In its quarterly look at market trends, Davis Langdon reports on a fall in output that has led to cautious forecasts for 2006. Plus how the pre-Budget report affects the industry and the latest materials prices overleaf

Executive summary

Up Tender Price Index Prices continued their upward trend in the fourth quarter, rising another 1.3% over the previous three months. The Tender Price Index shows that prices in Greater London have risen 4% over the past year. Increases in labour rates have been restrained by a continuing improvement in supply; materials price rises have been passed on in full; management and other preliminaries costs have risen. Workload in London is likely to increase next year: tender price inflation is set to increase to 4-5%.

Down Building Cost Index The Building Cost Index rose 6.6% over the year to the fourth quarter 2005. This reflects the substantial pay rise for building operatives last June and an annual rise of 2.2% in materials prices. The 2006 wage award has not yet been negotiated but materials prices are expected to rise higher than last year (see page 66): the BCI is forecast to rise 3.9% over the year to 4Q06.

Down Retail Prices Index The Retail Prices Index increased 2.2% over the year to December, the lowest annual figure since October 2002. The Consumer Prices Index rose 2%, down from 2.5% in September. The CPI is now exactly in line with Treasury aims. Gordon Brown forecasts that the index will fall to 1.75% by the end of 2006 before coming back into line at 2% in 2007.

Output may have suffered a drop for the first time since 1994 - which can be blamed on infrastructure and public non-housing work.

Infrastructure output in the first three quarters of last year was down 10%, following workload declines of 9% in 2003 and 13% in 2004. However, a 50% increase in new orders last year means that civils firms face a brighter 2006.

A year ago, the public non-housing sector was expected to lead the construction industry into another year of strong growth. The Construction Products Association forecast 9.6% growth for 2005 but warned of the danger of slow delivery of the government’s spending plans. Public non-housing in the first three quarters of 2005 turned out to be worth 7% less than in 2004.

The CPA’s latest forecasts are more cautious. This year it forecasts a rise in public non-housing of 1.3%, but again warns that slow delivery of planned government investment would delay a recovery in industry output. Already there are danger signals that this may recur, witnessed by a moratorium on PFI hospital projects.

The provisions outlined in the pre-Budget report (see below) generally have positive implications for UK construction and housebuilding in particular, though it remains to be seen whether some of the provisions in relation to planning are able to provide the intended benefits.

Private housebuilding has picked up steadily since 2001/02. But social housing provision continued to fall until last year, when there was a slight recovery. Additional funding provided in the 2004 Comprehensive Spending Review should ensure further improvement over the next couple of years. However, the private sector probably peaked in 2004/05. Lower demand has resulted in housebuilders cutting back, though most continue to blame the planning process for slow delivery. The measures outlined in the pre-Budget report are unlikely to ease such difficulties for at least a year or two: private sector housebuilding is unlikely to mark an increase before 2007.

The private industrial sector is small in relation to the construction industry as a whole but has been improving steadily from a low point in 2002. Demand for large warehouse facilities remains strong and spending in this area is expected to continue its renaissance in 2006.

Weak consumer spending suggests the retail and entertainment sectors are unlikely to increase investment this year. But there are more positive signs for offices. Last year new orders for office building grew 24% in cash terms, and the recovery in London is at last being seen on the ground. London remains a premier international financial centre and prime City rents rose last year for the first time in four years. There are strong hopes that many more projects at planning stage, including some of the proposed tower schemes, may soon get under way.

Investment in both the private residential and commercial sectors may be given a boost in the medium term by the introduction of Real Estate Investment Trusts providing further funding for development.

Experts predict that output in 2006 will be slightly higher than 2005 but there is a risk if government spending comes under pressure.

Labour supply, which has dogged the growth of the industry over the past decade and been responsible for much of the price inflation over that period, continues to ease as labour, particularly from Eastern Europe, fills vacancies. Wage inflation therefore is not likely to be a serious issue in 2006 and the cost of materials may turn out to be more important.

Tender prices in London have been more subdued than most other regions over the last couple of years but in 2006 workload in the capital may rise faster than elsewhere as commercial activity gathers pace. Given this, tender prices are forecast to rise 4-5% this year and probably a similar amount again in 2007 as Olympic expectations begin to build.