UK Economic Outlook
The economy expanded by 0.6% in the second quarter, picking up from 0.4% in the first quarter according to the Office of National Statistics (ONS), who also said there is no sign of the uncertainty having significantly impacted investment or GDP. The forecast for the UK has been downgraded following Brexit by forecasting organisations, with The Economist poll of polls reducing GDP forecasts to 1.6% for 2016 and 0.5% for 2017.
The Bank of England (BoE) said that the UK economy will be 2.5% smaller than the Bank was predicting before the Brexit vote. They said the sharpest slowdown will occur next year, and they downgraded their GDP growth forecast from 2.3% to 0.8%, but the average 2017 forecast is 0.5%. This means that the UK should avoid a technical recession, and growth is predicted to rise to 1.8% in 2018.
Construction Industry Outlook
Barbour ABI reported a drop in construction levels in July. Using their 3-month rolling average measure, new contracts awarded was at £5.8Bn (£5.5Bn in-month) which was a 6.4% reduction on June and lower than July 2015. The number of UK construction projects in July decreased by 3.7% from June, and was 6.9% lower than July 2015.
In August the residential construction sector enjoyed the value of contracts awarded reaching £1.7bn which is an increase of 13% compared to the same time last year, based on a three month rolling average. For the 2 months after the vote to leave residential construction values are significantly higher when compared to the same months in 2015.
The residential and infrastructure sectors combined kept the numbers up last month providing £3bn of the £5.5bn total construction contracts awarded according to Barbour ABI.
The commercial and retail sectors had a difficult August, experiencing a decrease of 43% compared to August 2015. According the Building Cost Information Service (BCIS), new work output is now expected to remain unchanged in 2016 but will fall by 2.7% in 2017 and 1.8% in 2018 until an upward trend returns;
New Work Output…Year on Year Forecast
The seasonally adjusted Markit/CIPS UK Construction Purchasing Managers’ Index (PMI) rose to 49.2 in August, up from 45.9 in July and 46 in June. Values less than 50 show a deterioration and above 50 indicates an increase. This is an important move towards a positive outlook.
Markit's survey respondents suggested that Brexit uncertainty continued to "act as a brake" on the construction sector during August, especially for house-building and commercial work, but some noted that sales volumes had been more resilient than expected. Construction firms cited a nascent recovery in client confidence since the EU referendum result and a relatively steady flow of invitations to tender in August according to Tim Moore, senior economist at Markit.
There is pressure on the government to provide certainty on major infrastructure projects. Hinkley Point C is now confirmed, however there is uncertainty surrounding HS2, Heathrow’s 3rd runway, Northern Powerhouse and other major investments in the pipeline.
Recently, the Chancellor hinted in a parliamentary hearing that the Autumn Statement scheduled for 23rd November would see a splurge on UK infrastructure designed to boost growth in the wake of the Brexit vote. Hammond has already indicated that he will focus on "modest, rapidly deliverable investments" on roads and railways.
Commercial Property Outlook
Commentary from Mark Stevens, Head of Commercial Property: The commercial property sector saw considerable turmoil either side of the referendum vote but now appears to be entering a period of stabilisation. Property funds saw large withdrawals immediately post Brexit, forcing 10 large funds to suspend trading to stave off the rush for redemptions. Some, such as Aberdeen Asset Management also began a programme of asset divestment to maintain fund liquidity. Most quickly lifted the freeze but in turn imposed a withdrawal levy of up to 19%. With some stability now returning to the market, these penalties are now returning to pre Brexit levels.
Residential developers took a hit either side of the referendum yet results for residential sales during August have shown house price increases returning to levels experienced in the first half of the year. Although figures from the BoE show that mortgage applications in July fell to their lowest levels for 18 months , experts are suggesting the pick-up in house prices is being driven by lack of supply coming on to the market. Whilst foreign investment has been encouraged by the fall in the pound the effect of the higher taxation imposed by the Chancellor in April is beginning to take effect. In London there are signs that wealthy foreign investors are turning their attention away from expensive central London properties to cheaper suburban locations to avoid paying heavy stamp duty bills.
Anecdotally, contractors we have spoken to seem fairly optimistic in the short term, reflecting perceived stabilisation in the market, however the commercial development activity index (monitoring overall performance of UK commercial property) in August stood at -3.5%, up from an 89-month low of -18% in July. The degree of optimism amongst UK commercial developers for activity over next 3 months stood at -4% in August. Private office project activity fell for 5th straight month in August, but at a weaker rate than July (-18.1% July vs -6.3% August). The only category in commercial property to see an increase in activity is private new build which is up 5% in August.
