Tender price inflation forecast
As activity levels tail off, construction shouldn’t assume prices will fall
With the UK economy softening, it is tempting to assume that tender price inflation will fall as client demand cools. But while past precedents suggest this is likely, it is by no means assured. Despite superficial similarities, recessions are seldom identical, and those preparing for the current downturn need to examine its specific circumstances to identify how they will be impacted.
In the face of rising borrowing costs and the uncertain economic outlook, current forecasts offer few grounds for optimism when it comes to demand – which is usually the biggest indicator of the future direction of travel for prices. The Construction Products Association (CPA) winter construction output forecasts suggest activity may fall by 4.7 percent in 2023, before settling to a 0.6 percent increase in 2024.
Source: Construction Products Association
However, there are still pockets of growth, especially when looking at the CPA’s Autumn industrial and infrastructure outlook. The Sunak Government’s re-commitment to a pipeline of critical infrastructure – from HS2 to Sizewell C – brings a welcome level of certainty that will help these schemes continue in earnest.
Input costs are arguably the second largest determinant of pricing. And despite falling for only the second time in 27 months in October 2022, the cost of construction materials and components is still a painful 44.0 percent higher than its pre-COVID-19 level. This is due to a combination of factors such as increased demand, supply chain bottlenecks and high energy prices.
Source: Department for Business, Energy and Industrial Strategy
These elevated costs could remain sticky for as long as energy prices stay high and sterling is undervalued. Contractor expectations in Q3 2022 suggested that, even though the pace of material cost rises is likely to slow, material prices could still increase by 10.3 percent over the next 12 months.
Likewise, the ongoing skills shortage is also buoying labour costs. In 2022 Q3, there were 46,000 vacancies in the construction industry, the highest level seen in over a decade. Coupled with a lack of new entrants into construction, employment decreased by 1.4 percent on the quarter in 2022 Q3. Border closures, early retirement and workers switching to different industries following pandemic-instigated lifestyle changes are also having an impact.
The Royal Institute of Chartered Surveyors’ Building Cost Information Service suggests labour costs may increase by up to 8.1 percent in 2024. So, while demand is set to fall and material pressures are easing, labour costs will persist, putting a floor under inflation to a certain extent.
Source: Building Cost Information Service
Overall, these factors suggest that even with the inflation-cooling effect of a recession, for now, the construction environment remains inflationary. While deflation may eventually materialise, clients and contractors should continue to be proactive in tackling cost pressures on a project-by-project basis, tailoring their approach to a range of factors from region and sector to project size, procurement route and market. In the event that prices fall and deflation becomes a reality, a considered approach to tendering will be required as low, unstainable prices come with a list of risks that could outweigh their benefits.
Success will come down to getting the basics right: assessing risk at an early stage, dialling up productivity gains to increase efficiency and forging close, agile relationships with supply chains through early engagement and closer ties. Together, these strategies can all help to mitigate the impact of inflation as recession begins to bite – both during and after the downturn.
What does this mean for our forecast?
Our central scenario estimates that real estate tender price inflation averaged 9.5 percent in 2022, 0.5 percent higher than our Autumn 2022 forecast. We have maintained our forecast for 2023, while our forecast for 2024 has been revised down by 0.5 percentage points to 2.5 percent. The remainder of the forecast horizon has been left unaltered.
Figure 8:
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.
Softening market conditions will help curb industry price pressures in 2023 and contractors are anecdotally starting to feel the pinch in the form of rising pipeline uncertainty. Economic turbulence and reductions in confidence are leading to more projects and programmes being delayed or cancelled.
Material costs are also becoming more manageable and extended lead times are less problematic. This will contribute to a potential reduction in the pace of tender price growth by approximately half. Prices, however, remain sticky, as labour shortages continue to bite and insolvencies persist, reducing the pool of available contractors, and the people that work for them, to bid for work.
Whilst our central real estate forecast doesn’t suggest deflation will materialise for now, it is a very real prospect and prices could potentially fall – depending on project vagaries - in 2024. The UK’s economic performance, and the construction industry’s resilience to a marked weakening of activity, will play a key role in pricing moving forwards.
Source: Turner & Townsend Survey
Our infrastructure tender price inflation forecast has also changed. Our Autumn 2022 forecast anticipated a possible 9.0 percent increase in 2022 and that has now been revised to 10.0 percent, up by 1.0 percentage points. There are also upward revisions to the remaining forecast horizon, and price rises are now expected to hold at around five percent per annum.
Committed Government expenditure will help keep infrastructure demand more buoyant than that of the real estate sector, although some constraints persist, driving strategic trade-offs, slow-downs and accelerations. Long-term skills shortages are also starting to bite more deeply, compounded by the increasing size and complexity of large investment programmes.
The contracting supply chain for large infrastructure projects and programmes also spans multiple geographies, and specialist capacity and capability are sought after. This means that contractors do not just service the UK market – they cover Europe as well – and contractors can still be selective when bidding for new work, adding to price pressures.
However, while there are pockets of growth in UK infrastructure, some of its subsectors and real estate sectors are much less bullish, leading some constructors to pivot to new opportunities. Though this can contribute to increased buying power for infrastructure clients and lower price pressures, as more firms compete for a reduced pipeline of work, there can be difficulties when entering a new sector. If risks aren’t fully understood, significant price variances can emerge, as highlighted in our range of forecasts.
Source: Turner & Townsend Survey
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