ºÃÉ«ÏÈÉúTV

01 / Executive summary

Tender price index

The third quarter of 2008 saw building prices in Greater London slip back by 1%. This looks like the start of a downward trend as work dries up, labour becomes abundant and materials costs drop. Prices are forecast to fall 5-7% next year and further the following year.

ºÃÉ«ÏÈÉúTV cost index

The building cost index rose to an inflation level of 6.8% in the third quarter 2008, reflecting record materials price rises in the first half of the year and a significant wage award at the end of June. The rate should reduce as economic conditions worsen.

Retail prices index

The retail price index hit 5% in September, lower than the consumer prices index (5.2%), the government target for which was just 2%. The main upward drivers have been gas and electricity prices. Rates are expected to decline with lower oil and commodity prices.

02 / Trends and forecast

Tender price inflation, a feature of the industry for the past three years, came to an abrupt halt in the third quarter of 2008. Prices in Greater London fell by 1%.

In the first half of the year, prices had continued to rise on the back of soaring materials prices, despite a slowing of activity, but they stopped rising as world demand eased, and contractors and subcontractors now have weak forward order books. The first areas to see a change have been contractors’ profit and overheads demands, where the new realism has seen expectations trimmed markedly. Preliminaries costs have also started to be pruned.

Areas outside London were hit more quickly by the slowdown, and prices charged by contractors began to slip in the second quarter. The housing market has been in distress since late last year and prices in this sector have been falling for an even longer period. However, the commercial sector has been faced with steeply rising steel prices, which contractors were unable to absorb in the first half of the year.

The UK and much of the rest of the world is already in or about to enter recession. Stock markets lost about 35% of their value since the beginning of September. UK indices have fallen 45% in the last year. The increase in unemployment figures in August was the worst for 17 years. Mortgage approvals were down 70% in August on last year, with just £143m lent, compared with £9bn last year. Halifax’s price index registered a 13% fall in house prices over the year to September, its highest annual drop since the index’s inception in 1983.

October’s purchasing managers’ report from the Chartered Institute of Purchasing & Supply found a continued rapid deterioration in industry activity, particularly in the housing and commercial sectors. A similar picture was painted in the RICS third quarter construction market survey, which found construction workloads declining at their fastest pace in the survey’s 14 year history; the decline in commercial activity was particularly marked, with tenant demand for office space at record lows in virtually every region.

The Construction Products Association forecast that new work output in 2009 would be 9% lower than in 2007, a sharper fall than occurred after the boom of 1989. It is clear that construction is in for a period of deflation. The scale of any price falls is not expected to be as severe as in 1990-92 as the current period has been presaged by neither such rapid growth nor such steep inflation as characterised the late eighties. However, significant price falls now look likely as workload disappears quickly, the industry retrenches, commodity prices drop and competition returns.

While the prospect of falling prices in the new year will be welcome to any clients taking new projects to market, the change in pricing will not have come in time to affect projects which have been procured during the summer and early autumn of 2008.

Our forecast represents a significant change in sentiment from just three months ago, though the possibility of falling prices had been mooted. Over the next year, prices in Greater London returned in competition are expected to decline by 5-7%. The following year the outlook may be bleaker still with contractors hungrier and even more competitive and further price falls of 6-9% now envisaged. As in 1990, price falls outside of London, which may have started slightly earlier, may not be as extreme, as the decline in workloads may be less marked.

Not every sector will be affected in the same way. Contractors with a significant proportion of workload tied into framework agreements will be partially insulated from this new competitive world (at least until the frameworks are due for renewal). Sectors such as M&E services, generally later in the chain of procurement, are, for the moment, unaffected by the downturn and still have full order books: declining commodity prices have not yet manifested themselves in suppliers’ prices and tender rates remain firm for present.

 

The next government will have to reign in spending on large health schemes

03 / Hot topic: Will the public sector be a saviour?

Construction has been one of the hardest hit sectors in the UK economic downturn. Activity has started to decelerate, and a further decline is expected in 2009 and 2010 as private sector construction stalls.

Slower industry activity was anticipated for the next couple of years, but the decline will now be sharper as the credit crisis is squeezing consumers and businesses alike.

Construction work over the next years will therefore be heavily reliant on the prompt delivery of promised government capital programmes in health, education, social housing and transport. Already the public sector sponsors more than a third of construction work and this share is set to increase to close to two fifths over the next two years.

However, public finances have deteriorated in recent years and are under increased pressure from a worsening economy. In addition, the announced £500bn of public support for the banking sector – equivalent to nearly a year’s worth of government spending or 40% of national income – will affect public finances. The amount is unlikely to be reflected in the headline public finance figures but nevertheless, with public finances in deep red, there are increasing concerns over whether the government will be able to maintain investment in the built environment. The 2008 Budget set out a sustained – if modest – rise in capital investment, from £51.5bn in 2008/09 to £57.4bn in 2010/11, given assumptions about growth, tax receipts and public borrowing. Economic growth is now expected to slow sharply and a recession looks more likely by the day. This will lower tax receipts and increase spending on unemployment benefits, which could push up borrowing beyond sustainable levels.

In March the chancellor pencilled in a budget deficit of £43bn for this financial year, which would decrease to £32bn by 2010/11. Only six months later, there are predictions that this figure could surge to £70bn and be close to £100bn in 2009/10.

With credit markets in disarray, there are also doubts about PPP/PFI programmes and big schemes such as Crossrail, owing to credit being more expensive and the fact that land used as collateral is worth less now.

