Rising demand for public and private sector construction
House prices across the UK rose around 8.8% in the year to June 2021, aided by stamp duty holidays and low interest rates. BuildScan’s New Build Homebuyer Index has indicated that across the UK, 38.7% of all new build homes are now being sold subject to contract or under offer, a nine percent jump compared with June 20201.
Infrastructure projects have also been boosted by recent government announcements, including the launch of a new £12 billion infrastructure bank and a £4.8 billion 'levelling up' fund aimed at regenerating town centres and high streets2 3.
Private sector demand for construction has been fuelled by increased need for warehousing space, with retailers and distributors racing to expand home delivery capacity as a result of growing e-commerce penetration. Commercial property investors are increasingly confident, funding speculative builds of 'big box' warehouses, and successfully letting them prior to construction completing.
The challenge for the sector is that this demand is dovetailing with two growing problems: construction skills shortages in specific trades, from electricians to HGV drivers; and supply chain disruption.
Construction skills shortage
The sector has traditionally relied heavily on EU workers to address the construction skills shortage in the UK workforce. The availability of overseas workers to fill these roles has, in recent months, become increasingly constrained. According to the Office for National Statistics, construction employment fell from 2.3 million in 2017 to 2.1 million by the end of 2020. This represents a four percent decline in UK-born workers, but a much more significant 42% fall in EU workers 4 5.
Figure 1. Construction employment statistics. Source: ONS.
Many operators in the sector are now reporting a shortage of skilled construction workers, including joiners, quantity surveyors, electricians, and other skilled trades. While the 2021 Budget introduced a range of measures aimed at incentivising employers to create new apprenticeship roles within the industry, it will likely take some time before newly-trained domestic workers can plug these skills gaps.
Supply chain and product disruption
Unfortunately for the UK construction sector, just as demand has surged, the impact of COVID-related slowdowns in manufacturing are being felt further down the supply chain. Shortages of building materials have resulted in associated price increases for many construction products.
Supplies have been constrained since 2020, and have tightened further in recent months. British Steel stopped taking orders of structural steel sections for a short period in May 2021, citing "extreme demand". Shutdowns of plants in the EU last year have left some producers struggling to catch up6.
Extreme levels of demand in China, combined with new emissions regulations, have reduced exports and contributed to increased costs of acquiring steel from overseas producers.
Cement has also seen price increases during 2021, with suppliers reporting not only shortages of the raw materials required for production, but also the polymers and kraft paper7 required to produce the packaging for bagged cement. Some industry commentators have, however, observed that because most cement is sourced and manufactured domestically, supplies should recover more quickly than other building materials.
The prospects for timber supplies are less optimistic, with sawmill stocks in key producer countries such as Sweden dropping to the lowest levels for 20 years. Warmer winter weather is making timber extraction increasingly challenging in sub-arctic regions.
Rising demand for timber as it's increasingly regarded as an environmentally friendly alternative to steel or concrete has placed further pressures on supplies. Much timber is now arriving into the UK market pre-sold, forcing construction companies to join the end of an increasingly long queue for timber products. Prices for some categories of timber have surged by up to 30% and industry players expect that they'll remain inflated for the remainder of 2021.
In addition to the construction skills shortage, there is also a reduced number of HGV drivers in the logistics industry. Even if companies do obtain supplies, it's difficult to get these products delivered to sites.
Reverse charge VAT
In addition to these commercial risks to the sector, HMRC has introduced a change to VAT arrangements for the construction industry, which became effective from 1 March 2021. As VAT can account for up to 30% of the cash in a business, depending on its position within the construction supply chain, this additional layer of complexity could ultimately have an adverse and lasting impact on cash flow and working capital.
As construction businesses move forward in a trading environment that presents both growing opportunities, and increasing uncertainty, continuing to closely manage financial performance will remain key.
Construction is an infamously working capital intensive business, with cash inflows from projects often lumpy, while costs and cash outflows are persistent throughout the project lifecycle. As a result, small delays in customer payments can trigger significant challenges in meeting supplier liabilities.
In a 'sellers’ market' for construction materials, suppliers will likely prioritise those customers who they trust to pay invoices in line with credit terms.
As demand is increasing, managing working capital is essential, with many contractors falling into the trap of over trading. These combined domestic and global factors significantly increase the risk of businesses entering into long term low or no-margin contracts, threatening profitability and cash flows for operators within the sector. I'm increasingly hearing about businesses having to re-quote for projects after only two or three months to maintain margins.
Ensuring cash is tightly managed is essential, preparing and continually reviewing a robust set of trading and cashflow forecasts is the road to survival, and preservation of cash will need to take precedence over the delivery of profit in the short term.
While it's essential to protect margins and financial viability, the multi-tiered nature of the industry will leave many sub-contractors unable to adjust pricing without damaging customer relationships.
Reviewing contracts is essential to determine which party is responsible for any additional costs and delays which may occur throughout the supply chain in advance. Early and pro-active engagement with customers and suppliers is key to ensuring the risk of costly and time-consuming disputes is minimised.
Sources of funding
In addition, consideration should be given to whether businesses have access to sufficient funding sources and short term liquidity to manage any cash pinch points that arise. This will be particularly important if Coronavirus Business Interruption Loan Scheme (CBILS) funding has been drawn down, and repayments are due.
Demonstrating to lenders that close attention is being paid to cash flows will be more important than ever to meet their lending criteria.
End of government support schemes
Separately, detailed planning will also be required for the end of other government support schemes, particularly the Coronavirus Job Retention Scheme (CJRS). ONS data indicates that, as recently as 31 May 2021, approximately 139,000 employees in the construction industry remained on furlough.
Figure 2: Construction employees on furlough April 2020-May 2021
While some operators have chosen to keep certain employees on furlough until materials are available to progress projects, the impending wind down of the CJRS in the coming months mean that businesses have to ensure the size and composition of their workforce is aligned to the scale of their operations.
Construction management checklist
The outlook for the UK construction sector in this period of increased change and uncertainty is unclear, but it's likely that some businesses will suffer. Some will inevitably fail. Taking appropriate steps in the following areas will improve business resilience and strengthen viability:
- Understanding key pressure points
- Identifying appropriate finance arrangements
- Avoiding over-trading as activity increases
- Monitoring risk factors, and taking steps to mitigate these risks.
Keeping a sharp focus on these areas, and drawing upon appropriate expertise where required, is essential to ensure businesses emerging from this period are best placed to take advantage of future opportunities.