Tender price inflation forecast
As demand cools, how far will prices decompress?
Demand is a central determinant of industry pricing, and the current economic backdrop supports our view of disinflation – a much slower rate of price growth. Monetary tightening by the BoE is filtering into the real economy and will make a fuller impression on investment, and construction activity, over the course of 2023.
Some external forces that drove tender price inflation higher in 2022 are also losing intensity. International commodity prices are cooling and price changes for industrial metals are poised to be negative in 2023 and 2024, according to the World Bank. “Demand destruction” policies in Europe have also been effective in curbing natural gas consumption and the heating season is nearing an end. This puts two key ingredients in the pricing mix – material and energy costs – on a calmer path.
As demand softens, and some input costs alleviate, tender price growth is starting to converge with construction costs. However, cost reduction and competitive tendering are not a mainstay in the market yet. Margin retention – following a fallow COVID-19 period - and concerns about future cash flow may see contractors withholding savings.
Source: Building Cost Information Service
An additional positive is that supply chains are adapting to persistent instability while China’s reopening from COVID-19 should unlock manufacturing capacity for inputs. The outlook for the pound is also firmer as higher interest rates encourage the UK to save more and the financial market is reassured by fiscal prudence, easing imported inflation.
Variability in construction materials and components, however, persists. Timber and steel products have naturally come down from their post-conflict in Ukraine peaks following supply chain recalibration. Whereas insulating materials have continued to increase. Recladding remediation persists post-Grenfell rulings whilst homeowners insulate their homes to combat the increase in energy prices.
Source: Department for Business, Energy and Industrial Strategy
The backdrop of falling commodity prices will undoubtedly ease pressure on industry pricing, coupled with softening demand. However, there are two important factors at play that are expected to keep tender prices in positive territory - ongoing labour shortages and contractors going bust.
Skills shortages in the construction industry have exacerbated, increasing overall costs. Brexit as well as workers taking early retirement after the pandemic have enhanced these frictions – leading to high vacancies. Recessions tend to increase unemployment, yet unemployment in construction is remarkably low, standing at 2.2 percent in 2022 Q4 - 1.7 percentage points below the whole economy. Given that there are insufficient workers available for projects, labour costs should be sticky as vacancies erode before unemployment rises notably. The March budget outlined plans to simplify and accelerate visa applications for many overseas construction workers, which could make a difference to skills and labour availability in the long run.
Source: Office for National Statistics
There has been a dramatic increase in insolvencies since mid-2021 as COVID-19 government support started to be phased out. The wave has continued to roll following a sharp increase in inflation since the conflict in Ukraine began and the BoE started raising interest rates.
In the sub-sectors worst affected by insolvencies, smaller firms with fewer than five employees and an annual turnover of less than £100,000 have an unusually high market share. These firms are most vulnerable to a margin squeeze as materials prices and interest charges increased.
This is common within construction and 2022 Q4 saw 1,112 more construction firms go bust in England, Scotland and Wales, increasing by 6.2 percent on the quarter.
Source: Office for National Statistics
In isolation that’s troublesome enough but the number of new construction companies forming is not keeping pace with company deaths. Births are close to their lowest point in five years, signalling difficulties securing credit and financial backing in an unstable market – shallowing out market capacity.
What does this mean for our forecast?
Our central scenario estimates that real estate tender price inflation averaged 9.5 percent in 2022, unchanged from the Winter edition of the UKMI. We have also maintained our projections up to 2026 and the horizon now stretches to 2027, where we expect tender price inflation of 4.5 percent for real estate and 5.0 percent for infrastructure.
Figure 9:
Tender price inflation: Annual percentage changes
Source: Turner & Townsend Survey
Our forecasts are representative for the UK as a whole and inflation may vary by project size, value, procurement route and region. Projects need to be assessed on an individual basis and may not always align to our central scenarios. For further assistance on cost assurance and inflation analysis in your area, please contact Turner & Townsend.
Bearing in mind that real estate tender price inflation is starting from a high base estimated at 9.5 percent for 2022, softer market conditions justify our expectation for swift disinflation over 2023. It is important to explain why there may be a floor under real estate tender price inflation at 3.5 percent for the year.
Labour shortages will abate as demand subsides in 2023 but this will first be evident in fewer vacancies – a trend already visible – rather than increased unemployment and noticeable “slack” in the market. Low skills availability and increased bargaining positions of workers will see a healthy contribution to tender price inflation.
The price implication of rising insolvencies on the supply chain is a smaller pool of sub-contractors and elevated risks for main contractors, both of which buoy tender price inflation. Given that credit conditions will remain restrictive, insolvencies are likely to continue an uptrend.
Materials prices and some lead in times are easing, yet the rate at which savings are passed on through the supply chain and to clients will be tempered by cost recovery efforts. Volatility in material prices means contractors are still pricing in a risk premium in case input costs surge again.
The BoE has limited control over cost-push inflationary forces, making further energy shocks something of a wildcard on tender price inflation given that the market remains tight and the geopolitical situation volatile. Renewed shortages – particularly next winter – cannot be ruled out, which presents an upside risk to our tender price forecast.
Source: Turner & Townsend Survey
Our infrastructure tender price inflation forecast for 2023 stays at 5.5 percent, unchanged from the Winter 22/23 report, as competing forces negate the overall impact on pricing dynamics. The remaining horizon, from 2024 to 2027, also stays the same.
Often based on framework contracts, infrastructure is less affected by market volatility and interest rate rises than real estate. Although recent inflationary pressure – and growing insolvency risk - has seen claims rise on projects in delivery, with firm price allowances evident in tenders to offset this market dynamic. A change in direction of some material prices, and their impact on optional clauses, should help to minimise these pressures as well.
There is also a pipeline of committed government expenditure, keeping our infrastructure tender price inflation expectations above real estate market values. This is even as the spending profile on some major projects and programmes begins to shift rightwards as expenditure is cut in real terms, notwithstanding bright spots in Defence and Aviation.
Not all sub-sectors have the same level of in-built demand, though, and there is a subtle commercial shift – moving from a seller’s market to a buyer’s one - for some clients as softening creeps into less ambient markets and regions. As such, there is a steady transition of firms altering their pricing practices to remain competitive and guarantee turnover after contracts come to maturity.
Albeit less volatile than real estate, infrastructure may still see a swing in pricing levels outside of our central forecast if risks aren’t fully understood, or mitigation measures are not put in place. Such as building in time to procure smartly, creating robust project controls and working collaboratively with supply chains through ongoing market challenges.
Source: Turner & Townsend Survey
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