Building for a recovery

IN MARCH, the government finally completed its overhaul of the UK planning system. A new National Planning Policy Framework came into force, a document that chancellor George Osborne hopes will give development across the country a boost.

Few hope he is right more than those in the construction sector. After apparently emerging from recession strongly in 2010, growth has been negligible, and the Construction Products Association (CPA) expects industry output to fall a further 5% this year. With such a dismal outlook, the industry could do with a surge of optimism.

“Contractors are still under pressure. Margins are tight, cash is tight,” says Richard Lyle, director in KPMG’s infrastructure, building and construction practice.

Neil Morling, finance director of EC Harris, says fierce competition for what little work there has been has forced the prices the construction consultancy can charge down by 50%.

“We have maintained our level of turnover, and have had to take measures to control our costs,” Morling says.

Falls in land prices, meanwhile, have made developers think twice about starting new schemes.

“We have to work hard to get something financially to stack up,” says Stephen Carter, finance director at Starboard Hotels, a specialist hotel developer with interests in house building.

Glimmers of hope

It is easy to be glum about the construction sector. But it is, too, an industry that defies easy description or summary. There are many glimmers of hope out there.

“The pipeline of large construction projects is shorter than it has been. But there are pockets of interesting activity,” says Paul Davies, an infrastructure expert at PwC. “There is less expenditure on social infrastructure, such as schools and hospitals, and more on economic infrastructure, like roads, rail and energy.”

The cuts have been well covered. The construction industry is still bearing the scars of the axeing of the Building Schools for the Future (BSF) scheme by the coalition in its first months in office. BSF would have delivered £55bn worth of work over its lifetime.

However, the positive stories have had less coverage. Green infrastructure is a particularly vibrant area. As well as the challenge of offshore wind, the construction industry is gearing up to overhaul UK housing, “retrofitting” millions of homes with better insulation and greener technologies.

The finance for the projects, which will be fixed to households rather than individuals, is an entirely new and radical concept – and one that will deliver £6bn worth of work to the construction industry over the next five years.

There is huge variety too in which areas are currently doing well, and which are doing badly.

“In London it’s still busy,” says Morling. “There’s a lot of activity. There are new cranes going up, new sites. However, there’s not the level of activity we would have hoped for.

“If you move outside London, it’s a different story, with very little activity.”

There is still a reluctance even in London, Morling says, to push the button on office development schemes – even with a looming shortage of office space in the capital. And what schemes there are tend to be financed by overseas investors rather than from within the UK – the Shard of Glass and the Chelsea Barracks are the most obvious examples, both being financed by Qatari money.

House building is one area where some are doing well. Taylor Wimpey, which almost collapsed during the downturn, announced its first annual dividend since 2007 earlier this year. Persimmon has seen its shares soar, meanwhile, after pledging to return £1.9bn to shareholders over the next ten years.

The cheap land that many of the house builders bought during the crisis is now proving invaluable, not to say very profitable.

Varying responses

Finance directors working in the construction sector have come up with varying responses to deal with the downturn.

Those at the more creative end – the consultants like EC Harris and the architects and engineers – have been able to diversify by finding work abroad.

“We have focused a lot of our energies on international new business, developing our overseas portfolio to compensate for the UK downturn,” says Natasha Martin, finance director at John McAslan and Partners, the architecture company behind the new King’s Cross Western Concourse. It is aiming at developing in Asia, Russia and the Middle East over the next five years.

EC Harris has diversified similarly into the Middle East and Asia, as well as starting to offer a broader range of advice – on issues like the operation and ownership of built assets as well as advising on construction.

Suicide bidding

The recession accelerated a process whereby contractors – the heavy lifters of the construction world – tried to move into the consultants’ space.

“They can see where the client is looking for value. Contracting is more and more commoditised as a business,” says Morling.

KPMG’s Lyle agrees that contracting is where there has been a real squeeze.

“Contractors are finding it very difficult,” he says. “They are having to think a lot more imaginatively in the way they do business, and having to be a lot more careful about what they bid for and how they bid for it.”

The issues of “suicide bidding” and also late payment have become prominent during the recession in discussion on construction issues. Contractors regularly accuse each other of bidding for work at below its cost – of buying turnover. And few industries are as fraught with issues of late payment as construction, with main contractors holding on to cash for months.

Starboard’s Carter adds that getting bank finance has become much harder.

“It takes more time, effort and information to get finance than it used to,” he says.

Banks want to know about all a company’s assets to determine if they are credit worthy, making the whole process much more time-consuming, he says.

Inevitably, some big contractors have gone under in the last few years, including repair and maintenance group Rok, which employed 3,800 people, and social housing specialist Connaught, which employed 10,000. Historic names such as Holloway White Allom – which built the Old Bailey and the Bank of England in the early part of the twentieth century – are also no more.

But there are signs of hope. Carter says Starboard Hotels is more optimistic this year than it has been previously.

The CPA’s forecasts suggest this year’s decline will turn to growth next year. It will be slow at first but will build as private sector construction returns.

The influential monthly Purchasing Managers’ Index (PMI) reports on sentiment in the industry, produced by Markit and the Chartered Institute of Purchasing and Supply, suggest rising optimism over the last few months.

“Positive signs can be seen in the new house markets in London and the South East which are still buoyant. [And] a growing commercial market in these areas is beginning to pick up the slack from the public sector,” says Lyle.

Ultimately, one of the biggest parts of the construction industry’s output is provided by private buyers developing offices and retail – the commercial sector, which accounts for as much as a quarter of the industry’s output. The construction sector is strongly pro-cyclical, as a general rule growing or declining at a rate of three times the growth or decline of UK GDP as a whole.

In other words, it will take an economic recovery to put a smile back on the industry’s face – another reason why construction is looking to George Osborne to deliver the goods. ?