Despite gloomy forecasts pre referendum the office market has shown remarkable resilience and there is little evidence of a post Brexit collapse. Indeed the weak pound has seen overseas investors pile into the UK real estate market with examples of trophy buying of several central London properties. The longer term view is still uncertain however. The office market, particularly in London is driven by occupier demand and this will be affected by the terms of trade renegotiations and whether it maintains its position as a leading global centre of financial services.
Commentary from Terry Stocks, Head of Education and Public Sector: Education continues to be an active market. The approximate annual expenditure on education in the last financial year was over £5bn, with an additional c£2.5bn in new contracts being let. There has been an increase in contract awards in FY 2015/16 over the previous year indicating an improving picture within the sector. The three month rolling average contract value output in year was approximately £665m. London and the South East together provide c25% of the expenditure, however Scotland with some major investments by the University of Edinburgh had a strong investment program. The university and college sector accounts for some 46% of the total and c42% state schools. The impact of the Brexit vote on future investments is yet to be known.
With changes in the UK Government leadership at all levels, a new Minister to lead the Brexit negotiations and varying economic forecasts, the impact on the education sector is hard to call. The number of required state school places will remain, thus expenditure on the Priority Schools Building Program will remain, as will the required capital maintenance funding allocation.
In higher education approximately 5.5% of students are from the EU and approximately 14% of research is funded through the EU. The numbers in themselves are not large, but it’s the overall effect of the Brexit impact on the UK economy and the wider global impacts that might trigger, are the unknowns.
Schools remain a key government focus and pace of delivery is a concern. The rise in construction costs of circa 5% does not help, given school benchmark costs were set in the period of the construction downturn. This is resulting in school new build opportunities not attracting the level of market interest they once did.
There remains a significant market in the schools sector with the EfA PSBP2 budget of c£2.7bn to build more than 270 schools in the next four years, school capital maintenance funding programs of c£1.4bn p/a and the Free school construction projects, the market will remain buoyant. Tenders will start to emerge latter in 2016 for PSSP2 with a program target completion of 2021. The PSBP1 budget is now committed and EFA have stated the program will be completed ahead of schedule. The new UK Government team and the new Education Secretary of State have not moved to change policy regarding the increased autonomy of schools through the acadamisation of schools and the construction of free schools. David Cameron’s pledged to build an additional 500 free schools to be opened in the next five years has not been altered, although the push to make all schools academies by 2020 has been dropped.
The Higher Education, universities sector remains strong with investment within the Russell Group of universities totaling c£9bn over their five year investment program up to 2016/17. The UK Government have removed the university placement cap which could result in an addition 30,000 students over the next two years. This is resulting in universities investing in their estate to attract students and improve the student experience. Local authority planners are also including conditions of consent to include the provision of dedicated student accommodation in line with increased intake. A majority of the UK universities have development plans in place that are now in build or procurement mode which is supporting the overall high value of projects within the education sector. In a recent universities estates report issued by AUDE, it stated the sector turnover is now c£27bn/annum with c£2.5bn on capital development / refurbishments.
In summary, the vote to leave the EU will continue to result in some uncertainty. However given the schools requirement to provide places and maintain the existing estate and the continued high standing of UK Universities, the sector has been and should remain strong.
Tender Price Indices
With the uncertainty, accurate forecasting is harder than ever. Many contractors have full order books for the next eighteen months and limited real data is available to support current predictions. Despite that, we can provide the following forecast and commentary.
There may be a degree of slowing in the market, but it is not going to be a dramatic dip like we saw as a result of the financial crisis, and as mentioned above, confidence among clients in improving and volumes are resilient.
A recent survey carried out by Building reported that consultants believe the vote to leave the EU will spark deflation in tender prices. This is also reflected in the BCIS revising their May 2016 Forecast of Tender Prices for 2016 from 3.7% to -1.8%, and 2017 from 4.3% to -2.6%, to reflect the forecast of a recession in the construction industry.
We know that the depreciation of sterling will increase the cost of imported materials and we also see pressure on wages due to skills shortages, which pushes up contractor costs. The graph below shows forecasts from BCIS. It shows costs increasing over the coming years alongside decreasing tender prices, which puts pressure on contractor’s margins.
BCIS Cost Indices Comparative
In the past Faithful+Gould has reported individual forecast figures, but on this occasion we provide a range.
Previously we reported a 4.5% increase in the Tender Price Index for 2016, 4% for 2017, and 4% for 2018. Our revised figures are now between 1% to 3% for 2016, between 0% to 2% for 2017 and 1% to 3% for 2018. Despite indicating a slight positive outlook, given the uncertainty there is a possibility that we could even see a negative value of up to -1% next year, however our “low” view is 0%, as shown on the graph below.
If you would like to discuss tender prices specifically in your sector and region please contact your local Faithful+Gould office.