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Post-millennium building trends

In the first of a quarterly feature, we chart the existing trends and projections for the construction industry

Department of Environment, Transport and Regions (DETR) statistics indicate that the sharp increase in orders for new construction seen during 1997 and 1998 has halted and that new orders in the year to January 2000 returned to 1996 levels. The total volume of orders for new work last year was significantly down on 1998. While it is apparent that one of the main causes of this reversal of fortunes is the impact of the fall-off in major lottery funded and millennium projects, it is worth noting that nearly all sectors and regions saw some fall-off in new work.

DETR figures indicate that in the year to January 2000 orders for new work in the private commercial sector fell by about seven per cent.

However, with orders for new construction in 1999 considerably exceeding 1997 levels, and the service element of the economy expanding at about one per cent per quarter, the private commercial sector is anticipated to remain reasonably active in the short to medium term. The latest RICS Construction Survey reports an upturn in commercial workloads for the first six months of 2000 in all regions except the South West.

The DETR reports that non-infrastructure public sector has seen a five per cent fall in orders for new work in 1999.

There is a big backlog of orders to be placed in this sector as major health and education projects are on line to be procured through the PFI process; it is hoped that some of this backlog will be cleared this year.

Further increases in public-sector workloads can be expected following Government initiatives announced during the Budget and Comprehensive Spending Review.

Government investment expenditure is scheduled to increase by 18.25 per cent to £26 billion this year, 15.5 per cent to £30 billion in 2001 and 16.5 per cent to £35 billion in 2002. With the strong pound hitting manufacturers, the private industrial sector has suffered the greatest fall in orders for new construction work. DETR statistics indicate that 1999 saw orders at 14 per cent less than 1998 levels, which in turn were 10 per cent less than 1997 levels.

Despite a small upturn in orders for new construction in the first quarter of this year (as reported in the RICS Construction Survey), provisional figures from the Office for National Statistics indicate a severe slowdown in manufacturing output over the same three months.

Therefore, any significant improvement in the medium to long term for this sector cannot be anticipated.

Poor performance in the private industrial sector hits the Midlands and North East regions the hardest: the proposed closure by BMWof all or part of the Longbridge Rover plant will undoubtedly have a knock- on effect on the car components industry and the local economy. However, the Dagenham wind-down shows that the South East is not immune to the manufacturing shake-up.

Costs and tender forecasts

Construction cost increases are anticipated to continue to operate above levels found in the general economy. Building costs increased by four per cent in the past year and are expected to rise by three per cent in the next year; while general underlying inflation levels are currently less than two per cent.

Material costs have fallen by 1.2 per cent over the past year, largely as a result of the strong pound (or the weak euro), suppressing the price of imported raw materials and fabricated goods. Over the next two years, and with no significant alteration in the exchange rate anticipated, material prices are expected to rise at a rate around or below general inflation levels. The one contradictory indicator to this rule is the continued firmness of oil prices, which directly impact on manufacturing and distribution costs Labour costs, on the other hand, have risen by almost six per cent overall. Skill shortages in some regions and sectors continue to drive up rates. For example, as a result of the South East housebuilding boom, bricklayers in the London area have enjoyed pay increases amounting to 30 per cent over the past year. Finishing trades have been in demand by housebuilders and on millennium projects as they near completion; rates have risen accordingly.

Tender inflation, after increasing steadily to more than seven per cent per annum during 1997 and 1998 stabilised last year at around a more modest 3.5 per cent level. UK average tender inflation for this year and next is forecast to remain at similar levels and just above the general inflation rate.

Regional variation is apparent for 2000. Tender inflation for London, the South East, the North West, Scotland and Northern Ireland is forecast at four per cent per annum; tender inflation for the South West, the North East, Wales and the Midlands is forecast at three per cent per annum for the same period.

Major contractors report that their order books are not yet full for 2000/2001 and that most projects are largely attracting highly competitive bids. However, there is evidence that these same contractors are either declining to tender for projects that are seen as 'difficult' or 'risky', or are adding considerable price premiums. It is of course a matter of conjecture whether this strategy can last, if a medium to long-term fall-off in orders for new construction occurs.

Employment and productivity

Statistics published by the Construction Industry Training Board (CITB) earlier this year indicate that labour productivity in expected to continue to rise at a steady rate of 1.5-2 per cent per annum over the next five years. On that basis, construction output will continue to grow until 2004. The CITB reports that employment in the construction industry (both direct and indirect) is anticipated to increase steadily over the same period, at about one per cent per annum.

