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Rising costs put risk and reward in the spotlight

Cost hikes across the board increase the focus on project risk and crank up the pressure on margins, according to Arcadis research.

Key events in 2016 have exposed the volatile, uncertain, complex and ambiguous political and economic operating environment.

For a sector that is highly sensitive to the political and economic cycles like construction, this has ushered in even greater levels of uncertainty than many sectors of the economy are facing.

The Arcadis Input Cost Index for Q3 2016 was up 3.8 per cent compared with Q3 2015 and 1.1 per cent over the quarter. Labour costs have continued their expected rise, while those for materials and plant are on a well-established upwards trajectory, exerting heightened and broader cost pressures on the value chain.

The shortage of skills in the industry remains the main driver of labour cost inflation, whilst the devaluation of sterling has been the dominant factor in the increasing prices for materials and plant – though prices of key commodities showing some recovery in recent months has also played a part.

The rise of input costs will put margins under pressure, and we expect tender prices to soften in 2017 as a result of a slowdown in demand in the face of growing uncertainty.

Mixed signals on construction’s outlook

While economic growth is expected to continue over the next five years, forecasts for performance in 2017 and 2018 have been revised down by both the Office of Budget Responsibility and the Treasury.

According to the Treasury’s November consensus forecast (based on an average of independent forecasters across the industry) the UK economy is forecast to grow by 1.2 per cent in 2017.

Because the construction sector is highly sensitive to the economic cycle and any uncertainty in the markets, some falls in demand, particularly in the commercial sector, are expected due to this slowdown in growth.

According to the Office for National Statistics, the first three months after the EU referendum saw the construction industry experience its weakest performance in four years, with volumes falling by 1.1 per cent compared with the previous quarter.

“Sentiment-based indicators should be interpreted with caution at times of great uncertainty”

These were largely driven by falls in R&M, which were partly offset by small rises in infrastructure and public building output. Construction output also suffered a surprise fall in October, decreasing 0.6 per cent compared with the previous month.

Many in the industry had expected growth of 0.2 per cent in October, after a rise of 0.9 per cent in September.

In spite of this, the Markit / CIPS PMI was positive for the fifth month in a row in December at 54.2 (an index above 50.0 indicate growth). Yet the survey also highlighted that input cost inflation was at the highest level since April 2011. Inflationary input cost pressures and low stocks among vendors has led to some of the respondents reporting a deterioration of supplier performance and difficulties in forecasting project costs.

Materials costs – Q3 2016
Region Concrete £/cu m Reinforcement £/tonne Structural steel £/tonne Bricks £/1,000 Blocks £/sq m Timber £/m
East of England 86 553 1657 309 9.2 3.3
London 88 504 1594 391 10.1 3.0
Midlands 82 525 1500 317 8.3 3.3
North-west 84 475 1500 283 6.4 3.1
Northern 83 433 1560 299 8.7 3.4
Northern Ireland 57 511 1500 330 5.1 2.7
Scotland 80 512 1500 168 7.8 2.5
South-east 89 482 1583 388 9.7 3.1
South-west 88 475 1538 355 9.5 3.0
Wales 76 428 1575 214 6.6 3.1
Yorkshire & Humber 81 442 1500 288 8.3 3.0
National mean 81 485 1546 304 8.1 3.0

However, sentiment-based indicators should be interpreted with caution at times of uncertainty.

Forecasts from the Construction Product Association and Experian point to flattening output over the 2017 and 2018 – with a growth in infrastructure predicted to pick up slack as demand declines in the commercial sectors.

The most recent ONS data shows that new orders fell by 2.4 per cent between Q2 and Q3 of this year. On a year-on-year basis, new orders grew by just 3.3 per cent in Q3 compared with a year earlier. Whilst not yet a trend, these numbers do potentially indicate a slowing down of new orders.

Labour costs up as Brexit threatens

Our survey indicates that the average cost of the trades featured increased by almost 1 per cent in Q3 compared with Q2, with bricklayers leading the charge with an increase of 1.1 per cent.

