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CNinsight100: Recovery to be slow and uncertain

In 2010 the construction sector witnessed a recovery of sorts, albeit from a low base: in 2009 output had fallen by more than 11 per cent.

But whether the recovery is sustainable is uncertain. A number of data points suggest that the market has started to stagnate, and at present it is unclear what the catalyst will be to push this anaemic recovery on.

Earlier this month, the Construction Products Association made the bold prediction that construction would be the first major sector to suffer a double-dip recession.

It had previously predicted a fall in output for 2010 of 2.69 per cent, which it has now revised to an increase of 1.29 per cent. But expectations for 2011 have been downgraded.

Its forecasts suggest the construction market will weaken in the second half of 2010 and into the first half of 2011, resulting in a fall in output for 2011 of 0.82 per cent.

Forecast output of £92.27 billion in 2011 is just 0.5 per cent ahead of the level in calendar year 2009 of £91.85bn.

Reasons for revisions This change to its forecasts came after Office of National Statistics figures showed growth in the construction sector of 8.6 per cent between March and June this year.

This growth was driven by the sector catching up on work delayed earlier in the year due to poor weather. The Labour government also signed off construction work worth several billion pounds in the five months leading up to its election defeat.

These commitments were reviewed by the new government, which approved projects worth a total of over £6.6bn but cancelled many others.

Other data points, such as Bank of England mortgage approvals figures, point to a slowdown in the housing market, which is a strong leading indicator of future activity in the housing sector and the economy more widely.

Since January, mortgage approvals have stagnated at just shy of 50,000 per month.

While this is a big improvement on the low point of 27,000 in November 2008, it is significantly short of the minimum of 110,000 approvals seen during 2006 and 2007 at the peak of the housing market.

If this trend continues into the future and nothing is done to increase mortgage availability, the outlook for the housing sector is not one of significant improvement.

Monthly survey results from the Royal Institution of Chartered Surveyors over the past four months have also pointed to a potential slowdown in housing activity.

Chartered surveyors asked to detail changes in activity, sentiment, housing instructions and sales, suggested the number of houses on the market has started to increase and is expected to rise further.

This increase in supply, if it continues while new buyer enquiries are falling, could have a damaging impact on the housing market. If it follows normal supply and demand dynamics over the coming months, house prices could fall.

The housing market is significant for both its overall size and the impact it can have on consumer sentiment. This in turn affects other parts of the wider economy - not just retail, but on the construction sector directly.

If house prices do fall, negatively affecting consumer activity, the construction industry will be hit across the sectors of retail, factories, industrial warehouses and leisure.

Unemployment impact

The government’s Office for Budget Responsibility suggested 600,000 jobs could be lost as a result of its austerity measures.

With the bulk of these to come from the public sector, these individuals, many of whom saw an increase in their disposable income during the recession, could hold the key to the performance of the whole economy.

Such large job losses could affect sentiment and demand and lead to further pressure on commercial construction activity, which is in the very early stages of its recovery in the London market.

As more people become unemployed, demand for services falls, and this could have a direct impact on demand for offices. If the economy falters then company profitability could be severely hit, especially those operating in the financial sector.

Financial and related firms traditionally dominate demand for space in the London office market and the recovery in
activity, which has seen projects such as the Walkie Talkie and Cheesegrater resurrected, could be killed off.

While there are a number of data points that indicate a downturn if there is no improvement, even in the worst
case scenario there are sectors such as energy, infrastructure and utilities that could see growth.

The utility sector, especially water, is heavily regulated. Under Asset Management Programme 5, the water utilities must spend a total of £22.1bn on upgrading, renewing and maintaining their utility and sewerage networks.

In the infrastructure sector, spending on rail is set to increase at the expense of road programmes, which are easier to shelve. Smaller roads projects in particular are likely to bear the brunt of spending cuts outlined in October’s Comprehensive Spending Review.

Cuts to hit hard

Overall, government capital spending will fall. June’s Budget outlined a projected cumulative £123bn shortfall in spending over the life of the current parliament compared with the level it would be if spending was maintained at
the 2009/10 level of £68.7bn annually.

The impact of this will be severe in a number of sectors. CNinsight analysis shows that, based on previous capital spending allocations sourced from the Institute of Fiscal Studies, the transport, housing, amenity and education sectors are likely to be the hardest hit.

This could lead to a potential cut in transport spending of £30.1bn over the lifetime of the current parliament, which may see projects like Crossrail come under threat or face potential delays.

Housing and amenity spending is also at risk, with a potential cut of £26bn over the same timeframe. According the CPA forecasts, the value of work from the private sector should help offset the expected declines in public sector spend over the next four years.

Increased outsourcing opportunities are one way private firms, which are widely seen as more efficient than the public sector, could benefit from the government cuts.

Results figures from a number of firms show evidence this outsourcing trend has already begun. CNinsight number two Carillion, in particular, has been increasing its outsourcing activities and classifies itself as a support services company, rather than a construction firm.

Such repositioning may be copied by other companies over the next few years as they seek to take advantage of these opportunities.

Another area of potential growth for traditional contractors is repairs and maintenance.

Given the pressure on spending, refurbishing existing buildings could be much more attractive than building new ones. The same is also true of non-government assets, including roads and other infrastructure, where spending is
likely to be very constrained.

Given the sheer number of variables that can affect the construction sector in different ways, at present there is no clear direction for the sector as a whole or, indeed, many individual sectors.

The detailed cuts to be announced in the Comprehensive Spending Review, central to the continuation of the sector’s growth or the pace of its potential decline, will make the outlook clearer.

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