The outlook is tender price inflation – and long-term pressures

Liam Drawwater, head of cost consultancy at Tuffin Ferraby Taylor, on price inflation and longer-term prospects for a market out of balance

Liam Drawwater

We have seen a dramatic increase in construction costs over the last six months to January 2015, as a result of the market regaining confidence, and anticipate that these conditions are likely to continue through 2015, 2016 and 2017.

This cost increase is also being driven by the effects of the previous downturn. The key factors affecting prices are labour being laid off at the start of the recession, material and plant shortages, longer lead times on manufacturing slots, changes to procurement routes and less price risk now being accepted by contractors.

We’ve also seen a shortage of skilled labour and salaries are increasing, reflecting greater construction demand. Lead-in times for materials are also lengthening due to lack of availability and the slow reaction of product manufacturers in upscaling their operations.

The sectors that are driving this in London are prime residential and commercial projects, which are a consequence of the lack of accommodation within London – both for living and workspace. On the other hand, other regions of the UK will not see such high construction cost inflation due to the lack of demand in these areas for prime residential property and commercial space.

The outlook on construction costs is that they will rise dramatically over the next two years in the region of 5-7% in London and other strategic cities, with the rest of the UK maybe less subject to the above factors. This is reflected in the Building Cost Information Services (BCIS) forecast, which predicts 4% per annum for the UK as a whole, while the recent report from Arcadis – International Construction Costs – What will it mean for 2015? – also states that “London will potentially see price escalation of between 5-7% growth for the coming 2-3 years”.

Mace has also stated that it anticipates prices to rise to 4.5% nationally and 5.5% in London, whereas others are suggesting that tender prices could even rise as much as 7.5% in London. The feedback within the industry is that everyone is busy and that these factors will lead to these increases being realised.

But what about other factors affecting construction costs? In terms of commodity prices, we have seen prices remain stable apart from the decline in oil, copper and steel prices. Aluminium and nickel have increased in price over the last year. Of course, all of these products are subject to global influences such as the conflict in areas such as Middle East, Russia, Ukraine, and the continued impact of Ebola in western Africa.

The UK construction industry could be affected by the General Election on 7 May this year, which could limit growth, but even a reduced rate of growth is unlikely to result in a slowdown in construction cost inflation.

With the UK economy becoming stronger, together with sterling, this is contributing to the lower costs of imported commodities. In contrast, countries such as Turkey, Indonesia and Malaysia have been affected by the depreciation of their currencies against the dollar. This could lead to an increase in key construction material costs, particularly of high-end finishes such as glazing, marble and stone, and is likely to affect highly specified commercial and residential schemes in London.

With construction activity in London being so buoyant these cost forecasts could easily be achieved as contractors are now starting to decline work and be more selective about the particular projects they want to work on. This has also affected the procurement route that contractors are willing to undertake. Two-stage tendering is becoming more favourable as the risk is not transferred until a later date, when it has been minimised/mitigated.

In this active construction market we are receiving more enquiries, which will lead to more committed projects. However, this state of affairs is not sustainable for the long-term future of the construction market: labour, material and plot shortages; and procurement strategies and risk transfer will all need to be addressed for the market to return to its former equilibrium.