Construction inflation report November 2010

Faithful+Gould UK Tender Price Index (TPI) forecast

	2009	2010	2011	2012	2013	2014
Jul-10	-10%	-3%	0%	2.5%	2.5%	3%
Nov-10	-10%	-3%	1%	3%	3%	3%

The Faithful+Gould forecasts follow the BCIS Industry standard forecasts, adjusted to reflect Faithful+Gould's market intelligence, and are based upon a year on year percentage change.

General Economic Outlook

The economy has been and will continue to be strongly affected by the Comprehensive Spending Review and the UK's gradual move out of recession. With growth of 0.8% in Q3 2010 and year on year growth of 2.8%, these figures suggest that the UK is now committed to a slow but steady recovery driven by subdued yet rising domestic demand and inward investment. By sector, the construction industry was most severely affected by the downturn with output dropping by approximately 12%, although it was also quick to respond positively during the modest upturn with rates of growth reported in Q2 2010 of 9.5% (now revised by the ONS to 6.8%) and 4% in Q3 2010. A note of caution should be registered against this positive statement it is not totally supported by Faithful+Gould's market intelligence which records many contractors and consultants not seeing evidence of such growth. Lending institutions still remain cautious, with credit conditions expected to remain limited for some time. Couple these factors with subdued prospects for earnings growth, house prices and various other risks the UK economy faces such as the possibility of a double dip recession and it is clear that the recovery still faces many challenges ahead. Now the government spending cuts have been outlined in more detail, here are some sector highlights from across the construction industry;

 

Education

• £15.8bn has been set aside between now and 2014-15 for work on schools projects including work on 600 former BSF and academy projects. This is a 60% reduction in capital spending in real terms during this period. A further 700 schools that were part of this programme remain in the dark, although some money will be set aside for more modest proposals for a selection of these.

Health

• Although not as severe as education, capital spending in this area will be reduced by 17% in real terms over the current spending review period, but will remain higher each year in real terms than the average annual spend over the last three years. Some hospitals such as Royal Oldham will be prioritised, but there still remains concern over the clarity of where exactly capital spending will be reduced.

Housing

• Spending on housing and regeneration will reduce by 75% in real terms by 2014-15, although existing commitments to housing associations totalling around £2bn will be honoured. A major reconfiguration of the existing planning system will allow for an additional 150,000 new affordable homes over a 4 year period as well as making the system more efficient and conducive to sustainable economic development although it remains unclear how the funding proposals will support this.

Transport

• Cuts will be less severe than in some other sectors. The budget will see spending reductions of around 11% in real terms over the spending period, with Crossrail seeing a £1.4bn reduction in its funding and its completion delayed by up to 3 years and Transport for London suffering cutbacks of around 28%. Some major capital projects such as Birmingham New Street station upgrade will proceed. Various key road and local transport schemes will also draw from a pot of £10bn, including work on the M1 and Tyne and Wear Metro.

Energy

• Faring particularly well, £1bn will be set aside for a pilot carbon capture and storage facility. £200m will also be invested in low carbon technologies including offshore wind technology. The warm front programme, helping residents with energy and insulation improvements will be phased out.

 

Construction Industry

The worry over the gap left by the diminishing role of the state in terms of the government's financial commitments to new construction projects is now being quelled to a slight degree as the private sector begins to pick up some of the slack left by a retreat in the quantity of new public sector work - down from approximately 50% between September and October 2010.

Some of the projects driving headline growth for this period include commercial and housing projects such as the £60m Warner Bros studio refurbishment, although the public sector continued to drive new construction work in certain areas. A £217m National Grid contract and the £52m refurbishment of Farringdon station meant that figures for output remained close to what they were in September. However when compared to the same period last year output is lower, with the average value of a project falling by almost a third.

It is clear that the Comprehensive Spending Review is already beginning to remove fairly large chunks from expected levels of construction output. Although the private sector is containing some of the lost output, it is unclear how long this can be sustained especially with the austerity measures only just beginning to kick in.

Despite the cuts, the Comprehensive Spending Review has brought a degree of clarity to the state of construction projects in various sectors of the construction industry, bringing with it fresh opportunities.

 

Commercial Sector Analysis

The RICS Commercial Market Survey for Q3 2010 reports continued easing of property lettings activity for a consecutive quarter, with demand falling in all sectors. Purchases of commercial property also declined for the second consecutive quarter, with office and industrial properties falling faster than Q2 2010. Available space for occupation is continuing to increase across the UK. Vacant office space increased at the greatest pace whilst retail availability fell for the first time since 2005. Again, caution is being exercised by occupiers as a result of the Comprehensive Spending Review which despite the degree of clarity noted above is still inevitably affecting investment decisions.

