hold the purse strings
Construction prices in London fell 1% in the second quarter 2003, a period that covered the introduction of the congestion charge and the increase in National Insurance that has affected all types of labour. The findings of Davis Langdon & Everest's Tender Price Index, which measures the movement of competitively let work in Greater London, indicates that the near halt in office development in the capital is beginning to bite. Most contractors are still busy, but workload for the end of the year is looking thin. The London market has always been much more dependent on the office sector than elsewhere, although it is less so than it was at the height of the last boom in 1989.
After a 0.5% increase in the first quarter of 2003, prices in London are now only slightly behind the level of six months ago, and are still 4% higher than a year ago. The rest of the country has not experienced a drop in prices in the second quarter of 2003, which are up to 8% higher than a year ago in many areas.
In London the lack of office developments has led to demolition contractors urgently seeking work, often beyond their normal geographic areas. European curtain walling contractors, who found London a fruitful outlet in recent years, are now looking further afield, especially as other European markets show no signs of picking up. Office fit-out specialists are feeling the pinch the most – projects are attracting fierce competition and bids are significantly lower than last year.
Outside London the market is still generally buoyant, with many companies benefiting from the continuing expansion of public sector work. However, statistics from the DTI show that total construction output in the UK in the first quarter of 2003 showed a dip in volume after nine consecutive quarterly increases in growth. Total output fell 2.6% compared with the fourth quarter of 2002, but was exactly equal to the average quarterly figure last year (at constant seasonally adjusted prices). The change in direction was due to a fall-off in private commercial and infrastructure activity.
The fall in private commercial work was caused mainly by the offices market. Office construction output in the first quarter was worth £1.3bn, representing a fall of 13% in real terms on activity in 2002. In London, private commercial output in total was 19% lower in the first quarter than in 2002, as measured at current prices. If the breakdown was available, the percentage reduction for offices alone would be much more.
A ripple effect can be seen in other regions. Significant falls in private commercial activity in the first quarter are evident in the DTI construction output statistics for the South-west (–18%), the West Midlands (–12%) and Scotland (–10%). However, areas such as the North-west (+12%) and East Anglia (+8%) appear unaffected.
A fall in infrastructure workload contributed to the drop in the headline figure. For firms in this sector, 2002 was a good year, particularly the first nine months when output was 14% higher in real terms than in 2001. However, the fourth quarter saw a sudden fall in workload, which continued into the first quarter 2003, even allowing for the traditionally lower spending in the first quarter.
In the first nine months of last year there were substantial increases in spending, particularly on roads and railways. Since then, spending on the railway network has fallen markedly: in the last six months it was nearly 20% lower than in 2002 and was back to the expenditure levels of 2001. Spending on roads and water also slipped back from the high levels of 2002.
Contractors' new orders
The decline in construction output in the first quarter does not look as if it is about to herald a general slump. The volume of new orders obtained by contractors in the first five months of 2003 was actually 1% higher in real terms than during the same period of 2002, a year when the volume of new orders was 9% higher than during the previous year.
At £2.3bn, the output figure for May (the latest monthly figure available) was the lowest since April 2002, but should not give cause for concern. Figures compiled by the DTI's annual business inquiry survey show that work won by the top 50 contractors in the UK in the first six months of this year was worth 19% more, in cash terms, than in the same period last year. Even allowing for inflation, this is a very substantial increase.
DTI data for the volume of new orders obtained by contractors in the first five months of this year (see table, right) suggest that construction activity in both the infrastructure and private commercial sectors will continue to decline this year. New orders for water, sewerage and roads are all substantially down on last year. New orders for offices in the first five months of the year were 14% lower than in 2002 but the entertainment sector (hotels, sports facilities, restaurants) is faring worse, at 19% below last year's levels.
Clearly, the prosperity of the industry lies in the hands of the housebuilders and the public purse. The number of dwellings being built in this country remained at a fairly constant level between 1997 and 2001, even though house prices rose 50% over this period. (Private sector starts fell within a range between 161,000 in 1998/99 and 172,000 in 1997/98.) Housebuilders complained planning delays were preventing them increasing production to meet demand.
Last year saw a noticeable increase in activity: private enterprise starts grew from 165,000 in 2000/01 to 178,000 in 2001/02 and the volume of construction output in constant price terms in the private housing sector rose 11%. New orders for private sector housing in the first five months of 2003 are 14% higher in value terms than in the same period last year.
This demand has increased the shortages of bricklayers and carpenters and forced up site labour rates. There has been an easing of labour rates in the London region in the last three months but elsewhere the story is different. Shortages of bricklayers in the North-east and the Midlands have seen rates increase beyond those normally expected to be paid in London.
Demand for bricks and blocks has also surged, leading to a reduction of the discounts that have been available on these products for such a long time. Lowest tender rates for brickwork and blockwork in the East Midlands, for example, are now £50 to £55 per m2 for low to medium quality facing bricks and more than £20 per m2 for 100 mm medium density blockwork. Difficulties in securing good quality bricklayers have led to the exploration of prefabricated techniques as a means of eliminating or reducing dependence on a limited resource.