The lastest RICS Construction Survey anticipates a sharp increase in employment over the short to medium term, with 39 per cent of surveyors expecting employment to rise over the next 12 months. A less confident view is taken for the long term.

Figures released by Insignia Richard Ellis and published in the RICS U K Economic Brief indicate that over recent months there has been considerable growth in the capital value of commercial properties across all sectors of the economy. Capital values grew by more than six per cent per annum in the year to February 2000 - an increase of about two per cent per annum when compared with the year to November 1999. The impact of the 0.5 per cent increase in stamp duty on property transactions over £250,000 announced in the March Budget has yet to be felt in published statistics.

With retail sales up 5.5 per cent per annum in the year to February, the RICS U K Economic Brief cites healthy consumer spending as sustaining strong demand for retail property, with rents rising by about seven per cent per annum. Compared with February 1999, this represents an increase of about 1.5 per cent.

Housing stats are dealt with elsewhere in this report.

The steady growth in the business and financial sector of the economy is fuelling continued demand for office property. Office rents grew by about 6.5 per cent per annum in the year to February 2000 - an increase of one per cent per annum over the year to November 1999.

Rental inflation in this sector is being driven, not only by increasing demand, but also by a continuing reduction in available and suitable office space. In the City of London, office rents have reached their highest level since the boom of 1989.

The RICS Commercial Market Survey identifies increasing demand for industrial property in the first three months of this year.

Rents grew by 4.9 per cent per annum in the year to February. As a result of poor performance in the manufacturing sector, a slowdown in demand for industrial property is expected. It is highly unlikely that current levels of rental growth can be maintained.

Mortgage lenders have issued contradictory messages on the residential property market. Figures released by the Halifax cite a fall of 0.4 per cent in house prices in March, whereas figures issued by the Nationwide identify an increase of 2.3 per cent for the same month. The RICS Housing Market Survey predicts that price inflation will level off as the impact of higher interest rates, increased stamp duty and the abolition of mortgage interest tax relief is felt on the housing market.

It should be noted that although these figures reflect the national picture, there are considerable geographic variations to the trends.

International perspective

The overlying trend in the international market is the continued development of the European Union, which has opened up most of Europe to global investors. New economic opportunities are being generated within the member states. The knock-on effect for London, with its close interaction with New York and Hong Kong, is the strengthening of its position as the financial centre of the EU, further assisted by new ties with Frankfurt.

Construction activity is on the increase in Europe, particularly within former Eastern Bloc countries.

Growth is strongest in the hotels, service and e-commerce sectors.

Poland is one of the most economically active countries in Europe. Despite a buoyant construction industry, building cost inflation has remained static at about 8.5 per cent per annum. Cost increases have tended to be absorbed by subcontractors who have been forced to reduce profit margins.

With local products having a significant price advantage over highly taxed imported goods, both domestic and foreign investors have seized the opportunity to increase production facilities for construction goods and materials within the country - a new chipboard factory at Grajewo being a case in point.

In Australia and Asia, building inflation has fallen for two consecutive years, with the most severe drop in Singapore of 9.3 per cent.

The sudden faulter of many Asian economies resulted in an almost overnight halt to many construction projects.

In Hong Kong, the completion of Chek Lap Kok airport and the collapse of property and economic markets were influential factors in an 18month slowdown in the construction industry.

In Japan, the recession has caused increased domestic competition, and the government's expenditure budget for public works has peaked.

Private sector capital investment is also due to drop in this year, and so the industry is entering a period of transition which will see the winding down of many construction companies as profit margins are squeezed to gain the few contracts that are available.

Prepared by Della Hughes and Robert Williams-Lock of the MDA Group, international property and construction consultants.

IN BRIEF

New orders fell by 9 per cent in 1999.

Commercial sector workload continues to grow steadily in the short to medium term.

Government capital spending is set to increase by 18.25 per cent this year.

Strength of the pound causing slowdown in the industrial sector.

No respite anticipated.

Skill shortages push building costs 1 per cent above general underlying inflation levels.

After two years of steady growth, tender inflation is beginning to stabilise at around 3.5 per cent per annum.

Labour productivity is set to increase at 1.5 - 2 per cent per annum over the next five years.

Office rents up by 6.5 per cent per annum fuelled by steady demand in the financial services sector.

House price inflation is set to level off in consequence of higher interest rates, increased stamp duty and the abolition of MIRAS.

Seasonally adjusted house prices in May show first decline since August 1998.

Mainland European construction industry is strong.Growth in demand for property is strongest in hotels, services and e-commerce.

Slowdown in Australian and Asian economies continues.

The seasonally adjusted employment figures in January 2000 were five per cent higher than those of October 1999.

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