the rOaD aheaD FOr COnStruCtiOnarCaDiS Market VieW, autuMn 2017

2

The Arcadis Autumn Market ViewFor the construction sector, economic and market signals continue to be very mixed, with some signs that a slowdown in activity could be taking hold. Fundamentally, this is a situation of politically-made uncertainty, borne out from domestic partisan turmoil and a perceived lack of progress in the Brexit negotiations on the continent. Continued relative momentum in the UK’s economic performance, in the face of all the uncertainty, is a clear marker of its strength in recent years.

Against this backdrop, we explore the likely future construction demand profi le, quantitative easing’s relationship with construction, what a Brexit ‘no deal’ would mean for the industry and more.

Key FaCtors shaPinG the direCtion oF tender PriCes:• Dampened economic growth continues to threaten

end-user demand and investment levels. Does it make sense to continue to build?

• Downgraded productivity growth is crimping the public-sector purse. Will public investment levels be sustained?

• Will suppliers compete for turnover or consolidate their position?

• Suppliers are still aff ected by weak balance sheets. How fragile is the supply chain?

• How profi table is the supply chain? Can it practically reduce construction prices?

• The risk profi les of projects play an increasingly accentuated role in pricing. What can and will the supply chain accept?

the arCadis tender PriCe ForeCast – MoVeMent in the year to Q4

year Lower regional upper regional Lower London upper London infrastructure

2017 -1% 3% -1% 2% 3%

2018 -2% 1% -3% 1% 3%

2019 2% 2% 3% 3% 5%

2020 3% 3% 4% 4% 5%

2021 3% 3% 4% 4% 5%

1 2 3 4 1 2 3 4 1 2 3 4 1 2 3 4 1 2 3 4 1 2 3 4 1 2 3 4 1 2 3 4 1 2 3 4 1 2 3 4 1 2 3 4 1 2 3 4 1 2 3 4 1 2 3 4

2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021

150.0

170.0

190.0

210.0

230.0

250.0

270.0

290.0

310.0

330.0 Regional TPI -Upper Scenario

Regional TPI -Lower Scenario

London TPI -Upper Scenario

London TPI -Lower Scenario

Infrastructure

note: these are assumptions related to the tPi forecast• Brexit-related slowdown taking hold from Q4 2017 into 2018, driven by

uncertainty surrounding EU negotiations and adverse impacts on demand in commercial sectors.

• Continued growth in infrastructure output.• From 2019, as negotiations conclude, uncertainty lifts and the UK’s

strong economic performance continues.

• Our London and Regional TPI forecasts only include the buildings sectors and cover all regions of the UK. They must therefore inform inflation risk allowances according to specific sectors and regions in question.

• We expect diff erent sectors and sub-sectors to see diff erent pricing conditions.

• Arcadis infrastructure TPI only includes infrastructure.

Prices and coststender PriCe ForeCastWe expect a slowdown in some sectors to take hold from Q4 2017, followed by a recovery of demand in 2019.

Prices and coststender PriCe ForeCastWe expect a slowdown in some sectors to take hold from Q4 2017, followed by a recovery of demand in 2019.

3

Input costsLabourThe BCIS labour cost index provisionally rose 2.7% in the year to September 2017. Some trades would have seen significantly higher labour cost inflation than this, such as high-end fitout.

PLantThe BCIS plant cost index provisionally rose 4.1% in the year to September 2017.

MateriaLsThe BCIS materials cost index provisionally rose 4.7% in the year to September 2017. Evidence suggests that the inflationary impact due to the devaluation of sterling is washing through, and is showing itself in reduced escalation of materials cost indices. The future strength or weakness of sterling against the Euro continues to be a key focus. Projects with higher proportions of ‘currency-linked’ packages will remain most vulnerable to currency volatility.

Commodities Despite short-term price increases in some commodities, the broader relatively low market price levels have been a silver lining for the resource-hungry construction industry. This is particularly true in the UK, where the devaluation of sterling has significantly driven up materials costs for buyers.

• Coal has seen a price rebound, up almost 25% over the year. Strong heating demand and low inventories at China’s ports and utilities was a major contributory factor. Coking coal is a key ingredient to the steel production process.

• iron ore, another key steel-making ingredient, rose 17% in 2017. Prices peaked near $95/ton (£72/ton) during February but have since fallen due to weakening demand, record high inventories at Chinese ports, rising supply, and credit tightening in China.

• oil prices have been relative stable over the past year, holding at around $55/bbl (£42/bbl). Prices are expected to see muted growth, forecast at 9% to 2021 by the IMF.

• aluminium prices rose almost 20% in 2017 due to strong global demand.

• Copper also saw a 20% rise in 2017.

