The above forecast is based on our own internal market research and external sources. Regional forecasts are based on several factors, including knowledge of local market conditions. These are subject to unpredictable changes; therefore, any published forecasts should be used with caution. Post-Brexit uncertainly has meant that many market commentators are currently providing a range of forecasts, demonstrating the continued volatility in market sentiment.
*UK Quarterly GDP growth, based on rolling 3-month growth from May to July 2018
**UK Annual GDP growth, including Q3 2017 to Q2 2018
Key Talking Points
- London’s economy generally remains resilient
- Short term outlook for industry is stagnant. circumstances of Brexit continue to dent market sentiment.
- Supply of office space has peaked, but underlying investment confidence in central London commercial property remains good
- Exodus of corporations from London yet to materialise, tech firms have committed to London
- Prime residential housebuilding market is stagnant, switch to PRS is evident
- Upward cost pressure on materials and labour remains a significant risk due to Brexit uncertainty
- Main Contractor appetite for work may not increase as much as previously predicted due to strength of order books in 2019
- Range of TPI forecasts underlines the uncertainty in the current market. Given the current political situation, this is not surprising.
Brexit and UK Context
As the date for the UK’s EU exit transition period approaches, we do not appear to be closer to an agreement on several key terms of the exit deal. Although July’s Chequers Plan and the Brexit White Paper provided further detail on the government’s proposals, the EU leaders’ September summit in Salzburg showed that there was minimal support for the Chequers Plan. Political uncertainty is therefore likely to remain during the coming months. The major practical details relating to goods, customs, agencies and services, particularly in relation to the Irish land border, are all yet to be agreed.
The latest ONS data reflects this uncertainty. The rate of UK GDP growth in 2018 has increased from 0.2% in Q1 to 0.4% in Q2. In the three months from May to July 2018, this figure has increased to 0.6%. These figures appear encouraging, given the UK’s current political climate. However, underlying economic data and sentiment remains questionable. Weak growth in 2017 and Q1 2018 resulted in the UK falling to the bottom of the league of G7 economies. Factors such as recent benign weather, in comparison to exceptionally cold weather earlier in the year, appear to have provided a temporary boost to the economy. However, the British Chambers of Commerce are forecasting 1.3% GDP growth in 2018, which would be the weakest growth since the financial crash of 2009.
40% of the GDP growth reported in the three-month period to July is construction sector related, demonstrating the sector’s impact on the overall health of the UK economy. Construction output in the UK increased by 3.3% in the three months to July 2018, which shows the short-term health of output is good. However, data for total construction new orders has declined by 6.5% in the quarter. This is the third consecutive quarter-on-quarter decrease, which represents the lowest value of new orders since Q1 2013.
Although a recent survey may have suggested that New York has overtaken London as the world’s top financial centre, London will continue to remain a leading global business hub. Despite Brexit headwinds, the London economy continues to be resilient, particularly in the technology, media and telecoms (TMT) sector, which has continued to consolidate and expand since the EU referendum. Overall, employment is on the increase and unemployment on the decrease. London has also remained at the top of global foreign transactions, with £14.2bn of capital spent in London in 2017. This compares to a figure of £5.1bn in New York, in second place. Meanwhile, according to analysts, office market investment demand in London has increased by 11% in 2018.
The proportion of UK construction activity attributable to London averages between 20% to 30%, so the national output figures are heavily reliant on healthy activity within London. In July 2018, London accounted for 28% of the total value of new contract awards across the UK, showing that activity in London is being maintained at a healthy level, for the time being. Three of the five highest value contracts awarded in July 2018 were in London, including the £650m House of Commons Northern Estate refurbishment programme contract. Due to the quantity of foreign investment in London’s construction sector from non-domestic sources such as the Far East, it remains one of the UK’s most resilient regions to a downturn, in the event that there is no deal.
The outlook for housebuilding within London has been tempered by both Brexit uncertainty and fiscal policy restraints. According to the Greater London Authority (GLA), housing supply in London at the end of 2017 reached levels not seen since 1977, with 27,160 new build homes completed. However, the 2017 London Plan identifies that there is currently demand for close to 65,000 new homes a year in the capital, so clearly there is a lack of stimulus to meet demand. In terms of the housebuilding pipeline, data provided by the National Housebuilding Council (NHBC) for Q2 2018 shows that the number of new homes planned for the capital dropped year-on-year by 12% in the period. This is approximately half the number of homes that were being planned a year prior to the Brexit vote. Newer data for July shows more positive data, as the number of planned homes in London soared to an 86% year-on-year increase in July 2018, with several large housing association and private rental sector (PRS) developments registered in the period. This includes Merton Borough’s £1bn scheme to build 3 new housing estates. The current outlook is therefore not as adverse it may have appeared earlier in the year. This also demonstrates the shift of focus away from the traditional private sale model to London’s burgeoning PRS model, a model implemented so successfully in other global cities.
