A government with a clear mandate and bigger majority may provide stability with a clearer roadmap to leave the EU, but we don’t know the result and there is inherent uncertainty.
UK Economic Outlook
Since the referendum economic forecasts have been revised upwards. The economy is expected to perform better this year than we forecasted last year following the vote to leave the EU. The OBR forecasts 2% this year but dropping to 1.6% next year, but with Brexit and election uncertainty, and other global factors forecasting cannot be accurate. The OBR produces a real GDP growth fan chart, which is replicated below. The shading shows 20% probability bands, indicating how difficult it is to forecast.
Devaluation of sterling following the referendum is causing inflation to rise above recent levels, above the target of 2% but not by much, although may hit 3% this year – OBR forecasts 2.4% for 2017.
With an increase in the rate of inflation and stagnant average earnings, real disposable incomes fall. Considering consumer spending has played a key part in the relatively impressive GDP growth it’s something to watch.
Business and government investment is weak in 2017, however in May the Bank of England revised its Business Investment forecast to a positive value. It is encouraging to see better performance in this investment over the forecast period, and steady growth in employment.
The main political parties have all issued their manifestos ahead of the election and unsurprisingly all agree on increasing investment in infrastructure, whether that be transport, housing, energy and broadband. All parties are approaching investment in a different way, therefore the Government Investment line in the table above may have to be revisited following the election.
Construction Industry Outlook
In 2016 the construction industry saw the residential market slowdown and concerns over commercial investment decisions as the primary negative factors. We have witnessed a strong start to 2017. Barbour ABI research showed that March saw an increase in construction activity, but April saw a decrease of 15.9% on March. The number of construction projects, however, increased in April by 25.7% indicating more projects at a lower value. The Markit/CIPS UK Construction Purchasing Managers Index indicated a rise in overall construction output climbing from 52.2 in March to 53.1 in April, then jumping to 56 in May.
The CPA is predicting the industry to grow by 1.3% in 2017 and 1.2% in 2018. Overall activity in the industry remains stable. Construction output was higher in Q1 2017 in comparison to Q4 2016, although the growth was only 0.2% overall.
The remainder of 2017 and 2018 looks set for stability in terms of construction activity. There has been growth in outputs although the rate of growth in many UK regions will have peaked. Despite forecasts that there will not be the levels of growth seen over recent years there is no part of the country that is expected to see significant reductions in workloads that would constitute a cliff-edge – just a slowdown as shown on the graph below.
Source ONS & Experian
Corporate Occupiers Outlook
Commentary from Chris Read, from our Corporate Occupiers Sector: CRE continues to be a challenging market where market uncertainty and reducing capex investment has materially altered the approach. Traditionally the retailers and financial institutions have reinforced the fit-out market where large scale industrialised roll out led the market through previous years. Successive serial tendering and aggressive price based approaches to frameworks have driven down the price in the fit-out sector and now there is an increased focus on value. The impact of Brexit, European and US uncertainty along with elections in the UK will continue to reduce investment and the winners will be those who can visibly release value through property solutions.
There are several factors that are affecting the decision making on corporate occupier clients which leads to more piloting type projects and less of the standard solutions and roll out projects that have been the feature of the last 10-15 years of investments:
Workspace and consumer buying habits continue to change. Large spaces for working, shopping and people interaction are changing in preference for areas where collaboration and differing dwell times are incorporated. Designs now incorporate flexible features to improve human interaction within spaces and this is leading to the emergence of specialist workplace and furniture design companies. Continued commercial pressure from spending restrictions will drive the hunt for efficiencies and new ways to engage customers and the workforce. Therefore, the cost of fit-out continues to rise through specialist needs putting pressure on traditional areas of construction and the affordability model.
Impact on the Supply Chain of the current political and economic landscape - Issues such as exchange rate fluctuations are hindering global sourcing by supply chains, and the growing trend of sourcing from the far east has slowed. Whilst the markets are volatile and the political landscape remains unstable, investments are on hold unless there is a strong and compelling need to change. There is a call from global teams to make the best of the changing economic landscape, and the opportunities exist to take advantage. The knock-on impact is the capacity of the supply chain, where many have scaled back skills and capacity to cope with volume due to constraints and procurement integration. This has driven the price point down through successive serial tendering, and the focus on price has removed value from relationships, although organisations are reluctant to change delivery partners due to price inflation risk when they re-tender.
CRE continues to be a challenging market where market uncertainty and reducing capex investment has materially altered the approach.
