Credit crunch: reasons to be fearful

The business environment

“I’ve been doing this job for 12 years and all the certainties I had have just gone out of the window; the rule book has been ripped up.” That was the conclusion of one City analyst on Wednesday morning last week, an hour after the story broke that Lloyds TSB was buying HBOS.

So, what’s changed now that Britain’s largest mortgage lender has had to be bailed out? “You can forget 110% mortgages,” says Richard Kelly, construction partner at BDO Stoy Hayward. “These latest collapses immediately sent rates back up and will prolong the pain for housebuilders.”

And banks will clamp down on builders as well as buyers, according to one senior banking source: “Bank credit is now a scarce resource. Combined with a worsening credit environment, bankers need to be even more judicious when lending cash.”

According to another industry figure, most construction companies with high borrowing are locked in “serious conversations with their banks”, which are “looking to put them on a tight leash”.

Those sitting on cash are clearly not suffering as greatly, and the crunch could bring acquisition opportunities for cash-rich contractors such as Wates, Kier, Laing O’Rourke and Balfour Beatty.

Meanwhile, Berkeley is the sole housebuilder well positioned to hoover up cheap land from distressed sellers when it senses prices have stopped falling. But there are few predicting that the crunch will trigger a wave of consolidation in housebuilding. Kelly says: “Mergers are about enhancing earnings, which only kicks in a few years down the line. The current problems are all about cash flow, so I’m not sure how mergers or acquisitions will help anyone.”

The macroeconomic picture

One factor underlying construction’s vulnerability to the downturn is that the public sector does not have the power it once to had to act as a Keynsian counterweight to the business cycle. According to the Construction Products Association (CPA), the public sector market in 1970 was worth £27.5bn and the private sector £28bn. In 2007 the public sector’s demand had shrunk to £21.5bn, about a third of the private sector’s £61bn. Noble Francis, economics policy development director at the CPA, says: “The public sector provides a certain safety net but it can’t completely offset the falls in the private sector.”

Tony Williams, a construction analyst at Building Value, puts it more succinctly: “Commercial property has gone to hell in a handcart and it is not going to come back anytime soon.”

Leading the way in the public sector is education and the Building Schools for the Future (BSF) programme. Some £22bn will be spent on this between 2008 and 2011. For those lucky enough to be on a BSF framework, there will be rich pickings whatever the colour of the government.

According to Williams, health spending has peaked and there are no large hospital schemes in the pipeline. Social housing is a boom area but, as he points out, “it’s a very small drop in the cosmos”.

So what about the longed-for cut in interest rates? Speaking at a Building/Pinsent Masons conference last week, Holger Schmieding, chief economist Europe at Bank of America, said inflation was the only thing preventing action. The good news is that lower oil prices should push inflation back down to 3.5% by next year and Schmieding predicts a housing recovery by 2010, on the back of pent-up demand and greater affordability.

But he believes the UK will find it tougher than other European countries to come out of the downturn because so much of the boom was fuelled by the buy-to-let market and mortgage equity release schemes, which have come to an end.

Large-scale regeneration schemes

For the past 10 years, the race has been on to rejuvenate the nation’s decaying urban environment, but the pace is slowing rapidly. Big regeneration projects, with all their planning costs, and all their transport and social infrastructure, were predicated on high and rising land values. But land values have plummeted far faster than house prices – by up to 34% according to Savills. Yolande Barnes, the estate agent’s lead analyst, says that big sites will no longer come forward.

Tony Pidgley, Berkeley Group’s chief executive, has already moved his company towards smaller infill sites.

“The big regeneration sites are going to get pulled until there’s a change in the market,” he says, before adding that some will get replanned and go back from high-rise schemes to more traditional housing.

Speaking at the Building conference, Stephen Stone, Crest Nicholson’s chief executive, agreed. He predicted the “death of the tower block”, as local authorities no longer want them in their plans, and housebuilders find they are tough to sell in places such as Leeds and Manchester. He added that most inner-city schemes no longer stacked up and we should expect “a return to traditional low-density housing”. New planning laws make it easier to build on the green belt, with no more than 20 units per hectare, he added.

As a result of this, the government will not meet its target for building 3 million homes by 2020 according to David Orr, the National Housing Federation’s chief executive. Indeed, planning sources are predicting that government and councils will have to forget all their calculations about how much social and affordable housing will come from section 106 agreements.

In a further blow to the government’s housing policy, John Stewart, director of economics at the Home Builders Federation, says the raft of eco initiatives that ministers have launched looks increasingly unlikely to be realised. These include such treasured initiatives as the Code for Sustainable Homes, eco-towns and the pledge that all new homes will be carbon-neutral by 2016.

Small businesses

“I always gauge the state of the market by the number of people calling up offering me work,” says Les Hillman of LJH Building Refurbishment Maintenance, a one-man outfit in the South-east. “The phone’s been very quiet recently.

“The other sign of trouble is that tradespeople keep asking me if I’ve got any work for them. A year ago it was a struggle to get them but now they are desperate.”

LJH is typical of the small construction firms feeling the pinch: “I can handle two or three jobs at once but I’ve only got one running at the moment,” says Hillman. “I’m making just enough money to keep going.”

Brian Berry, director of external affairs at the Federation of Master Builders, says the lack of business for small builders is being compounded by credit conditions. “It’s a double whammy. Small builders are suffering from the fact they can’t get loans easily from banks, which puts pressure on their cash flow. Meanwhile, their clients can’t borrow money either, so that extension or loft conversion is being cancelled.”

