Architect sector report – changing conditions create uncertainty
Summary of the architect sector
- 2023 ended with the latest RIBA Workload Index showing six consecutive months of either zero or negative balances.
- The outlook for 2024 remains uncertain, with conflicting indicators.
- Almost a third (32%) of architectural practices are at risk of failure.
- High interest rates and inflation are ongoing negative influences on commercial and domestic clients alike.
- Competition from unqualified ‘architectural designers’ is reducing both workload and fee rates.
- AI represents a constantly evolving challenge.
Market characteristics
Architectural practices predominantly service the construction industry which saw its GDP increase year-on-year by 4.7% in the twelve months to September 2023. This equates to some 6% of total UK GDP. This trend analysis is compiled by Trading Economics, here, from Office for National Statistics (ONS) data.
The sector is also partially dependent on the residential housing market, which appears to have steadied after the initial negative impact of the sharply higher interest rates after the Mini Budget in autumn 2022.
The total assets employed by the UK’s architectural practices are £3.1bn, with a total net worth of £1.6bn. They borrow only £156m.
Current market conditions
Construction sector output dropped by 0.5% in December 2023 and by 1.3% in Q4 2023 (equivalent to a £599m drop in output) with the private residential housing sector worst hit.
Prospects for 2024
The RIBA Future Trends Survey for December 2023 which covers 247 architectural practices revealed the following predictions for Q1 2024:
- 28% of practices expect a decrease in workload, while 20% predict an increase.
- 31% of smaller practices are looking to a decrease in workload, but only 15% an increase.
- 11% of practices foresee a reduction in permanent architectural staff, 9% think they will have an increase.
- 26% of architects reported being under-employed.
Specialist construction consultants, Glenigan, have reported that new project starts in the three months to January 2024 were down 22% on the preceding three months, but main construction contract awards were up 18% quarter-on-quarter in the same period. Its research also showed that detailed planning approvals were up 18 per cent in the three months to the end of January 2024, compared with the same period a year earlier. This indicates a mixed picture and an uncertain outlook for 2024.
Financial risk profile
We have once again used the database maintained by the financial health monitoring company, Company Watch, to analyse the latest published accounts of each of the 13,897 companies registered at Companies House as operating in the architectural sector.
We were able to examine the most up-to-date financial data available, but because of the delays in the filing deadlines at Companies House, the latest data mainly covers financial statements for trading periods ending in the second half of 2022.
The headline findings reveal a mixed picture, with deterioration in some headline financial elements since the previous year’s results, but also improvements in certain others:
- The average Company Watch health rating (H-Score®) has fallen from 45 to 44 out of a maximum of 100. Across the whole economy, the rating is higher at closer to 50 out of 100.
- The number of companies in the Company Watch warning area has risen from 30% to 32%.
- Total assets have risen by 7% from £2.9bn to £3.1bn, indicating investment and possibly increased activity levels.
- Total borrowings have fallen by 11% from £175m to £156m.
- Total net worth has improved marginally from £1.5bn to £1.6bn.
- 5% of architectural practices are ‘zombie’ companies with negative balance sheets and a combined shortfall of £61m.
- The number of companies with negative working capital is similar at 6%, but with a higher total deficit of £144m.
We look at the key statistics headlined above in more detail below.
Company Watch warning area
Just under a third of companies (4,515) of the companies were in the Company Watch warning area with an H-Score of 25 or less out of a maximum of a hundred. Statistics for the past twenty-five years confirm that at least one in four of these businesses will fail or need a major financial restructuring during the next three years, which means that over 1,000 architectural firms are at serious risk of failure.
Debt levels
Borrowings are not a significant factor at only £156m, down from £175m a year previously. This represents gross gearing against total assets of only 5% and net gearing against net worth of 10%.
‘Zombie’ companies
5% (674) of the companies are zombies, with negative balance sheets where liabilities exceed assets by at least a de minimis figure of £20,000. Their combined balance sheet deficits add up to £61m. A year earlier, 577 (still 5%) of the companies were zombies with combined shortfalls of £69m, so this risk indicator has improved.
Negative Working Capital
We also looked at the working capital position of those firms where ‘quick’ current assets such as receivables, cash, contract value and work in progress were lower than their short-term liabilities. We found that 6% (780) of the companies had negative working capital of at least our de minimis figure of £20k, with a combined deficit of £144m. A year previously, there were 5% (669) with negative working capital totalling £118m. These are not healthy statistics for the sector, indicating significant scope for short-term financial pressure.
Business failures
Unfortunately, the Insolvency Service data on company insolvencies combines architectural practices with some other types of consultants, such as engineering and technical testing facilities.
Nevertheless, this category saw 358 failures in England, Wales & Scotland in 2023, down 5% on 2022 but hugely higher than pre-pandemic in 2019, against which the latest figures show a rise of 52%.
Challenges for architectural practices in 2024 and beyond
As with most sectors, architects face a broad change of challenges. Some such as the inherent financial instability and high failure rate of construction industry clients are perennial problems, which have plagued the sector for decades. Others are newer and require innovative and radical thinking and action. None are easily or quickly solved. These issues include:
- Economic and political uncertainty in a low growth/no growth environment during an election year.
- Increasing downward pressure on fees in these difficult economic times.
- Planning and regulatory constraints, including endemic planning delays.
- Staff recruitment and retention, including diversity and inclusion considerations.
- Rapid technological change, most particularly the breakneck development of AI and digital transformation.
- Sustainability and environment aspects, including increased client focus on these ESG aspects.
- Disruptors with more flexible business models, but particularly those deploying unqualified staff to limit costs. These are adversely impacting workload and fee rates for more traditional firms.
- Evolving client expectations about:
- greater transparency
- greater involvement in the design process
- more cost-effective solutions.
The way forward for architectural practices
Our financial analysis suggests that architectural firms’ finances were reasonably healthy at the end of 2022 based on the latest data available, but not quite robust. The high percentage in the Company Watch warning area is a major concern and suggests that architectural firms need to focus closely on their cashflow and forecasting to help whether eroded finances after a tough year in 2023.
2024 could see these challenging conditions continue for the sector. For this reason, financial risk awareness will be key and restructuring and turnaround options could service firms well where there are signs of business decline.
If you would like to discuss any of the points in the report or believe you have been affected by any of these issues, you can speak to one of our Partners who can discuss options with you.
We have offices nationwide and by contacting us on 020 3326 6454, you will be able to get immediate assistance from our Partner-led team.