 

Output in the Construction Industry

Output figures for new construction work look positive, with the ONS reporting growth in the construction industry of 4% for Q3 2010 - this being 9% higher than the same period a year earlier. A closer look at these figures reveal growth in all sectors with the exception of infrastructure where output fell by 1%.

 

Source; BCIS

 

BCIS Material Cost Index

The BCIS has forecast future materials cost inflation set out below in graph 2. For this reporting period, it forecasts materials price increases of 2% between now at December 2010 and 1.7% between January and March 2011. Projections for mid 2011 forecast materials price increases of around 6%.

Source; BCIS

 

Input Prices

Steel reinforcement, fabricated steel work and ceramic tiles have been driving the upward trend in materials prices. Fuel and lubricants continued to rise by 1.8% for the month between September and October 2010, with petrol affected by the increase in road fuel duty, effective from 1 October 2010 (ONS inflation)

 

BCIS - General Building Cost Index

Source; BCIS

 

BCIS - All-in TPI

 

Source; BCIS

 

Tender prices remain relatively flat into 2011/ 2012, as rising materials prices bring the general fall in tender prices to a halt. Currently, tender prices fell by only 0.5% for Q2 2010, contrasting markedly to the 13% fall in Q2 2009. Faithful+Gould believe that this is due to the coupling of increasing resource and material costs with the downward trend in uncertain future demand.

The predictions for the General Building Cost Index (GBCI) suggest that costs will rise in the short term, with construction outputs also rising when compared to the previous year.

 

Rise in VAT rate to 20%

From 2011, the main rate of VAT will rise from 17.5% to 20% which the government forecasts will raise £13.5bn per year by the end of the current parliament to help reduce the fiscal deficit. Higher prices due to the VAT rise have the potential to dampen demand, although in macroeconomic terms GDP is generally seen to be driven by supply side factors such as technological progress and labour force participation rates rather than a one off rise in VAT. It is not expected that this will have a dramatic effect on the construction industry, with most of the work being reduced or zero rated.

 

Future Outlook

It is clear that despite a modest recovery, the economy is still fragile and subject to various risks. Lending institutions signal this clearly by remaining cautious and keeping lending conditions tight. Despite dampened but increasing consumer activity and confidence, there are still concerns regarding earnings growth, house prices and the drag of household debt levels all serving to increase the current risk averse nature of high street banks. On a more positive note, labour market activity appears to have stabilised somewhat recently with the employment rate for those aged 16-64 reaching 70.7% for Q3 2010, up 0.2% from the previous quarter. Although the number of people in employment is up on the year by 241,000, it is however down on the same period two years previously by 270,000. There are concerns on whether this improved employment rate can be sustained given the biting cuts in public sector employment just around the corner.

Commercially, the private sector does appear to be picking up some of the slack resulting from the reduction in government spending commitments to capital projects following the Comprehensive Spending Review. However, the full effect of the review is yet to be felt, by the construction industry which may result in further tightening of belts. Despite a revision to headline growth in Q2 2010 to 6.8%, output remains subdued yet positive for the time being although construction activity along with materials prices seem destined to become more turbulent in coming months.

 

Highlights

• Construction Tender Price deflation predicted to bottom out in 2011
• Modest UK GDP growth
• More detailed understanding of the Comprehensive Spending Review
• Uncertain output growth for the construction industry

 

Competitors Views

The table below shows our competitors' forecasts, highlighting the variable predictions on construction inflation (% change year on year, except for Gleeds which is 3Q to 2Q)

 

		2009	2010	2011	2012	2013	2014
Faithful+Gould	Nov 2010	-10.0	-3	+1	+3	+3	+3
BCIS - 5 year forecast	Sept 2010	-6.7	0	+3.4	+3.3	+3.2	+3.5
Davis Langdon	Q3 2010	N/A	-4 to -5	+1 to +3	+2 to +4	+3 to +5	+3 to +6
Cyril Sweett	Q3 2010	-7.0	-4.5	+1.25	+2.5	+4.0	+4.5
Gardiner & Theobald	Q3 2010	N/A	-4	+1	+2	+4	+4
Gleeds	Q3 2010	N/A	N/A	+0.2	+2.4	+3.0	+3.8
Sense	June 2010	N/A	-5	-2	0	+1	N/A