Housebuilders' increased activity is forecast to be short-lived. Construction Forecasting and Research (CFR) and the Construction Products Association (CPA) predict increased output in private housing of 7% and 8% respectively this year, but both forecast a fall in 2004 of between 2% and 3%. This is based on the premise of a levelling off of the housing market and the sharp price increases that have been running since 1997. Nationwide figures show that annual price inflation peaked in January this year at 26.5%, but prices have risen a further 8% since then and still stand at an annual rate of 19.2%. The latest reduction in interest rates may see the housing market continue its buoyancy in most areas for longer than many anticipate.
With the reduction in private sector activity, which is forecast to decline further in 2004, and the possible stagnation of the private housing market, the construction industry will depend heavily on the public sector over the next couple of years.
Public sector activity increased considerably over the past five years and was largely responsible for the strong growth in construction during that period. Between 1997 and 2002 public sector construction output increased 55% in real terms, including growth in 2002 alone of 25%. In health and education, the growth of construction work, both publicly and privately funded, increased 101% over the same period. In comparison, the private commercial sector grew by 52%.
The public sector is expected to continue to grow strongly throughout 2003 and 2004. Excluding privately funded health and education work, the CPA forecasts growth this year of 10% in public non-housing construction, with rises of 10% in 2004 and 5% in 2005. CFR is even more bullish in its spring 2003 forecast, predicting 18% growth this year and 10% in 2004.
Doubts have recently been expressed about the Chancellor's forecast of the public borrowing requirement: it looks increasingly likely that borrowing will have to increase or taxes will have to rise to meet Gordon Brown's spending plans.
Because of the declining private sector outlook, both CFR and the CPA downgraded their forecasts of overall construction growth in 2003 and 2004 in their latest reviews. CFR predicts total construction growth this year of 4.9% (after last year's 8% increase) followed by 1.9% next year. The CPA downgraded its forecast this year to an increase of 1.9%, in the belief that public sector funding is not working its way through to site activity in the way it is supposed to, followed by 1% growth in 2004.
Both sets of figures represent growth in an industry continuing to perform at record levels of activity, with resultant pressures on limited resources. Availability of capacity is the biggest concern of those organising the huge programmes of hospital building and regeneration projects in the near future. In September, the NHS decides on its framework partners for ProCure 2, after which some £1.4bn of capital construction work a year will be released on to the market.
It is hoped prefabrication will help to overcome some of the capacity difficulties that may arise with the release of such a huge quantity of work, but many remain wary of the method and it is only likely to impact on a relatively small part of the estate's construction plans.
The overall economic backdrop is that GDP growth is now expected to underperform in comparison to the Chancellor's last Budget forecast for 2003, the American recovery still looks fragile and, in the words of the Bank of England's monetary policy committee, "global economic recovery remains hesitant".
With this background, a continued high level of construction activity depends on the public sector fulfilling its commitment. Public sector spending plans are well spread around the country but London, with its higher than average dependency on the private sector, may face a bleaker immediate future than some other regions. However, outside the City and West End office markets, Greater London still has the massive Heathrow Terminal 5 development. Cities as far away as Newcastle are afraid Heathrow will attract resources to the detriment of the local market place.
Elsewhere, Liverpool's success in securing the title of European Capital of Culture for 2008 is already bearing fruit. Once dormant projects are stirring. Consultancy firms and contractors are already opening up local offices to take advantage of forthcoming opportunities.
Infrastructure, landscaping and remediation sectors look likely to be the first beneficiaries. The North-west already had the best prospects for construction growth over the next couple of years, so Liverpool's nomination is like winning the lottery for the city's businesses and dignitaries.
Total construction activity may increase by only a per cent or two over the next couple of years, but that still represents an increase on historically high levels of workload. Labour costs have been more restrained than they might otherwise have been as a result of migrant labour, legal or otherwise.
As well as shortages of traditional skilled craftsmen, many contractors are having to contend with a dearth of experienced site agents and other management staff. This is often the reason contractors are forced to turn down tendering opportunities. Post-tender interviews often focus on the people a contractor intends to use to run the contract and they are even harder to replace than site labour.
Construction price inflation in London is likely to be restrained over the next year or two as activity lessens, but elsewhere upward pressures seem likely to remain. The forecast for tender price inflation over the next year is for price rises of 2% to 3.5% in Greater London and 3% to 5% elsewhere. Over the year to the second quarter 2005, conditions in Greater London are unlikely to ease much so a price increase of 2.5% to 4% is forecast, while elsewhere a rise of 3% to 5% is seen as a likely outcome.
The ups and downs at a glanceCurrent trends
↓Construction prices in Greater London fell 1% in the second quarter, despite the congestion charge
↑Outside the capital, prices are up to 8% higher than a year ago
↓Offices output in the first quarter was down 13% in real terms compared with 2002 levels
↑New orders for private housing starts in the first five months of 2003 are 14% higher in value year on year
↑The Construction Products Association and Construction Forecasting and Research predict that public non-housing construction will rise 10% and 18% respectively this year
↑ CPA predicts overall construction growth of 1.9% next year; CFR says 1%