Tender prices are continuing to soar, especially in London, but the rise in the cost of building is set to slow over the next year

01 Executive summary

Tender price index

Building prices in Greater London rose another 1.5% in the past quarter. Over the year to the second quarter 2007, prices registered a rise of almost 8%. Outside London, prices did not rise as much. This rate of inflation is forecast to continue for the next two years.

Building cost index

The building cost index recorded a rise of 5.7% over the year to the second quarter of 2007 – the same as the previous quarter.

This is expected to decline over the next year to 4.2% as material price inflation begins to subside.

Retail prices index

The annual trend in the retail prices index (RPI) eased back from its peak of 4.8% in March to 4.3% in May. The Monetary Policy Committee’s fifth interest rate rise in a year is expected to help RPI return to about 2.5% by the end of 2007.

02 Trends and forecast

Building prices have risen for eight consecutive quarters and are now 14% higher than two years ago, owing to increased demand and rising materials prices. Labour costs have not been stagnant, but greater availability through the influx of foreign labour has held wages somewhat in check.

In Greater London, prices have risen almost 8% over the past 12 months, thanks to a steady rise in workload since 2005. Last year the volume of new-build output in the region rose 18% in cash terms, and the value of new-build work in Greater London for this year should exceed £10bn for the first time. Only north-east England was able to match this rate of growth, but with an industry only 25% the size of that in Greater London. Since the beginning of 2006, the value of new orders for construction work in London has been running at a level one-third higher than 2005.

Every sector has grown sharply since then, but none more so than the private commercial side, where development has been racing to take advantage of the mismatch between available space and tenant demand. At the same time, more than £1bn of new orders were received by contractors last year for private housing work, a 33% increase over 2005. This rate has been maintained into 2007.

Many projects currently on site or with a view to start over the next year, including the numerous tower schemes, are high-value, complex designs that only a small number of contractors are able or willing to take on. This has resulted in tender returns or negotiated bids at price levels that exceed even the 8% inflation reported above.

In Britain as a whole, new-build output last year was 5% higher than in 2005 in real terms with the first quarter of 2007 maintaining the trend. Office development activity topped the table of increased workload but was matched by the government’s investment in schools. Both areas provided contractors with an additional £1bn of work in 2006 over 2005.

Contractors have benefited from 12 years of nearly unbroken growth. In the past five years the new-build market has grown by 18% in real terms, providing work on site worth an additional £10bn. As a result, the industry has become much more of a sellers’ market, with contractors having more choice over the work they take on and more power to dictate contractual arrangements. Consequently, projects perceived as having greater risk or complexity may be difficult to bring to market, and will certainly attract a greater risk premium.

As such, single-stage tendering has been rejected by many contractors for some time now. For design-and-build projects, a two-stage route is almost always the only option. There is a clear preference at all levels for negotiated work or even prime cost. There is also an indication of a return to construction management by some experienced clients.

There has been a general increase in preliminaries levels at both main contract and subcontract levels. In part, this is to do with health and safety, and major subcontract packages may now make allowances for dedicated management teams. Profit and overheads levels have also increased, and rates of 10% are not uncommon. However, where there are gaps in future secured workload, it is still possible to obtain competitive bids.

At the resource level, although the influx of overseas labour has eased some of the severe shortages pre-2004, surveys still reveal problems in some areas. The demand for manpower often means contract labour moves on in the middle of a job for better rates elsewhere. Greater problems now exist at management level, in both contracting and consultancy.

All of the resource problems look set to stay for some time to come. Most industry commentators think demand will continue to grow for at least the next three years and probably through to 2012. The latest forecast from the Construction Products Association predicts a further 12% rise in new-build output in real terms by 2009 – another £8bn at today’s prices. It’s impossible to see how this can be achieved by an industry working near capacity without further inflationary effects. We are maintaininog our forecast of 6-8% inflation for the next two years.

Hot topic

The Blair legacy. In the 10 years that Tony Blair was prime minister, the construction industry grew 20%. Here’s what the money was spent on …


Tony Blair, or perhaps more precisely Gordon Brown, oversaw a decade of stable pricing in the economy as a whole. Retail prices have risen 31% over the past 10 years, during which time, until the past few months, year on year inflation remained below 4%, except for two single months in early 1998.

The construction industry, on the other hand, has been through a period of sustained high inflation, prices increasing by 82% over the same period – an average annual rise of 6.2%.


In 2006 the construction industry had grown in real terms by 29% since 1994 and by 20% since 1997. In 2007 the industry is expected to have grown by a further 3%. During Blair’s decade, the industry will have grown by an average 2.1% a year. GDP will have grown by 2.5% per year over the same period.

