Is construction in reverse gear?
Uncertainty around Brexit is contributing to a slowdown for the property and construction sector, reports Ian Harper. What could 2018 bring for brick and mortar?
The UK construction sector appears to be heading into crisis. Activity in this key economic sector slumped for the first time in over a year in September 2017, reflecting declines in civil engineering and commercial building, while expectations of future growth deteriorated to their lowest level for 12 months, according to an important report published on 3 October.
Defying expectations, the IHS Markit/CIPS Construction Purchasing Managers’ Index slumped from 51.1 in August to 48.1 in September, its lowest since July 2016 and dropping below the neutral 50.0 level into negative territory for the first time since August 2016.
The IHS Markit report added: “Optimism about activity levels over the coming year also slipped to the lowest since July of last year, when uncertainty fuelled by the Brexit vote blurred the outlook.”
According to British Property Federation Chief Executive Melanie Leech, the UK construction industry and the health of the UK are “inextricably linked”. As she pointed out: “We contribute £94bn annually to the economy, representing 5.4% of GDP.”
Muted economic activity and appreciable economic and political uncertainties threaten to be a highly challenging combination.
Chris Williamson, Chief Business Economist at IHS Markit, said: “The construction sector has slipped into decline for the first time since the brief downturn in the summer of last year when building activity was disrupted by the surprise EU referendum result.”
Tim Moore, the report’s author, said growth expectations across the UK construction sector are among the weakest for four and a half years, and that cost pressures have intensified, driven by supply bottlenecks and rising prices for imported materials.
Looking ahead, the construction industry faces some big challenges, from falling foreign investment to Brexit-related issues, including unfavourable exchange rates, rising inflation and future labour supply worries.
Howard Archer, Chief Economic Adviser to the EY ITEM Club, told The CA magazine: “Muted economic activity and appreciable economic and political uncertainties threaten to be a highly challenging combination for the construction sector over the coming months.”
Commercial building fell for a third successive month, rounding off the worst calendar quarter since 2009.
Leech commented: “For property investors and developers, who recognise development often spans decades rather than years, and anticipate the benefits and challenges presented by economic cycles, political and regulatory certainty is critical.”
However, the situation may be even gloomier. IHS Markit’s Williamson said: “Digging down into the construction data reveals further worrying trends. The biggest loss of momentum was recorded for civil engineering, where activity suffered the largest monthly fall since April 2013. However, commercial building fell for a third successive month, rounding off the worst calendar quarter since 2009. As commercial construction includes the building of industrial units, offices and shops, the recent decline points to a drop in fixed asset investment by businesses.”
Where is construction heading?
Why has activity slowed, can the challenges be met and where is the construction sector heading? The main driver of the slowdown, said Brendan Sharkey, Partner and Construction and Real Estate lead at accountants and business advisers MHA MacIntyre Hudson, is uncertainty.
He said: “There is little appetite for developments that are speculative and it’s hard to attract finance, but the real issue is that there is no clear picture of what is coming.”
According to Kelly Boorman, Head of Construction at RSM: “The slowdown we have seen in recent months has been due in part to challenges around the availability of resources and the fall in new investment, particularly that of large international investment.”
Iain Walker CA, Director, Corporate Advisory at French Duncan, said: “With Brexit looming, there is likely to be an impact on the freedom of movement for EU workers seeking employment in the UK, which will contribute to likely rising labour costs and a continued shortfall of skilled labour.”
The rising costs of raw material make the process of bidding for contracts increasingly difficult.
Boorman agreed: “The war for talent is likely to get even more intense. With the prospect of reduced flows of skilled and unskilled labour from Europe post-Brexit, this could make life difficult for sub-contractors and push up costs to tier 1 contractors.”
French Duncan’s Walker added: “Inflation is a problem. The rising costs of raw material make the process of bidding for contracts increasingly difficult. Another knock-on effect of inflation is that it makes it more difficult for companies to set their own budgets and forecasts. However, current exchange rates represent a larger issue than inflation.”
According to Boorman, cost pressures are leading to structural changes in the sector. She said: “Whereas some years ago the main contractors were looking to offload supply chain businesses to reduce costs and risks, we are now seeing the trend in reverse.”
Main contractors, she added, want to regain control over prices and delivery deadlines to improve their bottom lines. Carillion had to write down £845m because of overrunning projects.
The Bank of England’s Monetary Policy Committee expects investment in the UK economy to be 20% lower in 2020.
The big problem, though, could be investment. In the wake of the Brexit vote, both Aviva and M&G suspended property funds and in September, real estate analyst at Aviva Investors Tom Goodwin warned Brexit-related concerns could make UK real estate investors “more defensive”.
The Bank of England’s Monetary Policy Committee expects investment in the UK economy to be 20% lower in 2020 than previously forecast, but Goodwin notes that valuations of real estate assets have not yet adjusted to reflect this.
When the turn will come is not certain, but Goodwin points to shifts in sentiment of Chinese investors (a key supporter of London’s property market in recent years), possible moves by the Government to restrict to the cheap finance that has funded local-government property transactions of more than £700m in the year to date, and reduced demand for shop space from a weakening retail sector.
After Brexit: the way ahead
The future of the Private Finance Initiative (PFI), which Labour said it will scrap, is in doubt. Shona Frame, partner and construction specialist at law firm CMS said: “Without PFI it is not clear how many proposed infrastructure projects would be financed in future… Many within the industry would now be keen to know what alternative approaches to funding would be put forward by a future Labour government.”
On the upside, though, there are significant potential emerging opportunities, such as big transport projects. Sharkey said: “HS2 is with us and it is a matter of development speed. This would be a good time for Heathrow and Crossrail 2 to be pushed forward, as large infrastructure projects give confidence to the sector.”
We are a long-term industry – buildings, places and communities aren’t designed, built and brought to life in a day.
Chancellor Philip Hammond’s announcement, on the eve of the Tory Party Conference, of a £400m boost for transport links in the north could also help.
Sharkey also argues that house building will prosper as long as Help to Buy continues.
More broadly, Boorman points to the Infrastructure and Projects Authority’s recently published 2016/17 annual report. “This shows there are 143 major projects on the Government’s Major Projects Portfolio (GMPP), worth £455.5bn. The infrastructure and construction sector is the largest area of growth on the GMPP, reaching a record value of £222.5bn.”
However, for Leech at the British Property Federation, the way ahead lies in planning for life after the EU. She said: “Brexit has undoubtedly had an impact on the property and construction sectors in the UK.
"We are, however, a long-term industry – buildings, places and communities aren’t designed, built and brought to life in a day. Once the UK leaves the EU, businesses in the UK will still need high-quality infrastructure within which to operate and all of us will still need homes, as well as retail and leisure facilities in which to meet and relax. Indeed, it is arguably more important than ever that we create, over the next few years, the physical environment that will support the UK’s new future outside the EU.”