1

UK CONSTRUCTIONMARKET VIEWSUMMER 2018

MARKET VIEW | SPRING 2018 REACHING A TURNING POINT

1 2

We have held our tender price forecast for both buildings and infrastructure markets. The main factors considered in our forecast are:

INFLATIONARY FACTORS

Materials costs. Materials cost inflation continues with rates of 5-6% in the year holding up. Currency-linked packages where the whole subcontract is sourced from the EU continue to see even higher cost pressures, with little sign of sustained improvement in the pound’s valuation against the euro remaining at 1.16. Upward pressure from rising global commodity prices is increasingly a factor. The crude oil price has increased by 50% in the past year.

Labour costs. The labour market remains tight, which is leading to continued labour cost inflation of at least 3% a year. Specialist trades in short supply continue to see even higher rates. The unemployment rate in construction dropped to a historically unprecedented level of 2% in 2017, highlighting the pressure on all latent capacity.

Capacity. Capacity to deliver remains constrained. This is particularly pertinent in hot regional markets, such as Manchester and Birmingham, or on projects where complexity and scale leads to a smaller available pool of expertise. Carillion’s failure continues to threaten future capacity, with more than £1bn owed to lower tier suppliers unrecoverable. The failure of suppliers and loss of ‘organised capacity’ will have a tangible impact on competitive tension and therefore pricing. This issue is not limited to Carillion, with some other suppliers in special measures, such as Interserve.

Supply chain profitability. Tempered tender price growth and high input cost growth has squeezed supplier margins. This has negatively impacted profitability in the supply chain. As a result, the ability for the supply chain to reduce or hold pricing is very constrained.

Risk. Events surrounding Carillion mean that the attitude to risk will generally harden. For much of the supply chain it is likely this will manifest itself as higher prices. Additionally, the Brexit timetable now means that the supply chain are pricing projects that will start on-site after the Brexit deal has been made. However, because they are pricing them with no visibility of what the Brexit deal will be, and therefore the operating environment, are likely to factor this into the price as a risk allowance.

MARKET VIEW | SUMMER 2018

TENDER PRICE FORECAST

NEGOTIATING UNCERTAINTY

• Construction output in Q1 2018 fell by -2.7% on a three-month on three-month comparative basis. While some of the fall in Q1 was down to inclement weather, uncertainty is hampering investment decisions.

• The supply chain faces increasing difficulty pricing jobs today that will be delivered in a post-Brexit environment, as the terms of access to labour and materials are still unknown.

• Carillion’s failure has had a material impact on industry capacity and poses a contagion threat to the financial stability of thousands of suppliers.

• The final report of the Hackitt Review, Building a Safer Future, has been released. The implementation of the Review’s findings is a vital opportunity for the industry to improve its performance and reputation.

• The introduction of steel tariffs by Donald Trump could impact the costs and supply of steel for construction clients in the UK.

TENDER PRICE FORECAST

£

MARKET VIEW | SUMMER 2018

3

TENDER PRICE FORECAST ASSUMPTIONS

4

• Economic growth of 1.6% in 2018, falling to 1.5% in 2019 (HM Treasury Consensus Forecasts).

• Construction output rising 0.2% in 2018 and 1.7% in 2019 (Construction Products Association).

• £1.00 remains close to $1.40 and €1.14.

• A Brexit deal is struck with transition period.

• Global economic growth continues to be positive, with an annual rate of more than 3%.

• Industry capacity remains at current levels, with a workforce of approximately 2.3 million.

DEFLATIONARY FACTORS

Economic performance. Deep uncertainty associated with Brexit has undoubtedly had an adverse impact on the pace of UK economic growth. The economy grew 1.8% in 2017, the slowest rate since 2012. The potential for global growth taking off presents an upside for British exporters but, that said, the Office of Budget Responsibility forecast yearly growth of just 1.5% or less to 2022. Historically, with weaker economic growth also comes less buoyant construction demand. Growth in Q1 2018 was disappointing, with GDP growing by just 0.1%. This was below the 0.4% seen in the final quarter of 2017 and below the 0.3% economists had anticipated. Analysts remain divided on how much of this slowdown was caused by the inclement weather of February and March, versus the impact of Brexit-related uncertainty. Q2 economic data is likely to help resolve this debate.

