Tender price inflation forecast
Squeezed capacity, not prices
While the outlook for the UK economy is expected to remain weak in the near term, construction output is likely to contract. The Construction Products Association (CPA) has revised down its projections for construction output growth, with its latest forecast suggesting a 6.4 percent decline in output for this year, followed by modest growth of 1.1 percent next year. The CPA previously foresaw a more modest 4.7 percent contraction for 2023.
Source: Construction Product Association
According to the CPA, the main factors driving this downward trend in construction output are an anticipated decline in new housing starts, both private and public, as well as new work in general. These sectors are expected to experience significant decreases due to rising mortgage interest rates and persistently high input costs.
Additionally, typical leading indicators for demand, such as sales of ready-mixed concrete, delivery of bricks and concrete blocks, and sales of sand and gravel, are all trending downward, signalling cooling demand.
Sentiment gathered by the Royal Institute of Chartered Surveyors (RICS) Construction Market Survey, shows contractors in the construction industry are currently grappling with several significant challenges. Labour shortages and financial constraints have emerged as the primary obstacles.
The scarcity of skilled workers and an insufficient labour pool can hinder construction activities, leading to delays, increased costs, and potential difficulties in meeting project timelines.
Additional pressures come from wages. In Q1 2023, average weekly earnings in the construction sector saw a 3.7 percent increase compared to the previous year. However, consumer price inflation recorded a 10.2 percent increase over the same period. Consequently, there is a notable difference between construction earnings and general inflation, resulting in real wages experiencing a decline of 6.1 percent on a yearly basis. Since the end of 2019, real wages have fallen below nominal wages for the first time since the measure started in 2000, reaching the largest difference in Q1 2023. As their earnings lag behind the inflation rate, it is common for individuals to pursue job changes as a means of negotiating higher wages and improving their income.
Source: Office for National Statistics
Tightening financial conditions mean that contractors are facing limitations or difficulties in accessing finance for their construction projects. These constraints can hamper their ability to undertake and complete projects efficiently.
The construction industry is currently navigating a challenging period, marked by a surge in insolvencies to levels not seen since the global financial crisis (GFC). Moreover, profit warnings are also on the rise, indicating further difficulties. According to EY-Parthenon, the peak of insolvencies is yet to come, as there is typically a nine to 12-month lag between the peak in profit warnings and the peak in insolvencies.
Since the onset of the COVID-19 pandemic, the construction industry has experienced two waves of insolvencies. The initial wave involved voluntary liquidations of businesses that took the opportunity to retire or close their businesses once government financial aid was withdrawn. The second wave, currently underway, primarily consists of compulsory liquidations. This wave has been driven by an extended period of challenging, inflationary business conditions, worsening credit conditions and sustained interest rate increases, disruption in the supply chain following the impact of COVID-19 and the conflict in Ukraine, and prolonged labour shortages.
Source: The Insolvency Service
These challenges are shrinking the capacity of the market as contractors become more risk-averse and adopt a more selective approach to the types of contracts they are willing to accept. This heightened selectivity is offsetting the easing pressures from cooling demand, adding pressure to tender prices, and compounding the overall difficulties faced by the industry.
Moreover, a special report by Construction News has shed light on the financial struggles within the industry. The research revealed that 46,323 companies have defaulted on repayments of their COVID-19 loans. A further 18,878 were in arrears at the time. When combined with the amount of arrears, these defaults account for approximately 25.0 percent of the loans issued. Critics of the scheme argue that it has extended the lifespan of financially unviable ‘zombie’ firms, further impacting the industry's overall health.
The revelation of these defaults and arrears highlights the financial strain faced by many construction companies and emphasises the potential long-term consequences of the industry’s current challenges. The combination of reduced market capacity, heightened selectivity and loan repayment difficulties further underscores the need for strategic planning, financial resilience, and targeted support to address the ongoing issues within the construction industry.
What does this mean for our forecast?
Our central scenario estimates that real estate tender price inflation will increase by 3.7 percent in 2023, up from the previous forecast of 3.5 percent stated in the Spring report. Our forecast for 2024 has also been adjusted upward, from 2.5 percent to 2.7 percent. However, the predictions for the remaining period of our forecast horizon remain unchanged.
Figure 11:
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.
Decreasing demand for construction projects is alleviating some inflationary pressure. In addition to decreasing new orders, data from Glenigan shows that project starts have fallen in almost all sectors.
Despite the easing of the growth rate, material costs remain significantly higher. Persistently long lead-in times, geopolitical tensions between China and the United States, and uncertainty around energy prices are preventing material prices from returning to pre-pandemic levels. Additionally, long-standing labour shortages have added labour cost pressures to the equation.
Adverse economic conditions are having a more pronounced effect on specialist contractors and subcontractors, who undertake repair and maintenance work—the type of work that is driving growth in construction output. The consequence of contractors going bust is a reduction in industry capacity, which is evident as, for the third consecutive quarter, more companies were wound up than created in the construction sector. This decreasing capacity adds inflationary pressure to tender prices, countering the downward pressure produced by easing demand.
Another concern is the elevated level of core inflation, which currently exceeds by more than three times the Bank of England's target of 2.0 percent. This persistent high inflation may prompt further increases in interest rates. As interest rates rise, it becomes costlier for firms to borrow, having a detrimental effect on new investments and further cooling the demand for new work in the construction industry.
The uncertainty surrounding future interest rate hikes may also contribute to a more cautious approach among investors and businesses. This caution could lead to delays in investment decisions, further impacting growth in the industry.
Source: Turner & Townsend Survey
Our infrastructure tender price inflation forecast for 2023 stays at 5.5 percent, unchanged from the Spring report, but our estimate for 2024 has been revised down to 4.5 percent.
After the government's announcements in the mini-budget, several projects entered a resequencing phase and have been postponed. This has rattled pipelines of work at a time when overall demand in the construction industry is cooling off.
Business investment remains below pre-pandemic levels, while business confidence appears stagnant awaiting more favourable investment conditions.
However, there are pockets of growth in UK infrastructure. Network Rail set out a new investment plan for the next five years. The next phase of HS2 will be tendered in Manchester in July, and defence remains a hotspot along with public sector education and health, data centres and logistics.
The supply chain for large infrastructure projects and programmes spans multiple geographies, and businesses with specialised skills and capabilities are in high demand.
Source: Turner & Townsend Survey
© 2023 Turner & Townsend