Over the year to Q3, the average cost of labour increased by almost 6 per cent. Our sample shows that the UK average daily rate for a bricklayer is now £180 with London the most expensive, pushing almost £200 a day, while Yorkshire and Humberside is the lowest at £163.

“A ‘hard’ Brexit scenario could see EU construction workers leaving the industry at a quicker rate”

The construction industry continues to suffer from a skills deficit and labour shortage with the industry persistently lacking excess capacity. Unemployment within the construction industry stands at 3.1 per cent, which is substantially below the overall UK unemployment rate, which was recorded at 5 per cent in Q3 2016.

The 3.1 per cent amounts to around 70,000 people. Around 20,000 of these are long-term unemployed for a range of extenuating circumstances – meaning that these numbers show just how little spare capacity there is available in the industry.

Arcadis’ research indicates that a potential ‘hard’ Brexit scenario could see EU construction workers leaving the industry at a quicker rate than they are replaced, leading to a potential deficit of 215,000 EU nationals entering the infrastructure and housebuilding sectors between now and 2020.

Labour costs – Q3 2016
Region Bricklayers £/per day Carpenters £/per day Labour average £/per day
East of England 187 187 187
London 199 190 195
Midlands 175 173 174
North-west 185 185 185
Northern 175 163 169
Northern Ireland 181 173 177
Scotland 175 175 175
South-east 194 188 191
South-west 185 185 185
Wales 165 165 165
Yorkshire & Humber 163 158 161
National mean 180 177 179

Even in the event of a ‘soft’ Brexit, the construction workforce could again see a steady reduction in numbers of EU nationals totalling approximately 135,000. The impact of such a loss of labour is likely to push more investors, such as Crest Nicholson, towards offsite manufacture.

Businesses that don’t change their labour model risk being left behind in the challenge to become more productive.

What’s influencing materials prices?

The materials element of our input cost index increased by 2.3 per cent in the year to Q3. The biggest risers were bricks and blocks at 6 per cent and 5.5 per cent respectively in the year.

Fabricated structural steel has also seen a strong rise with the average price per tonne in our survey reaching £1,546. In October, the BEIS construction material price index increased 2.6 per cent in the year.The big risers cited by BEIS include imported planed or sawed wood, sanitary ware and fabricated structural steel.

Materials costs are generally under the influence of two dominant factors: the valuation of sterling and commodity prices on the global markets.

The pound has depreciated in value by up to 20 per cent and 16 per cent against the dollar and euro respectively to the end of Q3, taking it to a 31-year low or 168-year low if calculated on a trade-weighted basis. This makes the import of goods more expensive and many construction materials are imported.

“Ultimately, today’s uncertain climate is the cause of rising materials and labour costs”

The construction material trade deficit widened by £98m to £2.29bn in Q3 2016, an increase of 4.5 per cent, demonstrating our reliance on imports and exposure to currency fluctuation as a result. Until the impact of the vote for Brexit on the pound, there had been 20 consecutive decreases in the BEIS material price index.

After two years of falling prices, 2016 has seen some recovery in commodity prices. Data from the International Monetary Fund reports that commodity prices have climbed by 19 per cent in the first 10 months of 2016 – largely driven by 30 and 15 per cent increases in crude oil prices and metals, respectively.

The price of crude oil has reached $57 a barrel for the first time since mid-2015. Looking forward to 2017, further price rises are forecast for copper, steel (iron ore and coal) and other key metals for construction including zinc and aluminium.

Raising the stakes

Ultimately, today’s uncertain climate is the cause of rising materials and labour costs, as purchasing power and supply of skills in UK construction come under pressure due to these macro changes.

While a range of steps can be employed to try to keep a lid on rising input costs, the market will increasingly rely on the willingness and ability of its key decision-makers to take greater levels of commercial risk.

Clients will need to take risks on programme and project decisions while suppliers will likely need to take risks on their pricing strategies. A key question is whether this will play out as collaborative risk-taking or if the adversarial tactics that dominated in the last downturn will make a comeback.

With so much volatility, the ability to maximise certainty wherever possible is emerging as the most important competitive lever for 2017 – including, as always, certainty of cost.

Kevin Nimoh is a research analyst at Arcadis and Will Waller is market intelligence lead at Arcadis

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