The Money Should Follow the Market

As the GDP output figures show a rise in the construction sector of 0.9%, Jonathan Pochin, managing director of Pochin Construction, warns that other changes, particularly in financing, are needed before we can see a real return to growth.

If the post-2007 construction market has taught us anything, it’s that confidence is key. So the news last week that the construction sector has grown by 0.9% quarter-on-quarter will certainly have a positive impact on businesses. The increase may be a modest one, but after years of less than inspiring results, gentle growth is very meaningful.

A major concern for many in the sector has been the continued negativity that has been pervading construction firms across the UK, and the opinion of some that we talked ourselves into a recession that we are now struggling to get out of.

While it has been a challenge to ignore the constant doom and gloom surrounding construction in the media, as well as the deflating GDP figures from the ONS, the most successful companies have been those that have tried their very best to continue with business as usual.

However, bravado can only go so far. The impact of the consistently low output figures is that companies have been looking at their strategies and budgets, choosing to fight hard for the little available work that has been out there and dramatically decreasing their profit margins in order to price competitively. While this has kept many firms busy for the last few years, this strategy is not sustainable. It has slowly eroded the financial viability of the construction activity, while also forcing a reduction in pricing across the sector as competitors follow suit.

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While larger contractors have cash reserves, which enable them to keep busy and continue to deliver turnover with lower profit, those that have been unable to reduce their margins in this way have struggled and many have been forced to exit the market.

But with the announcement of 0.9% growth the sector has been given a tangible result that will hopefully begin to encourage construction firms to run their businesses with confidence. Crucially, it should also demonstrate to those outside the sector that now is the time to get started on new projects – in particular developers who have been dramatically reducing their output over the past few years. A boost in the development pipeline will result in a greater number of projects that contractors can compete for, allowing for a return to sustainable profit margins and ultimately a greater degree of stability within the industry.

Another positive sign in the market is the increasing activity of consultants, such as architects, project managers and quantity surveyors. While there is normally a six- to 12-month time lag between results in the advisory services and output in the construction sector, it looks likely that growth looks set to continue.

However, there is one key feature that could limit the growth trajectory – funding. Cash is king, and in a world that is still built on credit, project funding is not as solid as it needs to be to support growth. So despite the mood beginning to pick up, a lack of trust in the sector’s stability means that extensive due diligence processes are still in place before investments are made. This results in an overly long lead time, wreaking havoc with financial forecasting.

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Traditional sources of funding are changing. The rise of investment funds replacing mainstream banks as the main financier of construction projects has led to more stringent cost requirements, and the return they’re expecting is higher than the banks had previously asked for. This can have the effect of increasing pressure on the construction contractors to reduce their costs. The risk is that, despite confidence returning to the market and project levels increasing, the construction sector could miss the opportunity to regain its pre-recession position thanks to continuing pressure to keep low service costs.

Ultimately, the relationship between developers, contractors and funders is never going to be simple. But construction firms’ position will be strengthened by an increase in confidence. 0.9% growth may only be small, but for many it represents a light at the end of the tunnel and the promise of an increase in opportunities in the future.

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