Uncertainty impacting demand levels. There remain significant downside risks to future demand. The private commercial sector saw a gradual decline in output in 2017, as did the public sector. New orders for new work rose 4% in 2017 compared to 2016. However, construction output in Q1 2018 fell by -2.7% on a three-month on three-month comparative basis. This was driven by falls in both repair and maintenance, as well as new work. Whilst at least some of the fall in Q1 was down to inclement weather, uncertainty is hampering investment decisions. The nature of the Brexit deal will continue to be a pivotal factor in the outlook for all construction sectors, but particularly those relying on private, and speculative, investment.

TENDER PRICE FORECAST ASSUMPTIONS

YEAR REGIONAL BUILDING CONSTRUCTION TPI

LONDON BUILDING CONSTRUCTION TPI

NATIONAL INFRASTRUCTURE

CONSTRUCTION TPI

2018 2% (2%) 2% (2%) 3% (3%)

2019 3% (3%) 3% (3%) 5% (5%)

2020 4% (4%) 4% (4%) 5% (5%)

2021 4% (4%) 4% (4%) 5% (5%)

2022 4% (4%) 4% (4%) 5% (5%)

2,000

7,000

12,000

17,000

22,000

27,000

Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1

2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018

PRIVATE COMMERCIAL INFRASTRUCTURE PRIVATE RESIDENTIAL

PUBLIC SECTORPUBLIC RESIDENTIAL PRIVATE INDUSTRIAL

UK CONSTRUCTION OUTPUT VOLUME £m (ONS)

Our tender price forecast assumes a ‘central scenario’ in relation to Brexit. This entails:

We also assume that:

( ) Last quarter’s forecast

Percentage movements are in the year to Q4

MARKET VIEW | SUMMER 2018 HACKITT REVIEW

5 6

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

2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 2022

150

200

250

300

350

The final report of the Hackitt Review, Building a Safer Future, has exposed deep weaknesses in accountability, oversight and enforcement relating to the design, construction and operation of high risk residential buildings. The scale of the Grenfell tragedy gives the Review genuine momentum, creating the expectation that the industry must address shortcomings alongside the development of legislation.

Combined with other changes in design and procurement, the implementation of the Review’s findings is a vital opportunity for the industry to improve performance and reputation. Going forward, as new statutory duties are created, the challenge is to deliver safe, compliant, affordable buildings which meet the wider needs of stakeholders over their full lifecycle.

Looking beyond the specific recommendations, there are several themes that point towards behavioural shifts that the Review will drive:

HACKITT REVIEW

ARCADIS TENDER PRICE INDICES JUNE 2018 INDEX BASE 1985=100

REGIONAL BUILDING CONSTRUCTION TPI LONDON BUILDING CONSTRUCTION TPI NATIONAL INFRASTRUCTURE CONSTRUCTION TPI

FORECAST

• Adoption of a systems-approach to building safety. Hackitt highlights silo-thinking, for example when changes are made to specifications without a full understanding of the implications, as a real problem for the industry. Joined-up thinking will deliver far better results.

• Incentives and penalties for compliance and non-compliance. The proposed incentives are permissions to build and occupy completed buildings. The commercial imperative for ‘right-first-time’ design and construction is obvious, whereas penalties could extend to criminal sanction.

• Design, procurement and construction prioritised to meet Building Regulations. The aim is to deliver high safety, low-risk and best lifetime cost, rather than lowest build cost and fastest construction programme.

• Design and construction so that all stakeholders have the information they need. This describes the ‘digital thread’ that has focused on the potential use of BIM but also highlights the potential for information gateways at planning, start on site and completion. These will become central not only to the new compliance regime, but also to a wider push for industry transparency.

• Design and construction to facilitate lifetime safe management. This demands that both design and construction meet safety case requirements, as well as highlighting that the owner will retain an active, long-term responsibility for the safety of the building. This is likely to create new relationships with residents and new considerations around transactions and disposals.

Commercial implications stemming from these themes include:

• A potential move away from design and build procurement models to accommodate changes in future risk management.

• An increase in risk adversity when it comes to design and value engineering.

• Future hard costs and benefits associated with increasing levels of assurance.

• Future hard costs and benefits associated with use of ‘digital twin’ modelling.

MARKET VIEW | SUMMER 2018 CONSTRUCTION IMPACTS

7 8

Brexit implies a move away from the status quo of frictionless trade. The UK’s trading environment as a member of the EU single market and customs union has evolved to work as a finely tuned machine - but one that is reliant on light touch interventions when it comes to duties, VAT, tariffs, physical checks and standards.

For UK construction, any of the future custom arrangements that move away from the status quo introduce friction into cross-border trading. The existing model of ‘just in time’ delivery will come under pressure, leading to cost and schedule implications for projects up and down the country.

What will the impacts of these changes be? And what mitigations might construction clients consider now?

