This confirms our earlier forecast of sustained increases in tender prices.
Over the past 12 months, tender prices for most trades have risen steadily. Some have seen quite dramatic increases, such as 16% for formwork, 25% for plaster, and 27% for concrete. A jump is also expected in glass prices.
The overall increase in tender prices in the past year has been 9%. Over the past four years, tender prices have seen an average annual rise of 7.5% – a total increase of 33%. In the same period, retail prices rose by just 11.4% and the Building Cost Index by 20%. Annual tender price increases are expected to outstrip both retail prices and building costs again next year.
GDP and output forecasts
In July, chancellor Gordon Brown introduced the Comprehensive Spending Review, which will provide extra investment for specific sectors of the economy that the government has identified for improvement. As well as a £140bn, 10-year transport plan, new funds have been earmarked for social housing, education and health.
A target of 56 000 new social housing units for rent over the next three years has been mentioned, but this may mean only 10 000 new units on top of those already allocated. There are clear signs that the housing market has reached a plateau. While some major housebuilders claim to be undaunted, others are less confident.
Recent fluctuations in oil prices and exchange rates, added to a situation in which earnings are running ahead of inflation, may put pressure on the government’s earlier fiscal targets. Sterling has recently hit a 14-year low against the dollar, and the IMF forecasts that this could push UK inflation up from 2.0% to 2.4%. As the construction industry imports some key materials, future materials price rises could be even higher.
Treasury forecasts for national GDP growth, set in March 2000 at an average of 3% a year for 2000 and 2001 and 2.5% for 2002, are said to be still on target. Independent economists broadly agree, but their view is that overall growth may slow to 2.6% in 2001 and 2.4% in 2002.
Summer forecasts for construction output growth vary from 1.4% to 2.0% for 2000, and from 1.4% to 2.6% for 2001. Forecasts for 2002 vary between 1.9% and 4.0%. It is hoped that additional funding from the Comprehensive Spending Review will trigger booms in road construction and social housing to offset the anticipated falls in the factory, leisure and retail sectors. However, public spending increases rarely come on stream as quickly as predicted.
New-build output figures for the second quarter are 3% higher than for the same quarter last year, but are 3.6% down on the previous quarter. This fall is slightly worrying. Output has dropped by about 5% in social and private housing and by the same amount in the private commercial sector. A more dramatic 12.2% fall for private industrial work has been offset by a 13.6% rise in other public new building work.
New orders present a similar picture. Over the first seven months of 2000, new orders were 3.6% higher (at constant prices) than for the same period in 1999. Among the sectors experiencing a continued upward trend, public housing has seen new orders rise 3.3% over the year to £187m, and private housing has seen orders increase 7.2% to £1.74bn. The offices sector is particularly strong this quarter, with new orders up 71.6% over the year to £1.52bn, mainly because of some very large tenders let in June.
Sectors following a more erratic and largely downward course include schools and universities with new orders of £350m this quarter, a fall of 2%, and leisure and entertainment with £531m of new orders, a fall of 6.8%. Retail orders have dropped 22.7% over the year.
Following on from several exciting but not always successful millennium projects, larger contractors have moved away from competitive tendering and higher-risk projects.
Larger contractors are increasingly involved in mergers and acquisitions with a view to diversifying into other fields in order to secure more predictable sources of growth and profit. This trend should continue. As a result, there will be fewer, larger players in the premier division of the market and many of those that remain will be international or multinational companies.
The reduced competition means clients must accept less advantageous prices. The Construction Confederation’s state of trade survey for the second quarter of 2000 revealed that 59% of building contractors had full or nearly full order books. Some are now declining invitations to submit competitive bids, preferring negotiation.
A number of other contractors that had previously concentrated on public-private partnership or private finance initiative submissions have been unable to recover the profits they had expected for these projects, and have decided to sell on their equity once construction is complete.
A pattern is emerging of a second tier of contractors that continue to be more involved in competitive tendering. Despite their claims of sufficient capacity for additional projects, progress on certain sites is slow, suggesting a possible shortage of skilled labour. Fuller order books mean that some of these contractors, like the larger players, can decline riskier or more difficult projects.
Most regions and major cities still report reasonable but not excessive workloads. London and Edinburgh are particularly busy. In Scotland, the South-east and the South-west, construction is seeing a mini-boom, with tender prices rising strongly.
A number of clients are increasingly experimenting with non-traditional procurement methods. The increase in the size and mix of larger projects is helping construction management to re-establish a foothold. Partnering is growing in popularity, as are less formal variations on the partnering theme, involving the use of short tendering lists of preferred contractors. Large and medium-sized contractors see this approach as an opportunity to reduce their risk by using known clients and building types, while at the same time increasing their profit margins through negotiation.
Traditional competitive tendering now seems largely limited to medium-sized contracts, up to about £10m. Where it is used on bigger contracts, two-stage tendering is often the preferred route.
Head-office overheads and profit margins for larger contractors are about 5-7%, which equals about 15% of turnover, but for medium-sized main contractors and larger subcontractors, overheads and profit are closer to 10-12%.
Materials do not appear to be in particularly short supply, although increasing delays on joinery and glass products have been reported lately. Although steelwork prices have recently risen by £20 a tonne, the market is still very competitive. Steelwork subcontractors are busy, but margins are still tight.
For oil-based materials such as tarmacadam, asphalt and PVCu, already difficult conditions have been worsened by the recent petrol crisis. The Construction Products Association has estimated that the UK fuel dispute in early September could have cost construction in the order of £200m in lost output alone.
The Federation of Master Builders’ July 2000 survey reported a slight easing of previous labour market problems. Nationally, 66% of member firms reported difficulties in obtaining sufficient supplies of skilled labour. Builders enjoyed an average 11% increase in their workloads in the second quarter.
The Construction Confederation’s trends survey for the second quarter of 2000 states that the industry is optimistic about output prospects for the next 12 months. Construction output is slowly growing, with tender prices on the rise, builders’ margins improving, fuller order books and increasing new enquiries. The confederation’s main concern is the underlying cost pressures on labour and materials. It hopes that any reduction in private sector activity will be compensated for by increased public expenditure.
Tender price forecast
The office sector is doing well, especially in city centres, but new orders confirm that the retail sector is falling behind. Developers remain confident, although office tenants are taking longer to sign up. Thanks to the continuing soundness of the economy, a number of large commercial/retail city-centre schemes are set to go ahead. The only major cloud on the horizon is the recent output forecasts, which predict reduced construction growth in 2001 before a modest recovery in 2002.
Evidence from various sources suggests that projects coming on stream are at the highest level for three years. Assuming that this demand comes to fruition, the increased activity combined with ongoing labour shortages and rising material prices will cause tender prices to continue to rise.
Overall construction activity should continue to increase, with tender prices in London rising by 5-7% over the next 12 months. Inflation is expected to be high in the South-east and the South-west, but lower in areas of less activity, such as the Midlands and Wales. In the following year, if spending promises on health and education are kept, demand for construction services will lead to further price rises of 4-5%.