There is no question that housebuilding in London still faces the traditional challenge of low-availability of land, high land prices and high property prices. However, house prices have clearly been affected by a combination of higher stamp duty rates and the Brexit effect, demonstrated by a 1.9% year-on-year decrease in London’s property prices (according to Nationwide Building Society). But since this decrease has mainly affected the prime property market, PRS is set to benefit from property prices which are still well beyond the reach of those aged between 18-35. Nonetheless, not all developers are finding the current climate easy. Berkeley Homes are forecasting a 30% drop in pre-tax profits this year, mainly due to house price decreases. When lower house prices are combined with the risk of losing the EU labour supply and delays to imported materials, there is the potential for some interruption to construction work. While this risk is mainly a result of media conjecture, it is quickly becoming increasingly pertinent. So, concluding the Brexit deal remains paramount to ensuring stability and growth of housebuilding within the London market.
The office development market in London is no different to the residential market, in that its outlook is intrinsically linked to the outcome of Brexit. The supply of office space appeared to peak in 2017, with 4.6 million square ft of space brought to the market in 2017. This is well above the previous 5-year average of 3.3 million square ft. Conversely, only 1 million square ft has been delivered in the first half of 2018, which is a seven year low. Of the 259 developments currently underway in Central London, only 72 offer commercial space. In the short term, this demonstrates that a cautious approach is being adopted by developers with the UK’s departure from the EU less than 6 months away.
However, the long-term outlook remains reasonably healthy. There are several factors which indicate an underlying appetite to continue investing and developing in London. Firstly, there is a belief that global buyers will continue to transact in London – Knight Frank are currently tracking investment demand at £46.1bn, 11% up from the same point last year. A significant proportion of this demand derives from the Far East, including China, Hong Kong, Singapore, South Korea and Japan. Asian institutional investment in London has increased markedly since the EU referendum due to attractive yields and the weakened pound. In addition to this, leasing activity in 2017 was up by 31% on the average, indicating that demand has remained post-Brexit. Levels of demolition have also remained relatively healthy, hovering at consistent levels during 2017, although we have been forecasting a drop off in workloads for early trades for some time now.
Undoubtedly, it appears that some sectors have been more adaptable to the Brexit headache than others. The TMT sector has continued to invest heavily in London, with all the major technology companies committing themselves to London in recent months. The latest announcement included Facebook’s intention to lease over 600,000 square ft space in King’s Cross in 2021. Investment potential in biotech and fintech also remains strong. The risk of a retreat by financial and banking sectors has potentially been overstated by the Media. It is true that they are potentially more vulnerable to a no-deal scenario than tech firms due to their size and the complications of trading laws. However, as a centre for technological innovation, there is little doubt that London can adapt to the challenges of Brexit.
The risks which were present at the end of 2017 have not changed. Price escalation has varied from one material to the next, however specific increases in aluminium, copper and fabricated structural steel have contributed to higher costs in specific items such as cable management systems, suspended ceiling grids, metal stud partitioning and steel framed systems. National forecasts provided by the BCIS are still suggesting that building costs generally are forecast to rise at a constant rate of around 4% per annum for the years 2018 through to 2021. The main factors which have been considered in this forecast are:
- Devaluation of £ Sterling (15-20% reduction in relation to value of the Euro)
- Increase in specific material prices due to the above (for example: external cladding, lifts and mechanical plant, such as chillers and generators, procured in the EU)
- Risk of a reduced pool of labour resources available from within the EU
- Increases in reported labour rates
The potential for rising costs and falling demand still presents an agonising conundrum for contractors. This is particularly relevant to office building contractors in London, where the proportion of imported materials for large scale office projects is likely to be higher than in other sectors and regions of the UK. However, the stable construction activity data for London means that falling demand may not materialise as much as previously considered. Therefore, our tender price forecast is based on a construction economy which will remain resilient throughout the remainder of the Brexit negotiations.
Peer Group Forecasts
- Barbour ABI Economic and Construction Market Review – August 2018
- British Chambers of Commerce Monthly Economic Review - September 2018
- British Chambers of Commerce Quarterly Economic Survey - Q2 2018
- Bank of England Inflation Report - August 2018
- Cluttons – London Office Market Outlook - Summer 2018
- Knight Frank – The London Report 2018
- Office for National Statistics – GDP Monthly Estimate, UK - July 2018
- Office for National Statistics – Construction Output in GB - July 2018
- Mayor of London – Housing in London 2018
- Reuters – Slump in London house-building weights on UK housing starts - July 2018
- RICS – UK Construction and Infrastructure Market Survey Q1 2018
- Savills – Briefing note - Prime London Residential Development – August 2018
- Savills – UK Housing Market Update - September 2018