BREXIT, FUTURE CUSTOMS ARRANGEMENTS AND THE IMPACT ON CONSTRUCTION

IMPACTS MITIGATIONS

Review contingency funds for increased

costs of delivery

Develop contingency plans for alternative

routes into UK or UK-based suppliers

Pass through of increased costs

Review contingency plans for delayed

deliveries

Early supplier engagement

to prompt engagement

Check supplier logistics planning

Review cashflow impactsChanges to

cashflows needed

Review target cost allowances

for sensitivity

Encourage mixed-load delivery

Loss of access to capacity

Delays to deliveries

More administration• Number of customs declarations will

increase fivefold to 255m p.a. post Brexit.

• Enhanced checks at borders will lead to queues. Adding an average of two minutes to customs processing results in a 17-mile queue from Dover.

Lack of skills• Freight-forwarding expertise in short

supply.• Lack of experience with customs

processes.

Lack of ‘trusted traders’• 6 month process to get this

accreditation which avoids some routine customs obligations.

• Of the 141,000 companies using HMRC’s systems already, just 0.43% are currently trusted traders.

• Without this; frequent onus for physical proof of origin and penalties for mistakes on documents.

Reduced volume of trade due to increase friction• Empty or less than full

trailers on return trips.• Less efficiency and lower

utilisation raising per unit costs.

Tariffs• Increased absolute cost of goods.• Loss of access to supply capacity.

Suppliers of low margin goods such as concrete will see margins wiped out by tariffs making UK unattractive to supply to.

Duties, VAT and upfront costs• Cashflow changes with

more upfront required.

IMPACT FOR CONSTRUCTION

CAUSE MITIGATIONS FOR CONSTRUCTION

MARKET VIEW | SUMMER 2018 THE IMPACT OF TRUMP’S STEEL TARIFFS

9

THE IMPACT OF TRUMP’S STEEL TARIFFSThe move by Donald Trump to introduce tariffs of 25% and 10% on imports of steel and aluminium respectively from close allies such as the EU, Canada and Mexico ramps up previous action and rhetoric impacting China. This further raises the possibility of a global trade war. Although a significant concern, some perspective is needed when considering construction.

The industry’s tendency to buy simple, local products makes the sector relatively less vulnerable than other metal-dependent industries like the automotive sector. Other factors, such as the 50% increase in oil prices in the year, may come to be more significant for the construction sector in the UK than Trump’s tariffs.

The introduction of steel tariffs could impact the volumes of steel available in any given marketplace. In the US in this case, it is likely the supply of steel will be more constrained, driving up costs at least until more domestic production can come online.

In contrast, markets that were previously able to export steel competitively to the US before tariffs were introduced, such as the EU, may be left with more surplus steel and this could reduce costs in those markets.

The supply and cost impact could be quite unpredictable however. Those countries left with excess supply could seek to sell into alternative markets and so the demand and supply imbalances around the world could play out in a variety of ways. The ‘dumping’ of steel by China into the EU in 2016, which threatened to lower prices by up to 40%, was a past example of what this can look like. This will also therefore depend on which other countries implement tariffs, and at what level, as a result of the action in the US. In 2016 the EU placed tariffs on Chinese steel imports to counteract the potential cost impact for EU producers.

Only time will tell whether the UK market is affected and how much of any steel cost increases or decreases are actually passed through to construction clients in tender prices. However, construction clients should look to monitor the situation as it evolves.

CONTACTWILL WALLERDIRECTOR - MARKET INTELLIGENCE

WILL.WALLER@ARCADIS.COM

SIMON RAWLINSONHEAD OF STRATEGIC RESEARCH & INSIGHT

SIMON.RAWLINSON@ARCADIS.COM

SIMON LIGHTUK CLIENT DEVELOPMENT DIRECTOR

SIMON.LIGHT@ARCADIS.COM

WWW.ARCADIS.COM

@ArcadisUK

Arcadis United Kingdom

Arcadis

Our world is under threat - from climate change and rising sea levels to

rapid urbanisation and pressure on natural resource. We’re here to answer

these challenges at Arcadis, whether it’s clean water in Sao Paolo or

flood defences in New York; rail systems in Doha or community homes

in Nepal. We’re a team of 27,000 and each of us is playing a part.

Arcadis. Improving quality of life.

Disclaimer

This 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. While every effort

has been made to ensure the accuracy of the material in this document,

neither the Centre for Economics and Business Research Ltd nor Arcadis will

be liable for any loss or damages incurred through the use of this report.

© 2017 Arcadis