The cost of building
Build cost inflation has been increasing at an unprecedented rate. The unique factors of Brexit and Covid-19 have led to a ‘perfect storm’ whereby the cost of both materials and labour have risen exponentially against a backdrop of a sharp increase in consumption. These factors have contributed to supply chain issues, congestion at ports and the volume of delays to imported goods has had a detrimental impact on construction costs.
Towards the end of 2021, we were seeing an increase in activity across the construction sector – with the IHS/Markit Construction PMI up at 58.1 for November. This was against a backdrop of strong demand across the housebuilding sector and large infrastructure projects. However, activity has become increasingly constrained by limited supply of materials and labour, and delays such as the port of Felixstowe not being able to return shipping containers. Demonstrating the extent of the supply crunch, Asda chartered their own cargo ship in order to protect Christmas orders.
These pressures have increased volatility in pricing, leading to increased stockholding, long waiting lists, tender price uncertainty, and last-minute gazumping, further exacerbating supply problems.
By the end of September steel prices had increased over 70% y-o-y, according to the ONS.
By the end of September 2021, steel prices had increased over 70% y-o-y, according to the ONS, due to the cost increase of iron ore, while a shortage of concrete has driven a £150/ton increase since May 2021. Part of the reason is that large volumes of core materials are produced in Bulgaria and Slovakia, countries which have suffered significantly from the impact of the pandemic, with output not at full capacity. Fit out materials have not suffered as profoundly - these elements (such as laminate and tiles) were protected during the pandemic due to sustained opportunities for commercial fit outs.
ANNUAL PRICE CHANGE CONSTRUCTION MATERIALS (SEP 2020-2021)
EXAMPLES OF MATERIAL COSTS – VIEW FROM THE MANUFACTURERS
Alongside material shortages, the construction industry is experiencing something of a labour crisis – affecting supply of any materials that are available. The number of job vacancies are at the highest on record with over 48,000 roles available. It was estimated that almost a quarter of the EU construction workforce left the UK during 20203, while the number of insolvencies in the sector during 2020 were around specialist and supply chain industries. Consequently, the cost of labour has increased – and is driving contractual change, negotiation of new deals on ongoing projects and fluctuation provisions being written into contracts.
The number of job vacancies are at the highest on record with over 48,000 roles available in the construction industry.
CONSTRUCTION, TRANSPORT & STORAGE JOB VACANCIES
Impacts on Real Estate
Overall, pricing pressures are likely to ease during 2022 at least partially, but the complexity of the supply chain issues and the cost of inflation impacting the sector will continue to have a sizeable impact during the course of the year. Therefore we expect to see in some cases delays, postponements and reconsideration of development projects – with relatively little deflationary pressure likely to occur at least in the short term.
If anything, we are likely to see an exacerbation of this pressure generated by the green wave of the decarbonisation of the built environment.
The change in MEES – which if it came in today would render c.90% of commercial stock obsolete – will focus landlords' and investors' minds during 2022. However, more broadly, societal, business and investor demand to decarbonise, offer climate resilience, and the need to deliver net zero carbon development – or not develop at all4, is likely to create a refurbishment boom over the next decade. This will put further upward pressure on development and build costs, which will almost certainly have an inflationary impact on rents and capital values. This is in addition to changing energy requirements – as developers deal with the added complexity of grid connections and the need for self-generation.
BCIS MATERIAL COSTS INDEX
For housebuilders, the robust levels of demand for housing has put pressure on committing to development completion timelines – amidst an increase in the levels of housing construction.
The record demand for warehousing and logistics space – which essentially doubled during 2021 against the long-term average - is now being limited by supply constraints in a number of markets. Development delays as a result of construction issues (with 3-6 months often cited) will continue to contribute significantly to the inability of developers to match the demand for Grade A space. However, upward pressures on rents and capital values are likely to hedge against the increase in construction costs for developers.
In regional office markets, where the increase in construction costs has outstripped real rental growth over the last 15 years, the pressure will impact the desire to take on development risk, or rental tones will need to increase in a number of markets in the short-medium term.