MARKET ANALYSIS: House building continues to drive growth

Following several years of false starts and setbacks since the financial crisis and subsequent recession, UK economic growth has picked up since 2013 and GDP finally recovered to beyond its pre-crisis peak in the second quarter of this year. Against this backdrop of firmer economic conditions, the construction sector has also begun to stage its recovery. The Construction Products Association (CPA) is forecasting at least three per cent growth per year to 2018, writes CPA economist Rebecca Larkin.

Construction output was unchanged between the first and second quarters of 2014, but compared to a year earlier, the sector has expanded at an average rate of 5.8 per cent, outpacing growth registered across the production and service industries. Ever since construction made its first tentative recovery in 2010, there has been a clear market leader: private house building.

The £17 billion sector was the primary driver of growth in 2013, supported by a raft of government policies. Annual growth in private housing starts averaged 25.9 per cent in the first half of 2014. Positive sentiment in house building continues to be underpinned by the two branches of Help to Buy in operation until the end of 2016 (mortgage guarantee) and 2020 (equity loan), driving growth in private housing starts forecast at 18 per cent in 2014 and 10 per cent in 2015.

The dominance of housing poses a risk, however. Concerns over house price inflation accelerating beyond London and the south east could force the imposition of tighter lending constraints, in addition to the limit on high loan-to-income mortgages that was announced by the Bank of England in June.

Both a continued rise in house prices and expectations of interest rate rises kicking off in the coming months will exert a further squeeze on affordability and demand, implying that house building will not be able to maintain such high growth rates beyond 2015. New orders in private housing fell by 2.2 per cent in the second quarter, ending five previous quarters of growth in excess of 20 per cent.

Construction demand outside housing will be skewed towards the south east in the near term. Work on Thameslink and Crossrail, Europe’s highest value construction project, is expected to peak during 2014 to 2015, and a pipeline of skyscraper construction and subsequent office fit-outs is set to change the shape of London’s infrastructure and skyline.

Commercial construction, however, is one sector which has been showing signs of permeating beyond the capital region. Strong new orders data for the offices sub-sector throughout 2013 and 2014 underscores the momentum still to be translated into work on the ground and, overall, offices construction is set to rise 10 per cent in 2014 and 8 per cent in 2015 as increased business investment, higher employment and rising hiring intentions are boosting demand for office space across UK cities. A shortage of grade A space and a flow of deals for new development is driving office construction in Birmingham, Manchester, Leeds and Aberdeen, among others.

One area of interest is the divergent performance of the retail and warehouse sub-sectors. In spite of improving household consumption and easing access to credit, output and orders for retail construction have been subdued. This year, the sector is forecast to make little progress from two years of contraction in output in 2012 and 2013. In contrast, warehouse construction output is forecast to jump by 20 per cent in 2014 and a further 10 per cent in 2015, driven by strong growth in new orders in recent quarters. This is due in part to recovery from a low base following recession but, more interestingly, signals the ongoing shift from high street retail to warehouse storage for online retail operations. Online retail sales have recorded double-digit growth in values since 2008 and comprised a peak of 68 per cent of total retail in 2013. Total annual retail sales growth has averaged just 0.6 per cent over this period in comparison.

These signs of recovery predicate the CPA forecasts for construction to grow 4.7 per cent in 2014 and 4.8 per cent in 2015, adding £11 billion to the economy. Still, the breakthrough into higher levels of activity is not yet ingrained and output in the construction industry is only anticipated to surpass the 2007 pre-recession peak of £128 billion in 2017. A recovery in factories, retail and public non-housing output (public spending on health, education and leisure facilities) is not forecast until 2015, the latter reflecting the reduction in government capital investment plans for education since 2010. The CPA’s central view envisages that the full extent of this fiscal austerity will continue to be felt after 2014, as the sector struggles to attain levels of output recorded at its peak in 2010. Indeed, in 2013, public non-housing output was 35 per cent below its previous high recorded in 2010.

Naturally, given the general election scheduled for May 2015, there exists uncertainty about whether a successive government will plump for a supply-side housing market stimulus, how policies and funding commitments will differ, and how development of the nuclear and energy markets will progress. Until then, at least, it’s onwards and upwards.

Rebecca Larkin
Economist
Construction Products Association

www.constructionproducts.org.uk