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ANALYSIS OF HISTORICAL CONSTRUCTION COST MOVEMENTS IN SCOTTISH SOCIAL HOUSING FINAL REPORT

12.0 FORECASTS

12.1 Gross Domestic Product

Chapter 10 demonstrated the link between Gross Domestic Product and construction output. The last two years, 2001 and 2002, have seen Great Britain GDP fall below the long term trend but construction output has continued to grow. That growth has been dominated by public sector injections of funds into education, health and infrastructure as well as major projects such as Heathrow Terminal 5, the Channel Tunnel Rail Link and the Scottish Parliament Building but the private sector generally has really only seen a significant decline in activity in 2003.

GDP fell to 2.2% in 2001 and 1.9% in 2002. The government forecast is for growth of 2 to 2.5% in 2003 followed by growth of 3 to 3.5% in 2004. Economic assumptions for GDP included in the 2003 Budget were as follows:

However, independent forecasters are generally not so optimistic. HM Treasury's Economic Assessment Team compile 'Forecasts for the UK Economy: A comparison of independent forecasts' on a monthly basis. This is a collection of views from 27 City forecasters and 14 non-City forecasters.

Figures taken from the September 2003 publication show that the median of all the forecasts made in the previous three months (36 in total) is for GDP growth of 1.8% in 2003 with the highest forecast at 2.1%. For 2004 the range of forecasts widens with a median of 2.5%; the highest is 3.1% and the lowest -0.2%.

These forecasts suggest that GDP growth is likely to improve from its lowest figure since 1992 but may remain at or below its long term trend rate. This does not suggest that private sector construction is likely to increase greatly over the next year or two.

The May 2003 edition of 'Forecasts for the U.K. Economy: A comparison of independent forecasts' included forecasts from 11 forecasters for the longer term 2003 to 2007. At that time, the average forecast from these 11 forecasters was fractionally higher than the latest median forecasts reported above and the average forecasts to 2007 are shown below:

Over 4 of the next 5 years, the average forecast is for GDP growth to be at or very close to the long term trend growth for Great Britain of 2.5%.

12.1.1 Scotland

Experian Business Strategies, one of the independent forecasters included in the Treasury's survey above, forecast GDP (Gross Value Added) for Scotland to 2005. From zero growth in 2002, Experian expect GDP in Scotland to have grown to a mediocre 1.5% this year to 2.4% in 2004 and 2.8% in 2005, figures just fractionally lower than their forecasts for the U.K. as a whole but above the long term trend growth rate for Scotland.

12.2 Construction output

Experian Business Strategies, through its Construction Forecasting & Research team (CFR), are one of the foremost forecasters of construction output in the industry. They review and forecast levels of construction output in Great Britain four times a year. In addition, Experian prepare and publish regional construction forecasts twice a year.

The latest forecast for Great Britain was published in July 2003. Great Britain has experienced growth in construction output every year since 1996, increasing in real terms by 23% since 1995, including an 8% increase in 2002 over 2001. Table 12.1 summarizes CFR's latest output forecasts for the next three years.

From the table it can be seen that growth in construction output over the next three years is very dependent on continuing increased expenditure on public non-housing construction, backed up by strong anticipated growth in new infrastructure and new build housing, both public and private sector.

Table 12.1 Construction Output Forecasts - Constant Prices - Great Britain

Source: Experian Business Strategies

However, other forecasters are not so optimistic regarding short term growth in the construction industry.

Table 12.2 summarizes construction output forecasts for Great Britain from the Construction Products Association (June 2003) and the Building Cost Information Service (August 2003) alongside the forecast from Experian Business Strategies.

Table 12.2 Construction Output Forecasts Compared

The CPA forecasts are in broad agreement with those of CFR regarding growth in new build housing work but are less optimistic regarding growth in public non-housing work in 2003, infrastructure work in 2004-5, foresee sharper falls in private sector industrial and commercial work this year and include generally lower growth in repair and maintenance work throughout the forecast period.

The BCIS forecasts generally lie between those of CFR and CPA for 2003-2005 and provide further forecasts for 2006-2007. For 2006-2007, BCIS forecast growth in line with long term trend rates. BCIS suggest that the public non-housing and infrastructure sectors are likely to provide the main stimulus for growth in new work output throughout the forecast period but add the proviso that the "the forecast is based on the expeditious release of public sector funds".

12.2.1 Scotland

CFR's latest regional construction forecasts were published in May 2003. The forecasts examine new build construction only (rather than repair and maintenance, which in 2002 accounted for 45% of total construction output in Great Britain) and are published in current price (rather then constant price) terms.

New build output in Scotland suffered a 6% fall in 2001 (at current prices) but the industry was rescued by a 15% increase in repair and maintenance output. Nevertheless, as was seen in Chapter 10, construction output in Scotland has not experienced the continuous strong growth over the last two years from which much of Great Britain has benefited.

Chart 12.1 illustrates the pattern of construction output in Scotland over the last five years, demonstrating the different trends of new build and all work (including repair and maintenance work).

Chart 12.1 Value of Construction Output in Scotland - Current Prices

Chart 12.2 shows the forecast new build construction output growth for Scotland to 2005, in comparison with the North East, the South of England and Great Britain as a whole.