Use of space - Expansion has stopped with smaller more flexible space being needed on-demand. Rent inflation has slowed, and outside of London the UK now offers an attractive proposition for global companies, and there is high tenure turnover in London, leading to project activity. There are opportunities to change and modify space with innovative solutions with retailers and planning authorities. The corporate environment continues to change rapidly in the face of new technologies and models of work. The emergence of an on-demand economy, where goods, services and skills are available more flexibly has started to disrupt several established industries. With a growing reliance on professional workers available on-demand, matched by companies seeking headcount reduction that can flex to changing business needs there is the inevitable change on CRE solutions.
Aggregating total spend and being able to drive value from FM and Capex Data - With Royal Mail Group, F+G has structured intelligent data and linked this to business outcome and risk allowing for the true business need for investment to be realised. Greater data management solutions will underpin future property strategies. They use data transparently, and sharing our knowledge and knowhow is key, creating industry leading benchmarks to inform and guarantee project outcomes. The approach we are taking with data is helping to shape the industry as we grow global best practice through strong professional delivery.
Commentary from Mark Stevens, Head of Commercial Property: The commercial property sector sustains, with developers taking a cautiously positive approach to the market with sentiment driven by basic supply and demand dynamics.
On the supply side, new office completions are predicted to rise this year as the large number of developments started in 2015/16 finally comes on stream. In London, the 4.5m sq ft of new space delivered to the market in 2016 is expected to reach 6m sq ft this year. However the value of new construction starts fell in the first quarter of 2017, with the 3 months to the end of March down 7% on the same period last year in London and 24% nationally. In large, this is thought to be due to the high value of construction starts in previous years rather than to the deliberate holding back of new projects. Indeed some regional hot spots such as the South East, East Midlands and the South West were able to buck this trend with modest growth.
On the demand side, occupier take up has been strong with little sign of an exodus from London and the other EU financial centres that some were predicting. The consensus held at the recent BCO conference was that Brexit was having only a relatively minor effect on London office demand with major financial firms establishing or reinforcing European outpost offices rather than wholesale relocation. Indeed, in the last year an additional 13,000 jobs have been created in the City.
For the wider U.K. the statistics indicate that our dependence on European trade is perhaps not as great as many believe with only 8% of U.K. companies exporting goods into Europe accounting for circa 12% of GDP. This gives some confidence to the lettings market going forward.
With the general election looming and the Brexit negotiations yet to begin in earnest, the approach for the commercial property sector for the rest of the year will be “Steady as she goes”
Commentary from Terry Stocks, Head of Public Sector and Education: As with many other sectors the UK Education sector has several uncertainties revolving around Brexit and skills. The HE sector has additional pressures relating to the Westminster Higher Education Bill, which became an act of Parliament in April this year. The bill focuses on student outcomes through increased measurement and parliamentary powers to audit and intervene, including reducing the cap on fees that universities can charge because of new performance indicators. The bill also looks to increase competition in the sector, which could dilute the number of undergraduates seeking existing institutions. The bill will apply pressure to university budget setting, trying to balance the uncertainty around student numbers with the requirement to maintain an attractive student offer and experience.
In the schools sector there is ongoing pressure on funding. Pressures on rising student and operational costs are creating tensions within schools in protecting front line teaching while undertaking their statutory duties in the management of the assets. The main ESFA programmes continue the PSBP 1 and 2 programme, the Free Schools Programme and the capital maintenance schools funding programme. The schools sector continues to move towards Academy status with over 6000 academies now in place - an increase of c 2000 over the last period.
In general, capital estate funding across the sector has remained relatively constant at c£5bn. The average rolling monthly contract let is c£400m. In the next period this will likely remain static with schools continuing to procure and universities completing existing schemes and focusing on key aspects of their master plan. However, in the longer term much will depend on the wider economic market and emerging Brexit negotiations and immigration outcomes.
The total capital expenditure over the previous financial year was £2.5bn. However, AUDE state that they do have concerns that this level of investment can continue over a period of uncertainty, and reduced confidence in the financial markets will result in more expensive debt. Universities are seeking alternative routes including grants and institutional funding. Private developers are continuing to invest in student accommodation due to the continued under provision and the growing preference away from multiple occupancy households.
The university estate has continued to improve over the last ten years, however there remains a significant back log maintenance build up and c 14% of both the non-residential and residential estate is regarded as functionally inefficient and c22% requiring significant repair. Therefore, to maintain and grow student satisfaction and attraction, funding will be a continued requirement, especially in the light of the new Higher Education Bill criteria and competition.
