Input Costs

KEY INFLATIONARY DRIVERS

A comparison of various BCIS input cost indices indicates that labour will once again be the main driver of construction costs in 2024. While materials and plant costs have stabilised, returning to long-term annual average inflationary trends, the projected 6% rise in the BCIS’ labour cost index this year is above trend.

Although construction costs remain elevated input pressures are easing, mirroring the headline measure of inflation in the UK economy. Contractor pricing has become more consistent compared to 2023 and tenders are being held subject to lower inflationary allowances.

Nonetheless, certain inflationary pressures (ie global conflict, supply chain consolidation, MEP cost pressures and capacity issues as well as strong workloads in key sectors driving demand for specific resources) will continue to outweigh any deflationary drivers (ie softer material pricing, a slowdown in new work growth, high borrowing costs and a desire to fill order books).

Generally, fit-out has seen greater pressure than base build as the packages experiencing the least inflationary pressure (eg demolition and groundworks) aren’t applicable. Equally, MEP, which accounts for a higher proportion of fit-out cost, has been one of the most heavily inflated packages of late.

Of course, the inflationary outlook remains vulnerable to geopolitical developments, with the situation in the Middle East posing a potential risk of increased price volatility. Lead times, shipping costs and energy are all susceptible to escalation of conflict in the region. Certain imported items (eg MEP components) are also exposed. However, so far, the net impact on UK construction has been relatively muted, thanks to the preparedness of critical supply chains and robust distributor inventories.

MATERIALS TRENDS

Material prices have been on a general downward trajectory since the second half of 2022, but the latest data suggests the deflationary trend is easing and prices for several key materials are starting to bottom out.

The BEIS All-Work index – a basket of goods that tracks price movements for construction materials – has fallen 2.2% over the past year. However, February marked the end of the deflationary trend. Supply and demand have now rebalanced and there has been little aggregate movement over the past three months.

While inflationary pressures have become more balanced and material price movements less volatile, G&T is still seeing increases on some materials and product categories. M&E component costs continue to rise, as do concrete and concrete-based products. Sprinklers, fire alarms, and ventilation continue to experience strong inflation levels. Strong demand for these items is being driven by a rise in the number of MEP intensive projects in highly active sectors, such as Data Centres, Health and Life Sciences. Such schemes also require more complex MEP installations that are driving specification change and increasing cost. Supply side pressure is also driving MEP costs, with copper and aluminium being affected by trade embargoes/sanctions with Russia and China, limiting supply and increasing prices. Meanwhile, concrete price pressures arise from greater demand for low-carbon variants and some shortages of materials in mix (ie sand and gravel), driving up manufacturing costs. Additionally, localised supplier market power contributes to higher prices.

With supply and demand now more evenly balanced, materials are likely to see a period of relative stability with more predictable price increases. However, geopolitical developments pose an upside risk to the status quo.

LABOUR TRENDS

Skilled labour shortages continue to exert some upward pressure on earnings growth, but with growing spare capacity in the market, demand for labour has softened.

Vacancies have fallen nearly 27% since their 2022 peak – a consequence of weaker new order growth and lingering uncertainty over the short-term business outlook. Expectations of softer demand have limited appetite for additional hiring, dampening employment and recruitment activity over the past year.

Against this backdrop, the tight labour market is experiencing temporary relief. In March 2024, average weekly construction earnings rose just 2.1% compared to the previous year. It marked the lowest period-on-period growth rate observed in three years, falling below the industry’s long-term average annual rate of 3.1%. Construction earnings growth also lagged significantly behind the broader economy, which saw a growth rate of 5.7% over the same period.

The latest earnings data from the ONS offers some reassurance that construction earnings growth has passed its short-term peak and is beginning to normalise, but structural shortages and constraints remain. The industry is contending with a shrinking labour pool and reduced access to skilled migrant labour from the EU. Furthermore, the recently implemented Building Safety Act is expected to introduce further labour cost pressure through additional training/qualification requirements, as well as new practices and safety measures. These structural pressures are likely to maintain some upward pressure on earnings growth.

Domestic policy decisions will also contribute to inflationary pressures. Starting from April, the minimum salary threshold for the Skilled Worker visa route rose from £26,200 to either £38,700 p/a, or the going rate for that type of role, whichever is higher. These increases, along with changes to the shortage occupation list, aim to reduce reliance on overseas workers. However, this will make recruiting overseas more difficult and, in some cases, unviable. Curtailing this key source of labour risks adding further pressure on wages.

ON-COSTS AND PROCUREMENT

Preliminaries costs continue to see upward pressure from higher staff, insurance and utilities costs. The Building Safety Act, as mentioned previously, is also adding inflationary pressure to compliance costs within preliminaries.

Looking ahead to the next 12 months, views were split between those expecting preliminaries costs (as a percentage of total project cost) to stay the same and those anticipating further rises. Those expecting no further movement said staffing costs and other inflationary pressures should be balanced out by any “sharpening of pencils” due to reduced workloads. The more bullish respondents envision that sustained labour cost inflation, combined with other drivers (such as new regulatory requirements and carbon counting), will win out.

To a large degree, OH&P is influenced by demand conditions in the market and the pipeline of work, with contractors pricing more competitively where these are less certain. Declared OH&P has been relatively stable over the past 12 months (although some seek to augment their margins within trade package pricing). If new work growth remains subdued over an extended period, contractors may opt to reduce their mark up in a bid to secure work. However, this is not the current expectation. The vast majority of those surveyed anticipate no further change to OH&P over the next 12 months.