With greater certainty over Brexit, our 2021 UK average TPI forecast has been revised upwards to -0.5% (previously -1%) as overall demand holds up. We expect to see a bumpy start to the year as businesses adjust to the new trading relationship and supply chains remain strained due to a slowdown in production from some factories in the EU. We anticipate that the early part of 2021 will be the bottom of the market. However, tender pricing is expected to remain keen in the short-term as the economy recovers and normal levels of demand return.
All regions are expected to see gradual inflationary rises towards long-term average levels of tender price inflation over the next two to three years. However, the market is likely to remain cautious for some time and clients may hold back projects until there is greater confidence in the economic recovery and we see a return to pre-COVID behaviours.
Although trading conditions are, on the whole, expected to be tough in 2021 as contractors wait for the market to stabilise, they will vary by sector. In the healthcare, infrastructure and logistics sectors for example, we’re likely to see above-trend tender price inflation as capacity is limited. In other sectors, such as commercial and retail, contractors will be very keen to win work and market discounts will be prevalent. Several other factors are also expected to feed into tender price inflation levels in 2021. Towards the end of 2020, we observed that some contractors were declining opportunities to tender on the expectation that there could be increased tender activity in 2021 (and therefore the potential for higher pricing). Tier 1 contractors in particular were being very selective about taking on new projects.
While the current competitive market conditions could present clients with a good buying opportunity in the first half of 2021, some clients will expect more of a reduction in prices than contractors are willing to give. Faced with rising materials costs (particularly steel) and lower productivity, contractors are evidently pushing back and in some cases are even trying to raise prices.
A number of projects that were previously on hold came back to life in Q4, moving to the early stages of design and planning. TPI survey respondents expressed cautious optimism, noting that enquiry levels and new commissions had been positive and that there was an increase in the number of feasibility studies undertaken in Q4 which could potentially materialise into new projects. However, this was caveated, with some suggesting that whether clients commit beyond planning stage will be tenant-led and funding-related.
Uncertainty over whether the UK would secure a trade deal with the EU caused some clients to hesitate in 2020, but now a trade agreement has been signed, a degree of confidence may return in 2021. Consequently, tender prices may not drop as much as they could have done in 2021 but we have yet to see the full impact of COVID-19 and the measures taken in response to the pandemic over the last 9-12 months and how these will weigh on certain sectors. Securing turnover and cashflow in 2021 will remain a priority as contractors wait for market conditions to stabilise. Projects that can secure a significant level of turnover and pipeline work for the next two or more years will be competitively sought after.
Currently, there appears to be a two-tier tendering market with lower tier contractors more actively chasing a smaller pool of work and offering increased market discounts. Tier one contractors, however, whilst having to be a little more competitive with their tender price bidding, have largely secured their pipelines for 2021 with some projects spilling into 2022. Accordingly, tier one contractors have been better equipped to bid selectively and avoid low or even ‘suicide bidding’ to secure turnover. Many of these larger contractors have declined to bid in anticipation of more opportunities and increasing levels of tender activity as we progress through 2021.
In the second half of 2020, it was not uncommon to see tender returns 5-6% below the pre-tender estimate (PTE). Tender submissions for smaller projects, where there was heightened competition with single stage tendering deployed, saw more aggressive pricing and tactical bidding. Where an attractive project met a hungry supply chain trying to plug shortfalls in order books, tender price deflation was greater. However, reducing margins and underwriting business at a loss is unsustainable. This prompted concerns that the pricing impact would be shunted through the supply chain and would ultimately fall on the subcontractors to bear it.
Recent Government advice may give the impression that lockdown 3.0 is just ‘business as usual’ for the construction sector. However, the latest version of the CLC’s Site Operating Procedures requires contractors to take action if five or more cases of COVID-19 are identified on site within 14 days. Despite having good protocols in place which are being followed vigilantly, some contractors are concerned that with COVID-19 cases rising in the UK, there is a greater risk of sites having to temporarily shut. This is compounded in metropolitan areas by the lack of capacity on public transport leading to heavily congested travel with no social distancing. If site closures happened at scale, it would damage client confidence and result in delays and postponements of projects.