The HE sector has additional pressures relating to the Westminster Higher Education Bill, which became an act of Parliament in April this year.
An emerging trend could be to see UK university institutions opening campuses outside of the UK. This is already happening and is likely to be a feature in future years.
There is a case that the Higher Education sector needs to invest to resolve back log issues and build new and efficient facilities to attract students and research funding. However, depending on key economic outcomes major capital investment may be focused outside the UK, with investment in maintaining the existing stock in the UK.
The Education Skills Funding Agency (ESFA) continue to procure and deliver substantial programmes of work across their key programmes. The school capital maintenance funding is maintained at c£1.2Bn per annum, Free Schools programme continues with a new wave recently procured as part of the c5 year programme costing c£2bn. The Priority Schools 2 Programme continues with a budget of c£2.4bn as part of the overall PSBP with a budget c£4.4bn delivering over 500 new and refurbished schools by 2022. However a recent National Audit Office Report stated c£6.7 bn is required to return schools back to a satisfactory condition and a further £7.1bn to return them to a good condition. Despite this huge effort School places continue to be a growing requirement and at a premium in some areas.
Commentary from Andrew Prickett, Head of Residential: The Residential sector continues to perform well with sustainable growth potential.
In March 2017, the Residential sector had the highest proportion of contracts awarded by value with a 32% share of the total value of projects awarded. A year on year comparison shows market growth of 24.2% higher from March 2016 records. Residential remains and will continue to be the largest Sector in construction for the foreseeable future.
This is all against a backdrop of a sector which consistently fails to achieve its Governmental target of 200,000 new homes per annum; 140,000-150,000 per annum is a more likely outcome for 2017/18. With the availability and affordability concerns around good quality new homes (which is a UK wide issue and not London centric as some believe) we have seen a softening in house price growth, similarly we are not seeing such aggressive rental growth as previous years.
The Sector and the UK demographic are adapting and changing, the Thatcher Years of “Our Home is our Castle” has become watered down with the next generation more widely accepting that rental options such as we see in main land Europe and the US can offer a creditable alternative with ultimate flexibility. It is therefore not surprising that we see continued growth in the Private Rented Sector (PRS) with heavy investment not only from Institutional Funds but also the foreign investor market who are taking advantage of the weak pound (Most see the UK market as a sound long term investment “25-year cycle” with current values based on exchange rates which are near 20% cheaper than that seen pre-Brexit announcements).
London has approx. an 18.5% share of UK Residential activity, which is a significant slice of the cake. However, F+G as a business with 23 UK offices covering most regions the remaining 81.5% share is a segment that we are confident will continue to perform well.
With confidence in the Sector growing quarter on quarter, year on year we are seeing some exciting innovative building technologies come to market. Modern Methods of Construction (MMC) are taking a foothold with noticeable investment in manufacturing facilities (L&G being the most prominent). Forecasters including myself can see a real step change in how we deliver new homes and there is no reason why MMC could not deliver 15-20% of all new homes in the coming years.
With confidence in the Sector growing quarter on quarter, year on year we are seeing some exciting innovative building technologies come to market.
With a General Election imminent, all political parties continue to recognise the importance of the UK Housing Crisis and set out their response and articulate how they will make a difference if elected. Following our own Elections, we have the Brexit negotiations which need to commence and be concluded in a target period of approx. 24 months. The Sector has concerns of how this will affect the current skills shortage and growing need to use foreign labour, the uncertainty around rights to work and freedom of movement are therefore distinct background noise. This is a likely contributor/ catalyst to the growing MMC response as highlighted above.
In closing, the reality is the UK has a growing and aging population who need good quality affordable homes. We therefore should be confident that activity in both new build and refurbishment of existing homes will continue to maintain a large market share, likely the largest.
Tender Price Inflation
National forecasts provided by the BCIS are suggesting that building costs generally are forecast to rise at a constant rate of around 4% per annum for the years 2017 through to 2021. The main factors considered for this forecast are:
- Devaluation of Sterling.
- Increase in imported material prices.
- Robust demand for materials generally.
- Increase in labour costs through scarcity of some skills
With costs increasing at 4%, demand maintained across the UK and sustained construction output we expect tender price inflation to reach 4% in 2017, followed by 3% in both 2018 and 2019. This is at the upper end of our previous UK forecast where we offered a range due to the volatility of a range of factors at the time.
We will be updating our national forecast on a bi-annual basis, however if you would like to discuss tender price inflation in your area or for your specific project please contact your local Faithful+Gould office.