Peter Fordham of Davis Langdon presents the latest news of the blues, and an illuminating comparison between this recession and the previous three
01 / Executive summary
Tender Price Index
Tender prices continue to fall and are now 10% lower than a year ago. Prices are likely to continue falling for the next two years.
Building Cost Index
The Building Cost Index rose 3.8% over the last year but has been falling for the past three quarters. With a standstill in builders’ pay, next quarter, the index will show a year-on-year fall for the first time in its 40-year history.
Retail Prices Index
This index turned negative in March and by June was 1.6% lower than a year before, driven by the fall in housing costs. It is expected to remain negative until the end of the year. The Consumer Prices Index dipped below its 2% target in June for the first time in 21 months.
02 / Trends and forecast
Tender prices have continued to fall in the face of crumbling workload and a depressed outlook for the years ahead. Analysis of tenders received in the second quarter of 2009 shows that average prices fell by 1.5% and are now 10% lower than a year ago. This average figure hides a considerable variation between clients, some of whom have been offered price cuts greater than 10%. In other cases, for instance where two-stage tendering is still employed, the decline may be less.
There have been suggestions that the worst of the recession may be over. There have even been forecasts that the UK economy may be growing again. This optimism was dampened when the Office for National Statistics (ONS) revised its first quarter estimate from –1.9% to –2.4%.
The IMF, however, has become more upbeat about the world economy for next year. The UK’s GDP is expected to shrink by 4.1% this year but the IMF has now reversed a further contraction forecast next year to a positive 0.2% growth: the recession may not be as long and deep as previously thought but this does not hold out hope that construction activity will increase before 2011.
For now, our industry continues to contract with worrying speed (see page 52). Twenty billion pounds is expected to be wiped off the industry this year, leading to fierce competition for work. Those clients still in the market are benefiting from lower prices and a free choice of contractor. Two-stage tendering, previously ubiquitous, is disappearing as contractors relinquish their position of power.
Some clients are taking advantage of this situation to expand tender lists. However, tenders need to be scrutinised to make sure the work can be undertaken for the bid price. Overheads and profit requirements have fallen throughout the supply chain and so, in many cases, have preliminary costs: it is important to be sure that a project will be adequately resourced in terms of on-site management, as well as covering health and safety issues. Many contractors are slimming down by letting go of non-core staff and some have been able to trim their preliminaries costs by passing some responsibilities on to their subcontractors.
Some tender results end up with a narrow range of figures, indicating consistent pricing. But increasingly, one or two contractors are well below the pack and probably below any pre-tender estimate. These bids need to be interrogated.
Retendering by clients and contractors is becoming common as they perceive opportunities to make savings in a falling market. Significant last-minute directors’ adjustments are reappearing in tenders in the hope of securing a contract, but also in the belief that these figures can be recovered during the currency of the scheme.
Prices for M&E work held up until late last year, buoyed in part by the higher cost of imported materials and components, but they have now succumbed to the same pressures as building work, with smaller contractors particularly hungry. This is the same pattern that occurred with building contractors: in the middle of last year, smaller firms began feeling the pinch while the larger ones still had fairly strong order books. Now the larger projects have dried up and the bigger contractors and subcontractors are increasingly bidding for smaller jobs.
The industry has suffered many insolvencies, so far mostly at the smaller end of the spectrum. But the fear is that when the industry does recover and there is a call for more resources, they will not be there, leading to inflationary pressures.
For now, 2009 looks likely to bring more deterioration, and a further price reduction of 7-9% is forecast for the year ahead.
Demand for credit for capital investment is muted, although availability remains difficult. Credit availability to the real estate sector has worsened but as a result of falls in commercial property prices rather than any tightening of credit conditions. Property values have fallen more than 40% since spring 2007: it is going to be a long time before development equations look doable again. Housebuilding is expected to resume in 2011 but until then the industry will be reliant on the public sector. Workload in 2010 is expected to be lower than this year so prices are likely to fall further; however, the bottom of the cycle may be early 2011, so our predictions for the year to the second quarter 2011 is that prices may fall 3-5%.
Public sector spending seems certain to be cut after 2011; many expect it to happen in 2010 and the latest output figures suggest it is already being reined back, despite the fiscal stimulus. If the public sector is significantly curtailed before any private sector recovery begins, the construction industry recession could last even longer than the forecasts suggest.
03 / Hot topic: What can history tell us?
Fall in output
Over the past 12 months, new work output has fallen 20%. This rate of decline is much sharper than that in the early nineties or seventies, but was matched during the retrenchment at the turn of the eighties. Then, the new-build industry contracted 34% between the second quarter of 1978 and the fourth quarter of 1981, with an annual fall of 20% in the middle of that period. This time, the drop of 20% has occurred at the outset, reflecting the sudden credit crunch.
In the early nineties, the new-build industry contracted by “only” 14% over a period of 21 quarters, so that one was more like a period of stagnation than a sharp recession.
Fall in tender prices
In the early eighties, tender prices fell 6% over two years but at a time when retail price inflation was running at 13%. Over that period, tender prices net of inflation declined 8% a year.
This recession was characterised by a short period of growth followed by deep but short construction cuts, but as it did not come long after the seventies slump, the resultant price reductions were relatively mild.