Key inflationary and deflationary pressures
Based on our observations of the market, survey feedback and our extensive discussions with the supply chain, we have established that a number of inflationary and deflationary pressures are likely to impact tender pricing.
According to the ONS, the ‘All Work’ material price index rose by 3.1% in the year to November 2020. After briefly falling in the summer months, the index rose sharply in the autumn.
Shortages and supply issues helped push up prices as a whole in 2020. As site activity picked up in the second half of 2020 and demand outpaced supply, several key materials such as fabricated structural steel and imported timber experienced above-average cost inflation of 8.4% and 5.8% respectively in the three months to November 2020. Enduring lockdown constraints and low supply inventories conspired to create tight supply conditions for a number of materials and elevating input cost inflation – something which is likely to persist while supplier and distribution channels are dislocated.
Reports of shortages persisted through December and into 2021. BMF chief executive John Newcomb, who also co-chairs the CLC’s working group on product availability, explained that, “pretty much all the availability issues at the moment are COVID-related and the result of factories closing and re-opening, along with container capacity, which also flows from COVID.”
Transport delays at UK ports and a lack of stock among suppliers were the main difficulties reported by UK construction firms at the end of 2020. This resulted in longer delivery times and the fastest rate of input cost inflation since April 2019 according to the latest PMI data compiled by IHS Markit. Low availability of finished products and raw materials meant that suppliers increased prices for goods in short supply. France’s 48-hour ban on cross-border travel and pre-Brexit stockpiling in December exacerbated the supply issues that were building up before the latest lockdown restrictions.
Fortunately, the trade agreement with the EU has meant that immediate material price hikes have been avoided at the border. The construction industry breathed a collective sigh of relief as the deal allows construction firms to continue to forecast cost and availability of materials/products imported from the EU. Both the UK and the EU also agreed to co-operate mutually with regard to reducing technical trade barriers at the border. This should help avoid some of the potential risk of delay and disruption. However, from July, all traders importing goods from the EU will have to make full safety and security declarations on construction products at the border, increasing the risk of supply chain disruption in the second half of the year.
With demand outweighing supply, steel prices skyrocketed in recent months from an average of £650 per tonne in 2019 to £900 at the end of 2020. Some stockholders are reportedly quoting up to £1,250 per tonne after global mill production slowed due to the pandemic and stocks were depleted. Resurgent demand and rising raw material costs have also fed into higher prices prompting contractors to warn that pre-tender quotes prices will have to rise as a result of the higher rates. Steel supplies are expected to catch up to demand by Q2 2021 but the price looks set to remain high for some time.
It’s difficult to see material price inflation softening in Q1 2021. Construction will also need to brace itself for delays as new customs systems bed in. So far, imports of construction products from the EU have avoided major Brexit-related disruption but the industry should remain vigilant to the possibility of disrupted supply later on in the year as traffic increases through the border and when new declarations on construction products have to be declared from July.
Construction labour rates have seen a strong recovery since their low-point in May 2020. According to the ONS, average weekly earnings (total pay) rose for five consecutive months between May and October 2020, nearly returning to pre-pandemic levels. In October 2020, the three-month weekly earnings average was just 2.2% lower than it was one year ago.
Weekly earnings recovered relatively quickly once work on construction sites resumed and employees were unfurloughed. Whilst initially utilising the Government’s Job Retention Scheme heavily, BCIS data (covering 30th November to 13th December 2020) shows that the construction sector had just 2.8% of its workforce on partial or furlough leave, making it the third best performing sector in this respect. However, without the Government’s support to keep sites open, the labour market could have been starkly different.
A large percentage of construction labour comes from Europe. In London, for example, 33% of the construction of buildings workforce are EU nationals. Construction has benefitted from the free movement of labour from other EU member states. Now this has ended, European construction workers will be subject the new points-based application system. Under this system, several roles will be excluded (eg general labourers and some plant operators) and for those that do meet the relevant thresholds, the ongoing sponsorship costs to bring foreign workers to the UK may be prohibitive for some contractors.
