The UK construction sector has been a remarkable story of adaptation during the pandemic. An initial plunge of 40.7% in its GDP in April 2020 as almost the whole sector was forced to shut down, has been followed by a steady climb back up out of that financial hole marred only by a dip of 2.9% in December 2020 and a surprise drop of 2% in April 2021, when private housing output was cut by 11%. Construction output is now back marginally above pre-pandemic levels.

Challenges faced by the construction sector

So far so good, at least at the revenue line. Sadly, profits depend on much more than top line performance, however creditable that has been during an extraordinarily difficult sixteen months. The picture on costs and profitability, as well as operational efficiency is starting to look extremely challenging.  This is not good news for an industry plagued by wafer thin margins and an addiction to low ball pricing in contract bids.

Rampant cost inflation

There is continuing supply chain disruption and a growing mismatch between supply and demand of both labour and materials. The inevitable outcome is the latest PMI survey by IHS Markit/CIPS, which reported that input cost inflation in May 2021 was running away at the fastest rate in the survey’s 24-year history. Labour shortages have pushed up average construction earnings in most parts of the UK, but in London they rose by 4.5% in May alone.

Labour shortages

There is a clear picture emerging of increasingly severe labour shortages across many sectors in the UK economy; by general consensus this has been caused by the combined impact of Coronavirus and Brexit. Some estimates suggest that up to 1.3m people of working age have left the UK since late 2019. Data from the Office for National Statistics (ONS) revealed that more than one in four EU-born construction workers had left the construction industry between September 2019 and September 2020 and 42% in the past four years.

Job vacancies across the UK totalled 657,000 at the end of April 2021, up 8% from January. The ONS Labour Market Survey for May 2021 showed a jump in vacancies of 23% in the construction sector. The industry has been struggling with labour supply issues for many years, but the situation is deteriorating at a worrying rate. An added concern is the demographics of the industry. 500,000 of UK-born workers are aged between 55 and 65, a ticking retirement time bomb.

Product shortages

The CEO of the Builders Merchants Federation spoke recently of demand continuing to dramatically outstrip supply, especially for imported products and materials. Every trade body is echoing these sentiments. The list of items affected is extraordinary, including timber, roof tiles, some steel products, bagged cement, paints, sealants, chemicals, plasterboard and even bricks and blocks. The situation is already critical, but it is expected to worsen in H2 2021. The factors behind this include the pandemic, Brexit and shipping issues.2 2021

Driver shortages and delivery delays

The road freight industry has its own labour supply issues, already critical before the pandemic but made worse by both Brexit and Covid. Estimates of the HGV driver shortfall now vary between 75,000 and 100,000. As a result, problems with delivery delays are escalating, just for example as they are in the food supply chain.

Construction disputes

Another feature of the industry since time immemorial has been endemic contract disputes. The cost consultants, Arcadis reported this month that the average value of disputes doubled in 2020, rising by 117% to an average of £27.7m. They attribute this to a worsening level of understanding of contract terms, which is fundamental flaw in the contracting model.

Flammable cladding

The legacy of the Grenfell disaster continues to hit profits and is likely to have impacts well into the future. One major contractor has already written off £24m for remedial costs.

Pandemic legacy debts

Quite rightly, the Treasury has poured cash into the coffers of contractors through no-questions asked, government-guaranteed loans, the furlough scheme and delayed collection by HMRC of debts for VAT and PAYE.

This may been wonderful for short term cash flow in businesses disrupted by the crisis, but just as with social over-indulgence there is an almighty financial hangover waiting for some as these protection measures unwind. There has been a severe distortion of balance sheets, which are now bloated with debt and historic liabilities. This pain has been deferred, but it has definitely not been cured.

The prime example lies with the various Coronavirus loan schemes, which between them advanced over £76bn to 1.53m UK businesses. This means that it is likely that 38% of all construction companies took out one of these loans. The average loan was £30,390.  The initial one-year interest and repayment holidays are now starting to end, so that the lenders are now looking for the start of regular payments. It is not clear how the government thinks these loans can be serviced or ever repaid. The Office for Budget Responsibility has predicted that a third of these loans will eventually default, destroying the borrower in the process. 

The dangers of growth

Growth kills more companies as they emerge from an economic downturn than the recession itself. More precisely, headlong expansion with depleted working capital is what does for them. After the disruption, the losses and the gloom of it all, what construction sector entrepreneur would turn away that heady surge in new work?

The answer is a wise one and one with a good finance man at their side, reminding them regularly that growing sales without having the funding in place to support the increased turnover is a short road to disaster, especially when profit margins are often so poor.

How can Opus help?

The challenges for the construction sector business owners and managers have never been greater, nor has the need to take early independent advice on the right way forward and risks in front of them.  Product and labour shortages coupled with delivery issues threaten progress milestones and completion timeframes and will cause penalties and claims galore. It is inevitable that many entrepreneurs will be too close to their businesses to be objective, especially after enduring the trauma of the pandemic. There is no shame in talking to outside experts and the payback is often considerable.

Opus is vastly experienced in these matters and can bring a broad base of knowledge to their discussion and resolution. If we can help, please contact us at construction@opusllp.com or contact one of our Partners through your nearest office.