Faced with low consumer confidence and a housing market on its knees, are we heading for recession? B&E reports.

YOU’D BE forgiven for thinking the construction industry was heading into meltdown.

Terms like “sub-prime” and “credit crunch” have been repeated like mantras by financial analysts and the media over the last year. So much so that if we don’t head into a recession,it won’t be because we haven’t talked ourselves into one.

The Office of National Statistics has provided what appears to be, on the face of it, a little light on the sector this month by revealing continuing growth for the sector in the past 12 months.

Industry output in the first quarter of 2008 rose by 2.4% compared to the same period last year. But despite the strong growth in infrastructure and commercial, private housing continued to slump and was down by 5%.

Michael Ankers, chief executive of the Construction Products Association (CPA), tells B&E the figures in growth came as a surprise. At the start of the year the CPA forecasted 1% growth for construction output in 2008 – significantly below what it anticipated 12 months ago.

“I was surprised how strong they were,” says Ankers, almost apologetically. “Overall the thing pans out to be 2.4% growth and I must admit you wouldn’t have expected that from the first quarter, talking to people. If you take 2.4% growth – you’ve got to have a pretty dire next three quarters to go into serious negative territory.”

Housing recession
Tougher lending conditions and successive interest hikes continue to blight the private housing market.

In April, Persimmon postponed work on new sites until the mortgage market improves and this month Bellway Homes announced it expects to sell between 10% and 15% less houses than last year.

But while the headline stats for housing are poor, it is not happening everywhere. Telford Homes is a £160m a-year-turnover developer and will have completed 1,000 units in the last year. Director of construction, James Gaffney explains that the market for housing varies depending on regions. “The market in east London is slightly more vibrant than perhaps other more suburban areas. Many of the developers making announcements of office closures and postponing new work operate in the more suburban areas.”

Despite the upbeat note, Telford who works in partnership with housing associations and sells units early and off plan, says the year will be challenging. “It is fair to say on developments we’ve got on the periphery of London sales are significantly slower and it’s going to be a very difficult year.”

But are we being over-influenced by what’s happening in the housing market? “It is dire,” says Ankers. “There is no question about that, but there are some strong sectors. We expect commercial and infrastructure to be strong for the rest of the year, although we don’t see housing recovering at all.”

The growth in housing repair and maintenance was also a surprise given the current consumer problems. “Some of that may have been people getting their properties fixed and refurbished from the flooding last year,” says Ankers. “Also, when people don’t move house they tend to spend a bit more on their existing property.”

Included in the growth was a 4% rise in new build projects on the back of increases in infrastructure and commercial – but the scale of the strength appears to be the surprise. Infrastructure and commercial were up more than 9% from this time last year, although the future forecast of the two will deviate significantly. “Commercial is finishing off a host of offices and retail outlets which won’t be replaced next year,” says Ankers. “So commercial is going to be a very difficult sector between 2009 and 2012.

There was always going to be a surfeit of offices in London, because we’ve had a whole host coming forward.”

However the credit squeeze has seen firms slim down office staff with those firms now reconsidering future accommodation leading to the likelihood that those orders won’t be replaced. “No one is really committing to big orders at the moment,” says Ankers.

John Reyers, partner at Knight Frank says as a building consultancy it is seeing far less demand for transaction services for commercial new build projects.

“Increasingly what happens as the economic climate switches is commercial clients start working their assets and seeking to improve the performance of their existing buildings to retain clients,” he says. “So they’ll switch to refurbishment of their existing stock. It is something we are currently seeing. Schemes coming out of the ground may fall through for one reason or another as parties reassess their position in the current climate. So commercially there are fewer transactions – fewer of those big orders for new builds.’”

But Reyers signals future opportunities in the current economic climate. “The other issue you do get is offshore money coming into the UK, particularly in London to buy good, well priced assets, so there will be opportunities there.”