Although difficult to determine at this stage, some are speculating that labour costs will increase above inflation. The supply of labour is expected to become increasingly constrained and G&T understands that on some sites, site attendance in the new year has been down by as much as 20%. It’s unclear whether this is largely due to increasing numbers of workers being infected by COVID-19, extremely clinically vulnerable individuals choosing to ‘shield’, EU workers not returning to the UK or the number of visitors being limited on sites. Regardless of the cause, fewer operatives on site will impact productivity and lead to an increasing number of notices of potential delays being issued.
According to the ONS, the number of construction vacancies in the three-month period between September-November 2020 was 26,000 - 7% lower than the number of vacancies in the December-February 2020 period (just before the first national lockdown). However, vacancies in the sector have grown steadily since late spring and are now more-or-less on par with pre-pandemic levels. A strong rise in new orders in Q3 2020 helped employment return to growth according the December’s Construction PMI survey. The sustained improvement in construction order books meant that employment numbers were able to rise for the first time in nearly two years suggesting that the health of the UK construction labour market is improving.
The construction labour market has recovered well from the initial shock to workloads stemming from the pandemic. Providing new orders remain buoyant, the labour market should continue to recover. Brexit has certainly made it more difficult, expensive and time-consuming to on-board skilled labour. This will squeeze supply as EU workers instead opt to work in other European countries where the process is simpler and there are fewer practical deterrents.
Pre-COVID, shortages of skilled labour acted to push up input cost inflation and tender prices. The pandemic (which brought restricted travel) and Brexit (which is expected to reduce net migration) is likely to exacerbate labour supply issues, putting further upward pressure on labour rates and input costs. However, this pressure will be somewhat offset by a larger pool of available workers as a result of overhead reduction efforts and COVID-19 related redundancies in 2020.
Evidently, demand for labour returned in the second half of 2020 as site activity picked back up. The likely consequence of returning demand but worsening supply of labour is higher labour rates, putting upward pressure on tender pricing. However, the dynamics of the UK construction labour market are complex and the impact that Brexit and the pandemic will have into 2021 and beyond is not yet clear.
PROFITABILITY AND PROCUREMENT
Our latest TPI survey found that a slight majority of respondents (51.4%) believed that overhead and profit (OH&P) remained largely unchanged in the three months to December 2020 compared to the previous three-month period. However, over 45% of respondents said that they had seen an overall downward movement in OH&P in Q4 2020. These respondents noted that a lack of new work in certain sectors (eg commercial office fit-out) was putting downward pressure on OH&P, particularly on lower value projects receiving bids from smaller contractors. This trend isn’t expected to change significantly over the next 12 months according to survey respondents.
Most respondents (63%) reported that there were no changes to preliminaries costs in Q4 compared to the previous quarter. As with OH&P, smaller contractors appear to be more readily willing to reduce preliminaries despite the additional costs resulting from compliance with SOPs and enhanced welfare provision. It’s envisioned that stringent SOPs will remain in place for the foreseeable future and so most survey respondents (55%) believe preliminary costs will not change from current levels. However, a significant proportion (31%) believe that preliminary costs will fall in 2021 as firms feel sustained pressure to price keenly and offer discounts in order to win work.
While Design and Build (D&B) two-stage tendering was flagged as the most favoured procurement route in Q4 2020 (as it reduces contractors risk and exposure), our survey respondents continue to note a strong appetite for single-stage tendering. The market became increasingly client-led in 2020 and contractors, although very cautious about committing to schemes on this basis, proved to be more willing to participate in single stage tenders. Clients prefer single-stage procurement as it maintains competitive tension and often results in the most competitive market price. It also means that contractors take on all the risk. Although single-stage tendering was available on some larger projects in 2020, it was far more common on smaller projects where lower tier contractors were competing hard to win work.
All forecasts in this report take account of all sectors and project sizes as a statistical average, indicating an overall trend in pricing levels. It should be remembered that individual projects may experience tender pricing above or below the published average rate, reflecting the project specific components and conditions.