Early in 2020 there were signs that the sector was beginning to recover after being in stagnation since the EU referendum and the following uncertainty.
April saw a record 40% drop when most sites were closed, before there was a 7.6% increase in May followed by an increase 23.5% in June as lockdown restrictions were eased. Despite these increases in output in May and June, output remains 25% below the February level.
Even the most optimistic forecasts do not anticipate that output will return to pre Covid-19 levels to the end of 2021, with some suggesting that it could be as long as 2024.
Source Construction Output All New Work - ONS July 2020
Construction Inflation Influencers
The effect of the pandemic has been to show how the individual factors are linked to produce the cost changes in industry. To highlight the influencers we have spilt them into deflationary (downward) and inflationary (upward) pressures.
Reduction in domestic demand
- The longer the pandemic lasts the more likely it is that confidence will be lost, and clients become risk adverse leading to proposed projects being put on hold or cancelled.
- Closed Sites – Initially most of the closed sites were residential and this was coupled with a virtual closure of the housing market with a suspension of mortgage applications and personal viewings forbidden for a period. Although this has been lifted the current lack of confidence in committing to personal expenditure is affecting this sector. While the lifting of restrictions has seen an increase in house prices and demand initially surging due to the suspension of stamp duty, the OBR have forecast a fall in house prices of at least 8% this year before recovering next year. This is coupled with evidence that people are looking to move out of major cities and a growth in home working bringing new requirements.
- These may lead to a reduction in new orders and see contractors adopting increasingly competitive pricing to maintain turnover and market share.
Reduction in global demand
- Indicators are that most countries will fall into recession reducing global demand & investment.
Realignment of cost base
- Reduced demand for labour & materials - We have seen contractors and consultants begin to shed jobs and apply salary cuts. There is expected to be a 7.5% reduction in the number of directly employed workers across the industry by September.
- Homebuilders, specialist contractors and contractors are the most significant users of self-employed and agency workers, contractors are mooted to be looking to reduce self-employed and agency workers.
- Overheads costs are likely to be reduced, and it is possible that these will be passed on as price reductions. Contractors margins will be reduced to win work, but this is a double-edged sword as lower margins will increase the risk of insolvencies and could cut the expenditure on training much needed apprentices.
- Cost savings are being passed down the supply chain with reports of main contractors attempting to renegotiate contract prices down with sub-contractors by up to a 10% reduction.
Personal confidence levels
- People are also faced with job security, reduced spending power and a reluctance to venture outside of the home needlessly.
Loss of industry capacity
- The reduction of the labour force as many operatives move away following the UK leaving the EU. This will leave the industry shorthanded due to a lack of enough home workforce. Going forward as the economy recovers this will have a major impact on tender costs as without easy access to skilled and unskilled workforce this will drive labour costs up
- There will be an increased risk of insolvencies due to increased cost pressures, payments for goods filtering down the supply chain and non-recoverable costs of delay.
- Any increase in insolvencies will lead to fewer contractors to choose from. This will lead to a less competitive market place and tender price increases in some sectors.
Material production shutdown
- Supply chain – at present many manufacturers have reduced their manufacturing capacity, some including Ibstock and Forterra have already announced restructuring and job losses. Manufacturers and suppliers have stated that demand will have to return to an appropriate level before increased capacity is resumed
- The disruption of material supply chains continues to cause problems with pinch points in continuing to impact productivity with delays being reported across some areas of materials.
- Brexit looms and any lack of confidence in Sterling will push exchange rates down as market investors look for safer currencies and markets. Any reduction in the level of Sterling will lead to an increased cost of imports.
Introduction of Tariffs
- Without any trade deal there is a potential for the introduction of tariffs for the importing and exporting goods to / from the EU.
- Within the property sector most of the curtain walling and MEP is imported from the EU and they may suffer from the double effects of currency movement and tariffs.
- Presently the RICS believe that output productivity in June to be at 80% of pre-covid levels.
- Upward cost pressures due to the impact of social distancing measures, leading to reduced output and the need to provide more staff space and site monitoring leading to increased preliminaries.
- Difficulty in coordinating deliveries, due to unavailability or late delivery of materials and dealing with multiple trades on site whilst social distancing remains.
- Logistics - problems with obtaining specialist equipment, especially with transportation issues and the possibility of the specialist suppliers going into insolvency.
- Possible labour shortages may lead to reduced output, and unavoidable delays on site and the elongation of the project and the addition costs through preliminaries etc. that this causes. This could lead to more off-site manufacturing being introduced to reduce site labour requirements and logistical challenges, thus increasing on-site productivity
Increased Government Borrowing
- Result of high government borrowing may mean that the government will look to increase revenue by increasing taxes and national insurance, albeit this is countered by presently being able to borrow at record low rates
Increases in risk & Non-recoverable costs of delay
- Contractors are looking to cover themselves against unforeseen circumstances & interruptions, these include pricing greater risk into the tenders and requesting specific Covid-19 clauses. These will have inflationary pressures due to additionally costs.
TPI Predictions – Q3 2020
Current trading conditions are resulting in a market re-assessment about initiating projects. These reflect not only economic demand but also a potential shift in the way that we live and work with potentially more home working, demand for housing outside the major cities and a shift of retail away from city centres to where the consumers reside.
With the outlook indicating a slow growth back to pre-pandemic levels this will place pressure on increased output costs against the need to secure work and costs driven down, at a time where the investment is low which will likely result in tender price reduction.
For larger and more complex projects where there are only a limited number of contractors and suppliers capable of undertaking the work, we anticipate that tender prices will remain firmer with a limited profit in operation. For smaller, simpler projects where there will be sharp rivalry for securing work there is evidence that tender prices are beginning to fall and will drop further until the pipeline for new orders is stabilised.
Due to the uncertainty that we currently face and how the economy will recover our forecast provides predictions representing our current thinking on how the economy will recover via the most popular “L” and “Delayed V” shapes.
We anticipate that these will increase through the year if the new confidence turns into placed orders, forcing contractors to compete for labour resources.
With the most recent published figures and the sentiments of most economists we recommend the adoption of the “L” figures as the most likely route.
Faithful+Gould also provide global indices for major cities around the world based on input from our worldwide network of offices and publicly available material. Click on the link https://www.fgould.com/americas/articles/2019-global-location-indices for further details.