With commitments to the £16bn Crossrail project and the £5bn upgrade of the M25, the public sector, and in particular infrastructure, looks like taking some of the flak of the private sector. Ankers says the government’s £45bn Building Schools for the Future (BSF) programme is also beginning to take off.

“Contractors are still very busy,” he says. “They are very conscious that around the corner might not look so good, but none of them are saying this year is going to be difficult.”

Crippling materials prices
As well as the suffocating credit conditions, material prices look set to cripple contractors and developers. Construction product manufacturers typically account for some 40% of the value of a construction project. Material prices shot up approximately 7% in the last year – and the greatest risk facing future prices is energy.

“Energy is absolutely crippling people,” says Ankers. “And it is the cost of energy, in particular gas. Our energy prices are higher than any other part of Europe and we’re working with the government to try and explain that. It is really adding seriously to the cost base of our companies.”

Particularly vulnerable have been plastics and steel prices – exposed on two fronts: both the combination of hikes in energy and the price of raw materials. “They’ve had it both ways round,” says Ankers. “The increasing price of oil and transport costs is putting real pressure on the supply side,” says Professor Rudi Klein, chief executive of the Specialist Engineering Contractors Group “But it might also put some pressure on getting more sustainable output when it comes to building.”

The cost of raw materials and energy have been driving up the overall inflation in construction, which is running at approximately 6%; double what’s happening in the economy. Where this is having a particular effect is in the public sector – where a lot of the government’s programmes haven’t built in an inflation rate higher than the economy.

“What we’re finding with some of these big capital programmes with government is that the actual price inflation is eroding the amount of work that can be done,” says Ankers. “In other words, your project is more expensive, so the money you’ve got doesn’t go to so many projects.”

Where material prices have been putting pressure on price is the Olympics, which has already seen its budget escalate from £2.4bn to £9.3bn.

“Inevitably if material prices continue to rise through circumstances beyond our control then it’s going to be putting the price up, says Ankers, “but what the Olympics is doing is it is being flexible within its programme.”

He points to this month’s announcement that the Olympic Delivery Authority will make four design changes to the Olympic Park, which will see the Fencing Arena, which was to be held in a temporary venue on the Olympic Park, move into Excel London.

“They are looking at what they’re doing all the time to keep the cost base,” he says. “While there is no doubt the cost of materials is putting pressure on the cost of the Olympics, and I suspect it’s pressure they hadn’t taken account of, it won’t necessarily feed through, because they are looking at ways of accommodating these
pressures in the way of downsizing arenas or redesigning arenas and so on.”

The void?
Can public sector spending growth continue to fill the void of the private sector? “It is difficult for government not to continue to spend on the BSF programme and substantial infrastructure projects, which include water as well as rail and road,” says Ankers. “We think there’s going to enormous pressure on government spending, but we feel they are not going to stop in any significant way.”

But are we heading into a recession? “With the construction industry driven by so many different markets and budgets from private and consumer to public spending, it is difficult to say,” says Ankers, being carefully vague.

“Housing is in a very serious recession, but if you’re in commercial building at the moment or the BSF programme and infrastructure, then everything is fine. If all of those sectors go down – it is really bad news, but very rarely do they all go down at the same time.”

Klein says the public sector will continue to take up a fair amount of the slack over the next few years. “The government’s Comprehensive Spending Review did anticipate quite significant growth, particularly in health and education,” he says.

Klein is optimistic the industry will survive the credit crunch. “This is a totally different situation to the recession in the late 1980s and early 1990s because there wasn’t the degree of spending in the public sector as there is now,” he says.

“There was also a lot of adversarial conflict in the industry, which meant firms were going out of business. That hasn’t completely disappeared, but here is more of a collaborative approach now.”

Ankers is also keen not to get too carried away. “At the moment I think contractors will be cautious about expanding their operations and taking on new people,” he says. “There’ll be desperate to keep costs down. But at the moment they are very busy.”