Chart 12.2 Regional Forecasts of Construction Output Change

2002 - 2005

New construction output in Scotland is forecast to grow by 19% by 2005 (at current prices, average of 5.9% per annum), the same as the increase in the North East, though with a steadier rate of rise. Both are forecast to have slightly greater growth than Great Britain as a whole (16%, average of 5.2% per annum) and considerably more than forecast for the South of England (10%, average of 3.2% per annum). Over the period to 2005, the North West is forecast to be the region displaying the greatest growth in new work construction output, rising by 23% (average of 7.1% per annum).

12.3 Construction Prices

12.3.1 Building Costs

BCIS and DTI both provide long term forecasts of building costs, index series excluding the full effects of the market place.

DTI publish the FORVOP (Projected Formula Variation of Price) Index, a projection of its NOCOS (Resource Cost Index of Building: Non-Housing) Combined Index.

BCIS, in its 'Five Year Forecast', forward predicts its General Building Cost Index.

These two forecasts are summarized in Table 12.3, expressed as annual average percentage change figures.

Table 12.3 Building Cost Index Forecasts

Both organizations predict a gradually declining rate of building cost inflation over the forecast period but, allowing 2.5% per annum general inflation, a real cost increase is predicted every year throughout the entire period.

BCIS reviews its two year forecast every three months but revises its Five Year Forecast only once a year. DTI revises its forecasts every quarter.

12.3.2 Maintenance Costs

Two organizations predict future trends of building maintenance costs - Building Maintenance Information and NHS Estates. The former provide a 24 month forecast of its principal series of General Maintenance Cost Indices, including its Local Authority Maintenance Cost Index and its Private Sector Maintenance Cost Index. The latter provides a three year forecast of its index series relating to Engineering Maintenance Equipment and Materials, Engineering Contracts, Building Maintenance Equipment and Materials and Building Maintenance Contracts

Table 12.4 summarizes the forecasts, expressed as annual average percentage change figures for BMI's Local Authority and Private Sector Maintenance Cost Index series and NHS Estates' Building Maintenance Contracts index.

Table 12.4 Maintenance Cost Index Forecasts

The difference in the BMI forecasts between Local Authority Maintenance and Private Sector Maintenance is largely the result of differential known and anticipated wage awards in the two sectors. NHS Estates' Building Maintenance Contracts Index shows a 6.3% jump in the 1 ^st quarter 2003 (which had not been predicted in their May 2003 forecast), followed by quarterly increases to the 3 ^rd quarter of 2006 of 0.3% to 0.5%. NHS estates provide no commentary to explain this erratic pattern of forecast changes.

12.3.3 Tender Prices

A number of organizations - Davis Langdon & Everest, EC Harris, the Building Cost Information Service and the Department of Trade and Industry - publish quarterly forecasts of construction price inflation two years ahead.

Table 12.5 summarizes these forecasts which are all national average forecasts. EC Harris also provide forecasts specific to Scotland.

BCIS now publish, once a year, a Five Year Forecast. Their most recent edition was published in August 2003. It is a national average forecast.

Table 12.6 shows the BCIS forecast of tender price change up to the first quarter of 2008. The equivalent real increase is shown, based on the assumption of 2.5% GDP Deflator inflation each year.

Table 12.5 Forecasts of Tender Price Change

Table 12.6 BCIS Forecast of Tender Prices - All-in Tender Price Index

Source: BCIS

The table shows that BCIS anticipate real growth in construction tender prices throughout the forecast period to 2008. This trend of continuing real price growth is based on the assumption of continuing growth in construction output and above inflation wage settlements. Stimulus for growth is expected to come primarily from the public non-housing and infrastructure sectors over the next five years but the forecast is "based on the expeditious release of public expenditure and the assumption that the Chancellor stands by his current commitment to expenditure on construction over the next few years".

NHS Estates also provide longer term forecasts, currently up to the third quarter 2007. Table 12.7 summarizes their forecasts for the Median Index of Public Sector Building Tender Prices (MIPS), effectively the same index as the DTI's PUBSEC index, a national average index. Once again, the equivalent real percentage change is shown, based on the assumption of 2.5% GDP Deflator increase each year.

For the first two years of the forecast, strongly positive real construction price increases are forecast, the figures not dissimilar but not quite as high as BCIS in the first year. However, from the beginning of 2006, the forecasts for construction price increases fall to 2.5% per annum or just above, suggesting little or no real price increase for the remainder of the forecast period.

Table 12.7 NHS Estates Forecast of Tender Prices - Median Index of Public Sector Building Tender Prices

Source: NHS Estates

12.3.4 Scotland

New work construction output in Scotland over the next three years is expected to increase at a slightly higher rate than in Great Britain as a whole (according to Experian Business Strategies forecasts). However, growth in Scotland over the last two years, 2000 and 2001, has been considerably less than in Great Britain, exerting less pressure on tender prices (as seen in Chapter 4). Hence current spare capacity in Scotland may be greater than in Great Britain generally, leading to lower real inflation in the first part of this forecast period (as indicated in Table 12.5).

However, the output forecasts take no account of repair and maintenance work, which in Scotland over the last five years has represented 36-41% of total construction output, slightly lower than in Great Britain generally. As a result of housing transfers, there may be a significant increase in maintenance work over the next few years, exerting additional pressure on construction resources.

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