In the early nineties, tender prices fell 34% peak-to-trough, representing a net fall of 16% a year for three years. So, although the decline in output in the nineties was much smaller, it had been preceded by a long period of strong growth and a period of high construction inflation.
In the current recession, prices have so far been falling for “only” four quarters and have dropped “only” 10%, or 11.5% net of inflation. The principal forecasting bodies expect the fall in workload to last about three years, a period closest in duration to the turn of the eighties but, fortunately, not as deep. The overall depth may be closer to the seventies but spread over a longer period.
What is the likely impact on prices this time around? So far, they have fallen 10% and probably have further to go. Prices are not expected to fall as far as they did in the early nineties because they did not rise as steeply over the past few years.
The earlier recessions may have more to tell us about this one, but in truth, each has had different characteristics and underlying conditions. Neither of the earlier ones experienced much construction deflation but both were at times of high general inflation; stripped of general inflation, prices may have fallen against the general economy by around 30%. Both periods showed a drop in workload in excess of current forecasts, providing a degree of comfort that prices this time will not slide as far. However, it does seem likely that a 20% drop in prices from the peak in the second quarter of last year will occur before stability returns.
04 / Activity indicators
Figures from the ONS show that construction activity slipped in the first quarter of this year. The drop was greater than officials had anticipated and led to a sharper fall in GDP than had been forecast. The decline started in the second quarter of last year but accelerated in the first three months of 2009, losing 9% in volume terms; in total, the volume of work at the beginning of this year was 16.5% lower than its peak in the first quarter of last year. For new work only, the volume dropped 10% in the first quarter this year and was 20% lower than a year before.
The volume of output has now dropped to levels last seen in 2001 but, to put the numbers into perspective, the current level of new build activity remains higher than at any time during the nineties and still remains higher than it was in the peak of the 1989 boom.
The decline in output in the first quarter translates into a loss to the industry of £4.75bn a quarter, or £19bn a year, of which more than £15bn is new work. The biggest reductions, unsurprisingly, have been in the private commercial and private housing sectors.
Contractors’ new orders
It is clear that activity is going to continue to fall. The volume of new orders obtained by contractors peaked in 2007 and fell by 19% in 2008, leading to the fall-off in site activity noted above. However, worryingly, the volume of new orders in 2009 has plummeted from last year’s levels. In the first five months of 2009, the volume of new orders was 34% lower (in constant prices) than during the same period of 2008 and 41% lower than the same period of 2007. It is the private sector workload that has fallen, with only infrastructure showing growth of any kind. Even public sector non-housing work shows a 20% fall in volume compared with last year. The chart shows the fall-off in new orders by sectors in the first five months of 2009 compared with the same period of 2008 and 2007.
There is a glimmer of hope in the private housing new orders where the figures for April and May were significantly greater than the first quarter figures, although still only half the typical level of orders in 2007. This could indicate that the figures bottomed out in the first quarter and could represent one of the first green shoots.
Experian Business Strategies and the Construction Products Association (CPA) have recently published their summer 2009 output forecasts. Neither makes encouraging reading. Experian is considerably more optimistic than the CPA. It forecasts a 12% fall in total output this year, followed by a 1% fall in 2010 and then growth of 1.3% in 2011. The CPA expects falls of 16% this year and a 5% next, with growth of 0.5% in 2011.
Both forecasts represent a much more severe contraction than occurred in the early nineties but neither matches the 29% fall in new-build work that occurred between 1978 and 1981. At the moment the forecasts bear a close similarity to what occurred between 1973 and 1975. However, the risks may be on the downside for both forecasts given the calamitous level of new orders received in the early months of this year.
05 / Building costs
Building Cost Index
Despite the slump in the Tender Price Index, the Building Cost Index increased 3.8% over the year to the second quarter 2009. However, it peaked in the third quarter of 2008 and has fallen 1.6% since as materials prices have decreased. The index will be negative next quarter as this summer’s pay standstill replaces last summer’s increases.
Materials prices peaked last October and have since fallen almost 5% in seven monthly falls. The main downward pressure has come from steel prices. Fabricated structural steel fell 32% between last September and May and reinforcement prices fell 36% between last July and April. Raw steel prices in Europe appear to have bottomed out in early May and have since lifted 10%, but with weak demand, no sustained rise is expected. Although cement makers appear to have secured a price rise at the beginning of the year, ready-mixed concrete suppliers have been unable to pass this on and, with dwindling sales, prices have slipped back a point or two since the end of last year.
Commodity prices generally bottomed out at the end of last year and have made steady progress for much of the first half of 2009. Copper prices grew 75% between Christmas Eve and the middle of June; aluminium prices increased by 30% between the end of February and the end of June; most other non-ferrous metals have followed suit to a greater or lesser extent, as has oil. The prices of all these commodities peaked at the end of June and have started to slip back as demand remains weak.
The employers and unions within the Construction Industry Joint Council have been unable to reach a wage agreement for building and civil engineering operatives. The last three-year agreement expired at the end of June and the employers proposed that there should be no increase until next year. The unions rejected this, but no further negotiations will take place before the autumn. The BATJIC talks, covering members of the Federation of Master Builders, agreed a pay freeze for June 2009-June 2010 in April.