• steel prices have been on the rise due to increasing demand, mainly driven by China. However global steel demand growth is expected to slow to 1.6 percent in 2018, according to the World Steel Association. Fabricated structural steel prices rose 10% in the year to August in the UK.

Though some of these movements seem large, prices have effectively levelled off when looking at longer-term trends. There is little expectation from analysts of rapid growth in at least the next four years. However, the nature of commodity prices, influenced by a range of variable factors, means forecasts carry a high degree of uncertainty.

The impact of commodity prices on the final cost of manufactured materials and components can be quite limited depending on the extent of value added.

140.0

120.0

100.0

80.0

60.0

40.0

2010

Coal, Australian Crude oil, avg, spot Aluminium Copper Iron ore

2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 202120.0

GLobaL CoMModities PriCes indiCes 2010 - 2021 (F) (iMF)

Global commodity prices are expected to remain relatively flat for the foreseeable future.

Prices and coststender PriCe ForeCastWe expect a slowdown in some sectors to take hold from Q4 2017, followed by a recovery of demand in 2019.

4

Demand for constructionuK eConoMyForecasts show good global economic growth of 3.5% in 2017 and 3.7% in 2018, up from 3.0% in 2016, and only marginally below the 1987-2007 average. Growth in the Eurozone is the best it has been for a decade. Notwithstanding some significant geopolitical risks, including a potential war on the Korean peninsula, the outlook is positive for increasing global momentum.

In contrast, the UK economy is showing signs of slowing down compared to previous years. Despite a rise in interest rates, a vote of confidence in the UK economy, the Treasury’s consensus forecast for growth is 1.6% in 2017 and 1.5% in 2018, down from 2.0% growth in 2016. The first three quarters of 2017 has shown 0.9% of growth, raising the question of whether a further 0.7% growth can be achieved in the fourth quarter.

Although unemployment has fallen to a low of 4.3%, real wage growth remains in negative territory, falling -0.4% between May to July 2016 and May to July 2017. Almost two thirds of UK economic growth is driven by consumption and so a fall in real wages stokes fears that economic growth will slow because of reduced consumer spending. Consumer spending growth in the third quarter of 2017 slowed to its lowest annual rate since 2013.

The health of the construction market is directly linked and very sensitive to the economy, so any uncertainty or threats to the fundamentals of economic growth can endanger the progress of projects.

The UK EconomyStrengthSBuoyant foreign investment levels.

Global trade and investment outlook.

WeakneSSeSVulnerable to perceived and actual progress in Brexit negotiations.

Consumer spending slowing and consumer debt rising.

OppOrtunitieSGlobal reputation.

Government action.

threatSDomestic political turmoil.

Further consumer price inflation.

Quantitative Easing (QE) and Construction in FocusIncreases in interest rates in the UK and US, as well as a slowdown of asset purchases by the European Central Bank signals the end of an unprecedented period of loose monetary policy. What has the impact been on construction markets? QE has led to a quadrupling of the value of assets on the US Government balance sheet to $4.2tn; equivalent to $13,000 per person. Meanwhile, the ECB continues to purchase €30 billion of assets per month whilst the UK’s QE programme remains capped at £375 billion.

QE suppresses interest rates and encourages investors to seek better returns from more risky assets such as corporate bonds and infrastructure investments. Because of QE, pension funds and other long-term investors have focused more of their money into capital-intensive sectors such as infrastructure and property, whilst small-scale investors such as buy-to let landlords have benefitted from low interest rates and a sparkling housing market.

Low finance costs and rising asset values are closely interlinked, not only for property markets, but also in infrastructure, where borrowing costs have become an increasingly sensitive element of project viability. Thames Tideway and the recent successful offshore wind auction have both benefitted from low-funding costs which reflect, in part, the need for investors to accept higher levels of risk to secure a reasonable income.

Rising asset values – whether in the commercial, residential or infrastructure sectors - have insulated construction markets from many of the negative impacts of austerity seen in the public sectors. Furthermore, rising asset values have provided a cushion for rising construction prices and costs. Without rising asset values, it will be less easy for construction firms to deliver value to their clients. This highlights the importance of construction’s productivity challenge as the political focus shifts from QE and stimulus, via monetary policy, to investment in the real economy. These challenges are reflected in our tender price forecast.

5

Construction DemandsentiMentIn October, the IHS/Markit CIPS Construction Purchasing Managers’ Index was 50.9, up from a score of 48.1 in September. Any score below the 50 ‘no change’ level indicates potential contraction in the market. The commercial building and civil engineering sectors, which

together make up approximately 50% of UK construction output, were both down to a score of 49. The main causes are extended lead times for budget approvals and subdued risk appetite among clients in the commercial building sector, as well as a lack of new infrastructure projects to replace completed contracts.