But not every sector has improved uniformly. The private commercial sector has increased by the greatest proportion and the greatest value. It is now worth 60% more in real terms than in 1997 or £9bn more at today’s prices. However, as well as reflecting significant increases in private office and retail activity, the sector now also includes privately funded health and education work. In spite of this, the public non-housing sector has grown by almost 60% as well.

The private housing sector has grown by 35%, but has been fairly stagnant since 2005. The social housing sector has grown by 76% in value terms but from a very low base. A significant proportion has only occurred in the past two years.

The record regarding the much maligned infrastructure of the UK is disappointing, to say the least. Spending on infrastructure in 1997 was £6.3bn; in 2006 it was £6.5bn. Allowing for inflation, this means a reduction in spending of 31%. Spending on water, sewerage, roads, railways and harbours have all decreased by about this level over the period. Only investment in the electricity sector has increased. The overall infrastructure output in 2007 is forecast to grow by a mere 1%.

The success story of Blair’s era has been the spending on health and education. Over the decade, spending on health construction projects rose by 67% in real terms to £3bn last year, and spending on schools and universities rose two-and-a-half times to £7.9bn.

Over the next three years, spending on health is expected to be maintained with an increase of up to 5%, but education is forecast to continue its stronger growth with a further 10% real terms increase by 2009.

03 Large and complex projects premium

For a while now there has been a clear indication of the hardening of the market position of major contractors and their tier-one suppliers on some of the larger, more complex schemes proposed for central London.

A cost premium for such projects has emerged, characterised by:

  • Selective bidding in accordance with the relative attraction or risk profile of the project
  • Greater incidence of price negotiation, and in some instances, a “take it or leave it” stance by contractors
  • Increasing levels of preliminaries sought by contractors and specialists
  • Increasing levels of overheads and profit sought by contractors and specialists
  • Increasingly tough stances with regard to the transfer of design and cost risk.

Recent approaches to procurement transfer more risk to contractors and encourage the supply chain to take a close look at the risks they retain and to price accordingly. Present market conditions allow contractors to ensure their bids include comprehensive risk allowances and healthy margins. In effect, contractors have the bargaining position and can decline work on the basis of previous contractual arrangements or on rates of return that would not long ago have been considered the norm.

While this is increasingly common, and increased rates of inflation are affecting all projects, there are additional cost premiums for large projects with a value of more than £100m, or particularly complex or high-risk schemes.

Factors driving this cost premium include:

  • The disproportionate number of large schemes being introduced
  • The limited number of principal and trade contractors with the experience, resources and expertise to take on large projects
  • Competition between contractors for personnel from a limited management pool
  • Increasingly complex logistics, associated with project scale, method and programme
  • The adoption of innovative construction solutions

This premium associated with large or complex projects is assessed to be equivalent to 2% of overall construction costs. Owing to contractors’ hardening attitude to risk, where there is a substantial transfer of design and commercial risk to the contractor, a further premium of between 1.5% and 2% is also likely to apply to project costs.

Procurement strategies must be developed that best balance value and risk transfer but it is important for clients to realise that they are increasingly working in a market that cannot, for the time being at least, be bucked.

04 Materials

Last year ended with construction materials prices registering a record 9.9% rise over the year (according to DTI figures). The trend has continued, though somewhat less strongly, into the first half of 2007. The first five months of the year have seen prices overall rise by 2.9%, less than the 4% recorded for the equivalent period of 2006.

Over the past year, the price of timber has been the story to watch. Imported softwood prices have leapt 33% including 15% in the first five months of 2007, with no immediate sign of relief. The result is that the price of everyday timber used on building sites – battens, joists, wall plates – has gone up 25%, and composite items such as roof trusses have risen 15-20%. The underlying cause of the price hike is additional demand coming from elsewhere in the world, such as the Middle East and China, as well as increased building activity throughout Europe. Wood-based products such as chipboard and plywood have also risen sharply.

Steel prices remain of concern to many building projects. Everybody knows what happened in 2004 when China was blamed for causing prices around the world to jump 80%. The following year there was a partial return to normality as supply balanced demand and raw material prices stabilised, but in 2006 the steel bandwagon set off again and the past 18 months have seen the global price of steel rise 25%. However, in Europe, prices have gone closer to 50%.

In the UK the price of fabricated steel has risen 25% over the past 12 months but the rate of increase has slowed in 2007, prices moving up by about 7% since the turn of the year. Corus introduced a small price increase (£20 a tonne) from 1 July, but prices in Europe are now expected to stabilise or even fall slightly in line with normal seasonal demand.

The price of stainless steel appeared to have peaked at the beginning of the year but then started to rise sharply again.

Prices rose between 90% and 150% over the past 18 months depending on the grade of material, including a 10-15% rise in the three months between March to June. But the price of nickel has fallen 40% since the middle of May and the price of stainless steel is expected to decline for the remainder of this year.


05 % change to tender prices

(See table right)