Home Features The commercial  sector in uncertain times

Construction Products Association (CPA) economist  Amandeep Bahra outlines the latest construction industry scenarios for 2016 with a focus on offices and retail.

The UK’s decision to leave the European Union has left analysts wandering in an economic and political maze without a map. Attempts to navigate through this have seen a range of speculations and theories brought to the table. However, these rough estimates still do not provide a clear path of growth for commercial – the largest construction industry sector in the UK. This doesn’t come as a surprise, given the level of uncertainty and lack of hard data in the post-referendum period that makes forecasting incredibly tricky. In light of this, the CPA has taken a ‘scenarios’ approach, outlining three possible cases for the next three years that will very much depend on how the macroeconomic backdrop unfolds.

Offices and, to a lesser extent, retail are seen as the most vulnerable sub-sectors within commercial to the uncertainty created in the aftermath of the referendum. Five months on, and questions regarding the impact of the Brexit vote on these sectors only seem to grow more insistent, and this is likely to remain the case until a new relationship is  established with the EU –  something that could take many years. In the meantime, like many, we are left to ponder over the near-term prospects for offices and retail. So, what should we expect?

The central view

In the first case – CPA’s central  scenario – we anticipate growth in commercial offices to remain in positive territory in 2016 and increase 6 per cent as major projects underway in London and UK regional cities are unlikely to pause for a breath, especially those that have confirmed demand through pre-lets. Investor confidence was certainly impacted ahead of the referendum and dipped even further following the Brexit vote, but this is likely to weigh on new contract awards that will eventually filter into lower activity 12 months later. If you recall, two high-profile speculative office developments in the City of London were paused for re-evaluation following the Brexit vote. Keeping all this in mind, we anticipate offices construction activity to contract 5 per cent in both 2017 and 2018.

Consumer confidence was similarly affected in the immediate aftermath of the  referendum, with GfK’s Consumer Confidence Index recording its sharpest fall in 21 years in July before recovering somewhat in August. However, like with any other economic  indicator, we shouldn’t read too much into this variation as yet. Consumer sentiment is likely to remain unsettled in the near-term and as this translates into lower spending, prospects for the retail sector are far from bright. Our central scenario envisages three years of contracting  retail construction activity, although this is  largely attributed to the ongoing shift from bricks and mortar to online retail.

It would be incredibly naive to place all your bets on the central scenario given the dark clouds of uncertainty that give rise to two other scenarios.

A lower case scenario…

Our central scenario anticipates UK economic growth to slow down in the second half of 2016 amid uncertainty, with the economy narrowly avoiding recession. But, what if there was a prolonged period of uncertainty and economic contraction? The subsequent impact on business and consumer confidence and, in turn, business investment and consumer spending is likely to be more pronounced than under the central scenario.

Consumer spending will additionally bear the brunt of higher import prices due to the  exchange rate weakness and although this would also be the case in the central and upper scenarios, the risk is given more credence in the lower  scenario. Another consequence

of the sterling depreciation is a fall in commercial property  prices and foreign investors  would effectively trade-off this against uncertainty over returns.  As a result, a lower appetite in the higher risk environment wins. This,  alongside a drop in investor demand, will  particularly dent speculative developments. Based on this, a lower growth rate of 4 per cent is estimated for offices this year followed by double-digit contractions in 2017 and 2018. In terms of retail, construction activity is expected to contract in the three years of our forecast period.

…and an upper scenario

Of course, optimistic developments cannot be overlooked. In this case – the upper scenario – we assume the economic and political situation stabilises, providing some degree of certainty that would inevitably boost confidence.  As consumers respond to this, via higher spending, retailers are expected to continue with their expansion plans. But, as we have seen in recent years, the trend towards e-commerce spending is still expected to continue. Consequently, expansion plans are likely to be focused around warehousing, suggesting that retail  construction activity is still expected to  contract in this case, in 2016 and 2017, albeit at a lower rate than under the lower and  central scenarios.

Meanwhile, offices activity is estimated to expand at 7 per cent in 2016 under the upper scenario, with smaller declines pencilled in for 2017 and 2018. This assumes the security of long-term leases will underpin demand for office space, whilst the recent sterling depreciation will attract higher investments from overseas that will cushion any sharp falls in activity.

But where do we stand?

In all these scenarios, it is clear that  post-referendum uncertainty will somewhat hinder offices and retail construction in the short-term but it will surely not fall off a cliff.  As far as the medium-term is concerned, whether the sectors fit in the lower, central or upper scenario, this will only be clearer once more data emerges that will allow us to better gauge the ramifications of Brexit in 2017 and 2018. But even so, uncertainty will still hover in the background and the true direction of growth for these sectors will only be revealed once a new bridge is established between the UK and EU.

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