The construction new order data indicates that the EU referendum in June 2016 triggered a slowdown in new order activity. It is assumed that the political and economic uncertainty that has engulfed the UK has hampered the ability of decision makers to commit to long term, big projects – particularly speculative projects.

However, aggregated UK construction output remains at a historical high and has seen a robust performance since the EU referendum, showing a broadly sustained fl at performance and sitting 4% above the pre-referendum level. However, the outlook is increasingly variable by sector.

there were some signifi cant drops in new construction orders in major sectors including private residential, commercial and infrastructure in Q2 2017.

the data suggests that new construction orders have declined since the eu referendum.

on a four-quarter comparison, drops in new construction orders have been more measured.

Construction output remains at a historical high and 4% above the pre-referendum level.

neW orders and outPut

80% 74.8%

Construction New Orders % Change Q2 2017 vs Q1 2017 (ONS)

70%

60%

50%

40%

30%

20%

10%

0%

-10%

-20%

11.6%

Public Sector

InfrastructurePrivate

Housing

PublicHousing

PrivateIndustrial

PrivateCommerical

All NewWork

All OtherWork

8.2%

-15.6%

-7.8%-9.6%

-16.2%

-9.0%-13.4%

Construction New Orders % Change 4 quarters to Q2 2017 vs 4 quarter to Q2 2016 (ONS)

-5%

10%

5%

0%

15%

-10%

-15%

-5%

Public Sector

InfrastructurePrivateHousing

PublicHousing

PrivateIndustrial

PrivateCommerical

All NewWork

All OtherWork

-0.8%

-11.2%

-1.0%

10%

5.4%

-4.2%

80

85

75

70

65

60

55

50

2010

01 02 03 04 01 02 03 04 01 02 03 04 01 02 03 04 01 02 03 04 01 02 03 04 01 02 03 04 01 02

2011 2012 2013 2014 2015 2016 2017

New Work New Orders: Volume Seasonally Adjusted Index (ONS)

0

1,000

2,000

3,000

4,000

5,000

6,000

7,000

8,000

9,000

2010

Jan

Mar Ju

lSe

pN

ov Jan

Mar Jul

Sep

Nov Jan

Mar Jul

Sep

Nov Jan

Mar Jul

Sep

Nov Jan

Mar Jul

Sep

Nov Jan

Mar Jul

Sep

Nov Jan

Mar Jul

Sep

Nov Jan

Mar Jul

Public Residential Private Residential InfrastructurePublic Sector Private Industrial Private Commercial

Volu

me

£m

2011 2012 2013 2014 2015 2016 2017

Construction Output: Volume Seasonally Adjusted by Sector (ONS)

uK ConstruCtion deMand outLooKThe Construction Products Association (CPA) Autumn forecast of construction output has been downgraded from the Summer forecast. Infrastructure spend remains critical to aggregated demand growth.

year total Forecast annual Growth (%)

total Forecast annual Growth excl. infrastructure (%)

2017 0.7% -0.3%

2018 0% -1.0%

2019 2% 0.7%

6

Sectors in focus

CoMMerCiaL• First 8 months of 2017 have seen

commercial transactions fall by 6% against the long term average.

• Take up of space in regional office markets in H1 2017 showed a 14% fall on H1 2016.

• In London, demand in both the West End and City has defied expectations so far in 2017, with take-up above average at half year.

• Regionally, office investment volumes in H1 2017 were 40% below H1 2016, but still 4% above the 10 year first half average.

• Office rents in London have held in the West End and seen only a slight decline in the City. Both markets have witnessed an increase in the level of incentives being granted to tenants.

• Private commercial new construction orders are down -11% on a 4Q to Q2 2017 vs 4Q to Q2 2016 basis.

• Ourexpectationisforadeclinein construction demand in key commercial sectors in 2018.

residentiaL• New home registrations are broadly

in line with 2016’s level. 40,343 new homes were registered during Q2 2017 - a marginal 1% decrease on the 40,810 registered in the same period 12 months ago.

• On a seasonally adjusted basis, residential transactions have been flat since mid-2016.

• House prices rose 4% in the year to September.

• Prime Central London average prices declined 4.6% in the year to September, the most modest fall since October 2016.

• Rents continue to rise, up 1-2% in the year to July.

• Private residential new construction orders increased 10% 4Q to Q2 2017 vs 4Q to Q2 2016 basis.

• Ourexpectationisforanincreasein construction demand in the residential sector in 2018.

inFrastruCture• Infrastructure output is expected to

grow by c. 23% to 2019.

• In rail, the £48bn Control Period 6, as well as HS2, is expected to drive 40% growth in output to 2019.