The pre-Budget report later this year will reveal the government’s borrowing and spending plans. What appears clear is that taxes will have to rise in coming years and spending will be cut. What is less certain is when this will happen.

Expectations are that the 40% net debt rule will be abolished and investment will be maintained for the next 18 months until the election in mid-2010, as cutting spending on education, health and social housing in an economic downturn may not bode well for the government’s fortunes.

Encouragingly, the chancellor has announced plans to accelerate spending on education and health to boost the economy ahead of a difficult 2009. While the plan to bring forward capital from 2010/11 is welcome, it is not clear how the government intends to speed up spending. It certainly does not have the best track record in delivering programmes, having repeatedly under-spent in recent years. Large programmes, such as ºÃÉ«ÏÈÉúTV Schools for the Future, are still behind schedule.

It is also clear that whichever party forms the next government will have to reign in spending to bring the public finances back into balance.

Large building programmes are likely to be reviewed. The construction industry will hope that by then the private sector will start to recover, making spending cuts less painful. If not, the UK construction industry is not likely to rebound for a more extended period.

04 / Output and orders

Construction output held up well in the first half of 2008, as increased public sector and infrastructure work more than compensated for the decline in housing activity.

But these figures hid the underlying trend. New order figures were falling sharply – in the second quarter they were at their lowest level since 2004, 14% below the average last year. Housing orders were down 30% and private industrial orders 36%. Commercial orders were down by more than £1bn from 2007. The decline continued into the third quarter: housing orders in August fell to £589m, which was 45% of 2006 and 2007.

The value of new-build output in London rose almost 40% over the past two years – double the national average. This resulted in price inflation, particularly for high-value office schemes. On-site activity in the first half of 2008 continued to rise, but the value of new orders peaked in the middle of last year. A rapid decline in private commercial work has been partly propped up by more public sector spending. The outlook for the private sector over the next few quarters is grim. The Olympics will prop up the industry to a certain extent, but the cessation of office development will have a greater effect.

The Construction Products Association has forecast a 3.6% fall in new work output this year followed by a fall of 5.6% in 2009. The forecast fall over the next two years is sharper than that which occurred after 1989.

05 / Market signals

Market conditions are not uniform. Some contractors that have solid order books are too busy to tender, but others are seeking work.

Overheads and profits are being trimmed and two-stage tenders are attracting figures of 2-4%. There is also a clear move back in the direction of single-stage tendering. More contractors are pricing competitively, and some clients are opting for construction management.

Preliminaries costs are now also being examined closely, but there have been increases in the cost of insurance, bank bonds and warranties in the new financial world.

Subcontractors in trades such as concrete frames and curtain walling, who six months ago were dictating terms and conditions, are now more willing to negotiate sensibly. Staff and labour shortages have eased despite the reports of Eastern European workers returning home.

Contractors who were busy in the residential market are now directing their sights elsewhere and increasing competitiveness in those sectors. Similarly large contractors are moving into markets previously occupied by smaller players.

Many projects have been stopped during construction and sites mothballed though the public sector remains active.

06 / Materials

The increase in tender prices in the first half of 2008 was largely maintained by the rise in materials prices. In the first eight months of 2008, materials prices rose by 9%. For new non-housing work, the rise was 12.8% over the same period. The main driver behind these figures was steel. Fabricated steel prices rose 34% over the period as raw material price increases faced by steel manufacturers around the world were passed on while demand remained strong.

In the first half of 2008 there were monthly increases in the price of reinforcement. These are closely linked to the price of scrap and European scrap prices rose by some 95% in the first half of the year. Demand from the Middle East and rising international prices enabled reinforcement suppliers to push through regular price rises. Notifications from suppliers totalled some £450 per tonne in increases – more than double. However, Office of National Statistics figures, based on genuine sales invoices, registered a more sedate rise of just 55%.

Demand from overseas reduced sharply. Scrap prices have gone into freefall and 80% of the first-half rise was lost in the three months to September. Reinforcement prices have followed suit. Mid-year tender rates rose to £1,350 per tonne, but are now back closer to £1,000. Scrap prices are still falling and reinforcement prices could end the year lower than they started.

Corus announced another price rise in structural sections and plate prices for the end of September, but steel prices around the world appear to have peaked in July and have been falling since. Average European prices lost 14% to September. Corus has not attempted to implement the planned price rises, knowing market conditions had changed. The London Metal Exchange’s new steel futures market has seen three-month seller prices collapse from $1,200 a tonne in June to just $310 a tonne in mid October. Corus has now announced a 20% cut in output and ArcelorMittal and steelmakers around the world are undertaking similar measures to equate supply with demand.

With most of the world’s economies slowing, demand for all commodities has eased and prices of oil and non-ferrous metals have also collapsed. Oil prices have more than halved since July and a week ago had fallen below $65 a barrel, a level last seen in March 2007. Despite the sharp fall, few analysts are yet prepared to forecast prices significantly below this level. Gas and electricity prices should soon follow.

Non-ferrous metals have nose-dived since March. Nickel, zinc and lead prices have dropped more than 60% in the past six months. Copper prices held up for a while, but have now dropped 45% since the beginning of July to a level not seen since the beginning of 2006. July was the second turning point this year and the Reuters-Jeffries CRB global commodity index has also fallen 45% since July to a four-year low, accelerating through October.

Shipping costs have fallen more than 50% since September to their lowest level since 2002, as realisation hits that demand for goods around the world is fast disappearing.

Prices for coated roadstone and asphalt products have also hit double-digit inflation this year as the oil price rose but timber prices have continued their decline, imported softwood prices 15% lower over the year.

The trend of materials prices for the rest of the year is expected to be lower.