Builders are resorting to emergency strategies to stay afloat. Hillman thinks he will still make his usual turnover of £150,000 a year but he will have to work much harder to get there. “I’ve got a client who wants me to put a toilet under their stairs,” he says. “I’m not doing so many nice jobs these days.”

Other strategies include looking for clients likely to offer repeat business, such as letting agents, or hiring contract staff. Hillman regularly employs two people – a labourer and kitchen-fitter – on a subcontractor basis. He says: “I’m in a better position employing subbies rather than employees because if I have to shut down I can do it at no cost.”

Procurement

The self-employed people at the bottom of the supply chain will be getting paid less and waiting longer for it

Simon Rawlinson, Davis Langdon

The credit crunch could reverse the industry’s trend towards negotiated contracts and partnering. Instead, there is likely to be a swing back towards single-stage, lowest bid tenders aimed at achieving the lowest possible outturn cost. Simon Rawlinson, head of research and development at Davis Langdon, predicts that tenders will rise by between 0-3% next year, in contrast to the 3-4% rise likely in 2008.

To twist the knife further, contractors will also be faced with soaring materials prices. “The input costs for manufacturers have gone up by 25% this year and inflationary pressure is still there,” says Rawlinson.

Then there is the labour market. During the last downturn, labour costs were rocketing, which gave contractors scope to save money by pushing them down again. But that is not happening now because workers from eastern Europe has kept wages artificially low.

Although contractors are being less choosy about what work they take and the levels of risk they shoulder, Rawlinson says clients are unsympathetic. “They feel contractors have been getting a bigger share of their profits in recent years. Now clients are more interested in going down the single-stage tender route.”

With their margins being squeezed, contractors will do as the housebuilders have, and seek to squeeze profit from further down the supply chain. So in the coming months it is likely we will see contractors trying to get fixed prices from materials suppliers and discounts from specialists. Rawlinson warns: “The self-employed people at the bottom of the supply chain will be getting paid less and waiting longer for it.”

Recruitment and job security

Job security has been one of the principal victims of the credit crunch. UK unemployment rose 3.7 percentage points in August, its fastest rate since December 1992. That was the seventh monthly rise in a row.

In the construction industry in general, and the housing sector in particular, everyone from Wolseley to Persimmon and Barratt to Kier has been shedding jobs. It has been predicted by Experian and ConstructionSkills that employment in the housing sector could fall more than 35,000 in the next two years.

But Tim Cook, managing director of recruitment consultant Hays, says that though recruitment in the housing market has been “decimated” by the downturn, the bad news is not unalloyed. “Builders have stopped building but there is a lot of work in the pipeline, especially in the public sector, so that’s a good place to be looking. Then there is international work, too. Lots of opportunities are coming up overseas.”

He adds that things would be worse were it not for “the eastern European shock absorber”. He says that as these workers have responded to the downturn by returning home, this has eased the severity of the jobs situation. “These people are going back now as the market cools down, freeing up work.”

Cook’s final piece of advice is to look into freelance work, as companies are increasingly looking to hire people on a temporary basis. “People shouldn’t be frightened of this type of work,” he says. “We are placing lots of people this way as companies are more likely to hire on a non-permanent basis until the financial situation calms down a bit.”

Victims of the credit crunch

The worker

“It has been four weeks since I was made redundant. I worked in quality control for concrete maker Tarmac Topfloor and 16 of us have gone. I was on a good wage and I loved my job.

“After we were told there were going to be redundancies, we had to work for three weeks before we knew whether we’d be one of the ones going. Then I was on the night shift and one of our managers had envelopes in his hand. I walked past him a few times and he didn’t say anything to me, so I thought I’d be okay. But then he shouted for me to come over and said: “I’m very sorry to do this but I have an envelope for you.” I burst into tears. Then I had to carry on working there for another two weeks with the people who’d had kept their jobs.

“On the night we left, none of the managers came to say goodbye or thank us for our contribution. We just clocked out and that was it. I’m very worried about paying my bills because I left school without any qualifications. I’ve always thought there would be jobs out there for people that wanted them. But it is not as easy as that. I had to go on the dole today for the first time ever. I’m not sleeping properly and the doctor has given me some sleeping tablets. He has also given me some Prozac. I just don’t know what to do next.”

Lesley Shearman, 46, former quality control worker, Tarmac Topfloor

The manager

“As a contractor, about 90% of our business comes from housebuilders and the business has gone off a cliff since May. Our turnover was about £13m last year and this year it could be down by 50%. The business is drying up and we have had to go into the commercial markets. It is going to be a difficult year. I am so cross with myself because I have a background as a stockbroker and if I had seen it coming six months earlier, I could have diversified. This time last year we had 240 employees but since then I have had to lay off about 40% of the workforce. Some of these people have worked for us for more than 20 years. I’m disappointed with the way the regulators have allowed the banks to operate. At the moment, I am spending more time in the office and it’s hard to go home smiling and cheerful.”

Mat McAdams, 39, managing director, WA Browne

The graduate

“I completed a degree in project management in July and was excited about starting work. I wanted to do a chartership and was looking for a graduate scheme. After contacting 40 firms in the West Midlands I have had rejections from most and there are lots of others who didn’t bother to reply. After a while, I just started to expect rejection. It is depressing and embarrassing. I know economic conditions are not ideal but people are sometimes outright rude and a lot just say ‘no’ there and then if I phone up. I have a student loan of £15,000 to pay off and an overdraft of £2,000 so I just have to keep chipping away.”

Thomas Parrott, 22, graduate, University of Central Lancashire