• The roads sector is likely to see more muted growth of about 3% to 2019.

• For water, growth in large projects such as reservoirs, is expected to drive buoyant growth of 30% to 2019.

• The energy sector continues to grapple with issues associated with reliance on private investment. The Moorside nuclear new build plant, accounting for £10bn of pipeline, will be delayed to late 2020s. However, counterfactuals including offshore wind and smaller scale generation mean the sector still expects to see 28% output growth to 2019.

• Infrastructure new orders increased 5.4% on a 4Q to Q2 2017 vs 4Q to Q2 2016 basis.

• Ourexpectationisforanincreasein construction demand in the infrastructure sector in 2018.

* Sources: Savills, ONS, NHBC, HMRC, Halifax, Knight Frank, CPA

7

Navigating BrexitWith little progress so far in the Brexit negotiations, a ‘no deal’ scenario is increasingly being mooted, with Ladbrokes offering odds of 6/4 at the time of writing. What would this look like for UK construction?

no deaL sCenario uK ConstruCtion iMPaCt What Can the uK ConstruCtion industry do?

CurrencySterling would likely devalue further against the Euro and Dollar.

People Notwithstanding special arrangements, EU nationals and UK nationals would in theory no longer have residency rights. As a minimum, it is likely this would create an administrative burden.

MoneyThe UK would make no payment to the EU, reflecting badly on the UK as an entity that honours its debts but leaving cash to be invested where needed.

imports Traders will need to present goods to HMRC, creating severe congestion at ports. HMRC estimates 130,000 businesses that export to the EU would be dealing with customs for the first time.

trade The UK would cease to be a member of the single market. World Trade Organisation rules would apply. Tariffs will be imposed on goods flowing between the EU and UK. Firms would lose passporting rights, which allow them to sell services across the EU without having to obtain licenses in each individual country. The UK would be free to sign other bi-partite deals with trading partners.

regulationThe UK would cease to be a member of dozens of regulatory agencies. The European Court of Justice would no longer have jurisdiction in the UK.

demand A ‘no deal’ may undermine demand in some sectors, such as commercial offices. Speculative projects may be cut back in the short term. Some international organisations may move staff from the UK and reduce development requirements. Loss of access to the EIB could result in delays to housing and infrastructure investment. However, the likely further devaluation of sterling may stimulate more foreign investment.

People A ‘no deal’ scenario is likely to compound pre-existing concerns surrounding access to EU labour. In the short term, it may create an administrative burden. SMEs employing large numbers of EU workers may not be geared up to deal with this.

Materials The cost of materials will increase due to the further devaluation of sterling. The addition of import tariffs will also have an impact, likely to average 2-3% alone. Due to significant customs queuing at borders, supply of materials, such as imported timber, is likely to be slow, delayed and constrained - which could create logistical problems on projects throughout the UK.

regulation The UK will obtain freedom to fully control standards and regulations but these will need to flex to facilitate future trade deals. In the longer term, enforcement of contract conditions will potentially be more cumbersome and expensive and enforcement will not be automatic: it will be subject to each member state’s own national legal requirements and defences. For construction materials, the EU will continue to be a large market so there will be incentive to maintain parity between UK and EU standards.

rebalance supply chain Focus on UK-based businesses to limit exposure to some of the ‘no deal’ risks.

Minimise labour reliance For example, shifting construction to offsite or componentised methodologies where possible. This may require shifts in procurement behaviours.

develop contingency plans For example for the delay of materials deliveries.

Contingency fundSet aside a portfolio-wide Brexit contingency fund to cover surprise cost increases or solve emerging problems.

review contracts Review Brexit clauses in existing contracts and quantify their impact if called. Look to include Brexit clauses in new contracts. So called ‘Brexit Clauses’ are contractual provisions which trigger a change in rights/obligations as a direct result of a defined Brexit-related event. Examples of scenarios that might be covered include; changes to law or regulation that increase costs or adverse impacts on the ability to operate/deliver created by tariffs or loss of passporting rights.

Contact

Will WallerMarket Intelligence Leadwill.waller@arcadis.com

simon rawlinsonHead of Strategic Research and Insightsimon.rawlinson@arcadis.com

simon LightUK Client Development Directorsimon.light@arcadis.com

www.arcadis.com

@ArcadisUK

Arcadis United Kingdom

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disclaimerThis report is based on market perceptions and research carried out by Arcadis as a design and consultancy firm for natural and built assets. It is for information and illustrative purposes only and nothing in this report should be relied upon or construed as investment or financial advice (whether regulated by the Financial Conduct Authority or otherwise) or information upon which key commercial or corporate decisions should be taken.

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