The UK Economic Outlook
The UK continues to perform strongly, despite having slowed a little in early 2015. Domestic demand remains relatively strong, supported by lower oil prices. Risks to maintaining the level of growth are largely international factors such as uncertainties in Europe, China and other geopolitical risks.
The services sector will continue to be the main force for growth in the UK for both output and employment – construction and manufacturing growth has slowed since last summer. UK GDP growth forecasts for 2016 range from 1.4% to 3%, with an average across 20 leading forecasting institutions being 2.4%. The UK economy grew by 0.7% in the second quarter of 2015.
Business investment will also be a key force for growth and many companies plan increased capital spending and staff recruitment. The domestic outlook is good, boosted by the corporation tax cut announced in the summer budget.
Employment has increased by 359,000 in the year, with 73.7% of people aged 16 to 64 employed, with an unemployment rate of 5.4%, which is a 7-year low. Average weekly earnings are up 3% (including bonuses) over the past year.
The summer budget from the recently formed Conservative Government also set out plans for further fiscal tightening to reduce the budget deficit by the end of the decade, however it will be at a slower pace than previously envisaged.
Inflation was expected to rise towards the 2% target towards the end of 2016, however fell to -0.1% in September due largely to fuel, food and clothing. Hitting the 2% target is dependent on no further falls in prices in the global energy and food markets, and the Bank of England has forecast that inflation will reach 1% in spring 2016. Interest rates are expected to remain unchanged in the near term, but forecast to be subject to a first rate rise in H1 2016.
UK Construction Industry Activity
The construction sector in the UK has slowed since 2014, which saw growth of 9.5%. 2015 is expected to be 2.3% with 2016 being around 2%, although some forecast are more optimistic. The Office for National Statistics (ONS) has said that construction output fell 4.3% in August, its sharpest drop since late 2012.
The seasonally adjusted Markit/CPIS UK Construction Purchasing Managers Index (PMI) saw a 22-month low in April at 54.2. Any score above 50 indicates growth, however, and May saw a step up to 55.9 and June recorded 58.1. Housebuilding saw the fastest growing area of output, but the headline increase since May was driven by commercial and civil engineering activity. However, despite the confidence in the industry, housebuilding fell by 3% from July and output in other parts of the industry also contracted for the first across-the-board decline since 2010.
Recently there has been an upturn in job creation in the industry, and there is upward pressure on wages, particularly in the southeast. Greater workloads supported an increase in purchasing activity at construction companies in June, and this has led to a reduction in performance of suppliers with lead times growing. This has also put pressure on prices, with construction inflation at a 3 month high driven largely by higher materials costs but also increased workloads.
July saw construction activity increase by 5% from June with the value of contracts awarded at £6.5Bn. This is a 28.7% increase on the value in July 2014. In contrast to this, however, the quantity of construction contracts in July increased by 8.1% on June, but was 11.7% lower than in July 2014.
The 5-year outlook is relatively bright, with annual growth in the construction industry forecast to be greater than 4% from 2017 to 2019. The growth will be boosted by significant investments in infrastructure and the continued expansion in residential and commercial sectors.
The offices market is performing well, with occupiers and investors encouraged by improving confidence and a positive economic outlook. Commercial construction was the second largest segment of the UK construction industry in 2014 after residential. The three months to July in 2015 saw a combined increase the value of contracts commercial and retail sectors of 25% from the same period in 2014. In July 2015 53% of contracts in this sector were in London.
Greater London offices
Statistics published in Q2 2015 showed that supply of office space in Central London was 5.8m sq ft, equating to a vacancy rate of 6.1%, while demand stood at 8.4m sq ft in June this year. Putting this into context, the average historic average vacancy rate is 10%, showing that rents will continue to be attractive to developers. Optimistic business sentiment and three months of relative economic stability, following the general election, have also been considerable contributing factors to the surge in demand for quality office space in Central London. This is demonstrated by rises of 14% to office rents on 2014 figures.
As a result of extortionately high rents, which are up 14% from this time last year, and the lack of available space in the City of London, demand for office space in the less traditional locations such as Paddington, King’s Cross and Whitechapel, where offices are either conveniently located near major existing or proposed transport hubs, has increased dramatically. While take-up in the City remain largely by the financial services, banking and insurance sectors, the media and tech sectors are increasingly willing to compromise on location in favour of increased space and lower rental values. Activity is therefore by no means confined to the City, but also to satellite locations in numerous locations throughout London.
One of the major players in the commercial market is the Battersea Power Station Development Company, having awarded contracts in excess of £600m in value over the last 12 months. The Canary Wharf Group was also responsible for letting the £200m 1 Park Place mixed use development in August this year, which will include retail as well as office space. Further examples of developments let in August 2015 include the Old Bailey and the Marble Arch Tower, which have contributed to a 6.9% increase in contract award values since August 2014. The office sector is currently contributing heavily to the sharp rise in tender price indices witnessed in the first 6 months of this year.
Greater London Residential
The months between April and August 2015 have seen a decline in both the value and number of residential contract awards made in London, with an 18.3% decline in contract values awarded between July and August alone. However, the South East has performed better during the same period. Average house prices in London have risen to record levels, although the rate of increase has reduced slightly since this time last year. Demand generally remains strong.
These statistics reflect one key feature of the London Construction Market over the last 6 months, which has been the rotation of trade contractors from the residential sector over to the commercial sector, as opportunities in the latter have become more readily available. This shift may have appeared attractive to trades contractors who wish to re-establish relationships with long-standing large commercial developers. Therefore, it remains to be seen how this will affect the residential sector in the short-term. Examples of contracts let in recent month include the £80m Alto Wembley Park project. The majority of projects awarded over the last quarter have been in the private sector.
