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Growth on horizon but economic recovery required

With the UK in a deepening recession and uncertainty over the eurozone unlikely to disappear any time soon, the outlook for construction for the next 12 months is bleak.

Most concerning are public sector cuts and the subdued private sector, which are expected to result in significant industry contraction this year followed by a further marginal dip next year, before growth returns in 2014.

Some sectors boast brighter prospects than others, though much of this is dependent on when economic recovery returns.

Offices

With high-profile offices funded internationally, and international investors increasingly nervous, even the pipeline in the previously buoyant central London market is slowing.

The Shard has now opened and focus has switched to other towers under construction, such as 122 Leadenhall Street (the Cheesegrater) and 20 Fenchurch Street (the Walkie Talkie), in addition to those on hold since January 2012 such as Principal Place and The Pinnacle, valued at between £800m and £1bn.

Once economic recovery is under way, those projects currently on hold would certainly be expected to come back on line, but don’t expect this until 2013 at the earliest.

The majority of the offices market, however, focuses on smaller mid-sized projects and it is these that appear to have dried up in central London - the pipeline over the next year appears insubstantial.

The offices market outside London remains very weak with take-up around a quarter lower than the long-term average.

Despite positive noises by property agents who appear to be talking up the market, a surplus of office space outside the M25 means the near-term future is relatively poor.

Output in the first quarter of 2012 was 7 per cent lower than in Q4 2011 and new orders for offices in the six months up to the end of the first quarter were 14 per cent lower than the year before.

Office construction is expected to be much more subdued than we had anticipated a year ago, with a forecast fall of 2 per cent in 2012 before a growth of 1 per cent in 2013 following the start of economic recovery, and a pick-up in demand for central London office space.

Once the market is more certain, growth should accelerate to 6 per cent in 2015 with a further 5 per cent in 2016, yet even then activity will still be below pre-recession levels.

Private Housing

Private housing has a relatively bright future, although large housebuilders have brighter prospects than smaller businesses.

All the main housebuilders appear content at the moment, and having seen the positive results reported to the City over the past six months, it is not difficult to see why.

Following the 2008 financial crisis, housebuilders went through a period of reducing capacity, destocking and writing down the value of their land. Although the UK is again in recession, housebuilders are in a very different position.

They are raising the book value of the land, enjoying profit margins of around 10 per cent to 15 per cent and gradually raising the number of units. They also have plenty of land with planning permission, around six or seven years’ worth, although obviously not all of the land is in the main areas of demand, such as greater London and the South-east.

The NewBuy initiative should provide a small positive boost but is unlikely to be a game-changer, with some concern around the mortgage rates being too high, but it at least makes 95 per cent mortgages available now.

As a consequence, it would not be a surprise to see large housebuilders raise unit numbers by between 5 per cent and 8 per cent this year before double-digit growth next year onwards.

But small- and medium-sized housebuilders are not so fortunate. They are more dependent on cashflow and suffer from delays in planning, as well as struggling to obtain lending facilities and continuing to suffer from the general economic environment. In addition, they don’t benefit from NewBuy.

Private housing starts are expected to increase by 3 per cent over the course of 2012, driven by major housebuilders. Despite problems for small housebuilders, economic recovery is set to boost housebuilding by an average of 10 per cent each year between 2013 and 2016.

Rail

Rail is a major growth area for construction and represents a great opportunity for many contractors.

A lot of firms don’t think to enter into rail work as they don’t build tracks, but a considerable proportion of investment is not what most people think of as rail; it is station developments and refurbishments - retail, offices and even some residential.

A prime example is the £1 billion Tottenham Court Road station redevelopment that forms part of Crossrail, Europe’s largest construction project.

This includes 500,000 sq ft of high-profile retail, office and residential floor space.

Work is continuing on the £15bn Crossrail programme across London in addition to the £6bn Thameslink programme. But there are a number of station refurbishments within Network Rail’s spending programme of £34.6bn up to 2014, and therefore opportunities for contractors exist across the country.

Output rose by 59 per cent in Q4 2011 and was 28 per cent higher year on year in Q1 2012. New orders for rail construction during that quarter increased by one third compared with a year ago.

Rail output is forecast to grow by 16 per cent this year, accelerating to 22 per cent in
2013, and a further 9.3 per cent growth in 2014.

In the longer term, the government has made it clear that public subsidy in the next spending period to 2019 will not be as high as in the 2009 to 2014 period.

In July it hailed a £9.4bn pipeline of projects from 2015, though more than half of these had already been announced.

The remaining £4.2bn of new projects include electrification schemes from Sheffield to Bedford, £322m of track and capacity upgrades across Manchester and Liverpool, and electrification of the line to Swansea, worth more than £600m.

While this will boost spending from 2014 onwards, the government’s commitment to cutting the public subsidy means investment will not be sustained at the level it will reach over the next three years, which is set to be a golden period for rail investment.

Retail

Despite retail construction falling by a quarter following the financial crisis, supermarket work proved enough to ensure growth over the previous two years. However, 2012 is likely to be an uncomfortable year for most retail contractors.

Most major supermarket chains are well into expansion plans and while these will continue to provide fresh work, additional growth is unlikely. Tesco, Sainsburys and Marks & Spencer have all announced cutbacks to their renewal programmes.

Growth elsewhere will likely come from coffee shop chains, such as Costa, and sandwich shop chains, such as Pret A Manger, both of which will continue expansion plans. But general retail new-build and major refurbishment is relatively subdued, having been adversely affected by the economy.

Consumer confidence is unsurprisingly low given the return to recession and spending is subdued as a result.

This will not have been helped by the recent poor weather but more generally, real disposable household incomes are under pressure, falling by the greatest amount in more than 30 years during 2011.

Prime areas of central London continue to be boosted by international retailer investment at the very high-profile end of the market. In fact, investor activity in London was only constrained by lack of supply, with record rental values being achieved on Bond Street, Sloane Street, Oxford Street and Regent Street this year.

But this is very much a niche area, with yields on other major UK retail streets outside of London more than double those in prime retail areas of the capital this summer. Accordingly, our forecast for retail construction output for 2012 is a 3 per cent fall.

Retail is expected to recover as the economy and real incomes return to growth in the longer term, with consumer confidence improving.

But growth is unlikely to be rapid, with a negative long-term trend from the growth of internet shopping, leading to a rise in relatively low-value warehouse construction at the expense of retail construction and fit-out.

Noble Francis is economics director at the Construction Products Association

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