Education continues to be a buoyant market.There has been a slight drop of c6.8% in contract output compared to the same point in the previous year. The three month rolling average contract value output this year is approximately £650m. Approximately 35% of the output is in the London and South East region, 20% in the Midlands and 15% in the North West / East. The university and college sector accounts for some 30% of the total and c55% state schools. The expected whole year investment across the whole education sector is expected to be c£13bn. This has a projected rise to c£14bn in 2017. There are a number of drivers for this increase including the rise in the UK birth rate, numbers of young people entering the school system and removal of the university degree cap.
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. The Prime Minister, David Camron, has also pledged an additional 500 free schools to be opened in the next five years. Even with this level of investment London Councils are predicting a short fall of places in London from 2018 with a recent London Councils report calling for an additional £1.5 bn to create circa 100,000 additional places by 2020.
The Higher Education, universities sector remains strong with investment within the Russell Group of universities totalling c£9bn over their five year investment programme up to 2016/17. The UK Government are removing 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 now have development plans that are now in build or procurement mode which is supporting the overall high value of projects within the education sector.
In addition to capital new build there is significant investment in maintenance and operation across the education estate. The school’s annual maintenance budget is a combined c£1.4bn. However with only circa 5% of the school estate being deemed grade A (performing at intended and operating efficiently) and 9% graded D (life expired / in danger of imminent failure.) The Education Secretary of State, Nicky Morgan has stated there will be an additional £4.2bn of maintenance funding allocated to schools over the next 3years to 2017/18. In a recent universities estates report issued by AUDE, it stated the sector turnover is now c£27bn/annum with c4% (£1bn) being spent on maintenance.
The National Infrastructure Plan (NIP), published by the HM Treasury in December 2014, states that a high standard of infrastructure is an essential element for boosting the UK’s productivity in order to meet the government’s Long-Term Economic Plan. By declaring a pipeline of up to £466 billion of planned public and private investment, NIP aims to expand networks and bind together regions of the UK to provide greater economic potential.
Since then a review in July 2015 has revised the forecast for 2015-16 onwards to £411, i.e. a net reduction worth £55 billion, this after allowances for works undertaken in 2014-15.
Notable changes in pipeline include; a lower energy pipeline due to the falling private sector investment in oil and gas, increased investment in the communication sector from mobile network operators and an additional £1 billion 10-year investment of Manchester City Airport.
The funding for the government’s NIP is made up from £101 billion of public funding, £264 billion of private funding and £46 billion mixed funding. The total value of the pipeline is then divided into energy (60%) and transport (31%), with the remaining pipeline split between communications, science and research, flood defence, water and waste. Stretching across 265 programmes and 299 projects, the expected average annual spending figure sits around £48 billion over the next 5 years.
Current figures show that there has been an unpredictable, but positive growth in infrastructure. The latest statistics show that contract award values have fluctuated each month of 2015, but based on a three month rolling average, values have increased 34% from Q1 (£3.8 billion) to Q2 (£5 billion). More importantly, Q2 is 67% higher than the same period in 2014, representing a positive forecast leading up to 2016. Most recently, July 2015 achieved a total value of contracts awarded at £2 billion, some projects of note include the Burbo Bank offshore wind farm extension valued at £230 million and the M6 Junction 16-19 Managed Motorway at £130 million.
Looking forward to the end of year 2015 and the start of 2016, Highways England are in a perfect position to secure growth in infrastructure as they have recently announced plans to invest £3.8 billion on major A roads and motorways across the Midlands and East England. Furthermore, they are meeting with suppliers and stakeholders to discuss the spending on a further £2 billion on roads in the South-west which will be a vital key to the construction of the Hinkley Point C nuclear power station. Bidders for the £11.8 billion HS2 phase two civil works are also in the process of being shortlisted for tender as invitations to tender will be issued in spring next year.
To conclude, the above figures suggest that at the current rate of growth, the total contract award value of year 2015 is likely to fall short of the NIP assumed average annual pipeline spend.
Materials and Input costs
The Federation of Master Builders’ (FMB) State of Trade Survey in Q2 2015 stated that 67% of firms surveyed expected materials costs would continue to increase over the coming six months, with around 2% believing a decline in costs while around 28% of businesses expecting costs to remain unchanged. According to the Office of National Statistics (ONS) and Department for Business Innovation & Skills (BIS) the All Work material price index fell by 1.4% in the year to June 2015, however individual material prices showed a varied rise/fall for the same period. Asphalt products fell by 7%, fabricated structural steel by 12% and concrete reinforcement bars by 14%, whilst cement rose by 3%, ready-mixed concrete by 5% and imported plywood by 6%.
Contractors are still indicating that they are having difficulties in recruiting certain specialist trades, in particular bricklayers, carpenters, roofers and plasterers. This is supported by the FMB. In addition wages are on the increase, the Construction Industry Joint Council awarded building operatives a 3% increase in June and demolition operatives a 2.5% increase in July.
Commodity prices continued to fall during Q2 2015 according to World Bank (WB) figures, with oil and metal prices tumbling in the last 12 months. With crude oil currently trading at around $50/barrel, roughly half that of a year ago, experts are understandably worried about where oil prices may go next. The majority of metal prices have also seen a major fall over the same time period.
In the current market, contractors are now becoming far more selective when it comes to the tendering procurement route of projects with many preferring two stage tendering as opposed to the more traditional single stage, which was preferred when the growth rate in the construction industry was lower. This presents a challenge to the industry and is leading to construction inflation, and in some cases we have witnessed tender returns higher than expected.
BCIS Cost Indices Comparative