Market: construction and property

Overview

They disappeared as quickly as they appeared. Just a few months ago, building sites were springing up all over Britain, digging, drilling and hammering value out of every available scrap of land. Now many are boarded up, silent and deserted.

The construction and property industry is traditionally the first to suffer in a recession. This time is no different. Some of the sector’s most admired companies have already been forced to beg their creditors for money and cut their workforces to the bone.

According to the Chartered Institute of Purchasing & Supply (CIPS), which publishes a monthly snapshot on the state of the industry, the Purchasing Managers’ Index for construction hit a new low in November, with severe contractions in building work and record declines in commercial and civil engineering. Construction employs 1.9 million people, but a report by Public and Corporate Economic Consultants for the Local Government Association predicts that about 400,000 of them will lose their jobs before the end of 2010.

Insurers also know there will be much less business and many more claims, as firms scrabble for every penny to keep afloat. Where last year underwriters and brokers were jostling for market share in the industry, now they are stepping back and taking a cold, hard look at rates.

Housebuilding

The housebuilding industry has been one of the first victims of the downturn. According to statistics from the National House Building Council, the number of new homes registered in Britain during August-October this year is 62% down on the same period in 2007.

Almost all housebuilders have made swingeing job cuts and some are now on their second round of redundancies. Since the start of the year, Persimmon has cut 2,000 jobs, Crest Nicholson has lost 40% of its staff and numbers have more than halved at MJ Gleeson. Bovis Homes cut 40% of its staff in July, to 530 from 930, and in early December said it might cut as many as 200 more. Taylor Wimpey, once the giant of the sector, has lost 98% of its stock market value in the past year. It is now in talks with its creditors over its financial future.

The government’s attempt to kick-start the market with a stamp duty holiday for properties under £175,000 and the Bank of England’s decision this month to drop interest rates to 2% have yet to spur demand from buyers. This is because banks and building societies are still not prepared to lend, particularly not at terms first-time buyers can afford.

Allianz Commercial’s construction division has a high proportion of housebuilders among its clients. Andrew Miller, risk control surveyors manager, has noticed a drop in the number of sites his team is being asked to assess.

“We’re still seeing renovations and extensions, but the number of new-build sites has diminished. I wouldn’t expect the government’s attempts to restart the market to have any effect until March or April. It’s all about confidence. People don’t believe the market has reached the bottom. Would you buy today if you could get it for £10,000 less in a few months’ time?”

Commercial property

Contractors and consultants working on commercial projects are still busy for now, but they will see a stark drop in the number of new opportunities.

According to the latest commercial property index, a monthly survey of developers from property consultant Savills, the gloom is deepening. In October, 55% said they had seen less activity, compared with 6% who experienced an increase, creating a net balance of 49%. The index dropped to its lowest level since it began in March 2003, and measures of “business sentiment” showed optimism at the lowest level ever recorded.

“Look at the skyline of London and you still see an awful lot of tower cranes,” says Paul Knowles, managing director of the construction and real estate business units at broker Jardine Lloyd Thompson.

“But most of the projects were started in 2007. Projects take two to three years to build, and it’s very difficult and costly to mothball them halfway through. We’re not seeing a significant number of new developments in either inner cities or regional areas in 2008. A lot of developers are holding back.”

Many of the towers planned for London are now unlikely to go ahead until the market changes, if at all. British Land’s 225m Richard Rogers-designed “Cheesegrater” tower on Leadenhall Street is under review, Land Securities is reported to be reconsidering its “Walkie-Talkie” project in the City and Stanhope’s £300m Walbrook Square development – dubbed “Darth Vader’s Helmet” – has been delayed at least until next year. The project is also being redesigned to make it more commercially viable in the changing market.

“A lot have got into the planning stages, but no further than that,” says Duncan Cogdell, head of client services for property and construction at Barbon Insurance Group.

“I can’t see why anyone would build speculatively in this climate. Developments are only going to continue if finance is arranged and they’re pre-let to tenants. At the moment, none of these parts is there.”

Jim Fuller, construction, power and mining leader at Oxygen Insurance Brokers, agrees that “big iconic buildings” will take a backseat for a while.

“The rules of financing these projects have changed. Six months ago, people would be lending you money. Now you have to look harder and be a lot more robust on programme and costs to secure that money. If banks aren’t going to lend to each other, they aren’t going to lend to you.”

Developments in the first stages of construction are also being stalled until the much hoped for economic spring.

The phased nature of construction projects also means different parts of the industry can experience different parts of the cycle. Demolition and groundworks companies that prepare a site for construction have already felt the slowdown, whereas specialists in electrical systems or office fit-outs have plenty of work in the short term as their role comes later on.

Impact on construction insurance

In the past two years, construction has been a buzzing and highly attractive sector for insurers, with a number of new underwriters and brokers entering the market. The professionalism of the industry, its risk management and approach to health and safety are much improved, and the work once seemed unlimited.

But with sites being mothballed, contractors’ construction insurance premiums – linked to their annual turnover – will also drop.

“We could end up with spare capacity in the market,” says Jim Fuller, construction, power and mining leader at Oxygen Insurance Brokers. “There’s been a lot of movement in the construction market, with new teams and new capacity coming to the table. They’ve all got to be fed.”

Despite the competition, insurers are determined to push up rates by 5% to 10%. Fuller points out that insurers’ investment income will drop and they will need to raise rates to compensate. At Allianz, Andrew Miller, risk control surveyors manager, expects claims to rise, as is traditional in a recession. “Normally overcapacity does push rates down,” he says. “But I’m not sure a lot of companies will be vying to take on construction business at cheap rates – it’s a recipe for disaster. It’s been a soft market for the past two or three years, it’ll be unsustainable if we don’t push rates up.”

At loss adjuster Crawford & Company, Mike Skingsley, head of international construction, says the recession may initially increase its workload. “For the short term, it can even lead to an increase in our claim numbers. It also is likely to lead to a change in their profile and put a bigger emphasis on smaller-value claims. During boomtime, contractors don’t necessarily submit claims for small amounts. Now they may submit one for £1,000 or £5,000 that they wouldn’t have felt worth pursuing a year ago.”

The biggest issue for building firms is not whether their construction or liability premiums are going up, but whether they can get credit insurance at all. The French government has said it will offer insurance to small and medium-sized businesses, and a number of bodies, including the CBI and broker Aon, want the British government to do the same.

The dwindling number of insurers willing to cover suppliers is a big issue for construction as it is an undercapitalised industry heavily dependent on credit insurance to keep trading. A commodity such as bricks may go through three or four pairs of hands before construction is finished, each an insurable transaction. In recent months, insurers have withdrawn cover on a number of housebuilders, including Taylor Wimpey and McCarthy & Stone, a retirement home specialist.

“A lot of firms are left without cover,” says Graham Bristow, branch director of Aon Trade Credit in Manchester. “All insurers are putting premiums up 10 to 20% – and that’s for people who’ve got a pretty good record. We have long-standing policyholders and their credit insurers are saying, ‘We don’t want you any more’.”

According to Experian’s insolvency figures for the third quarter of 2008, the number of construction firms failing has risen 22.9% on the same period last year, while property insolvencies are up 221%. This figure looks inflated as there were few failures last year.

Impact on property insurance

Property firms are also expected to make more claims in the coming year, partly because of increased numbers of empty properties that are prone to attacks from vandals, arsonists and squatters, not to mention accidental damage from leaking water pipes or unattended power supplies. Insurers talk of rate increases for property owners’ insurance at a similar level to construction – about 5% to 10%.

Peter Doyle, head of placement for real estate at Jardine Lloyd Thompson, believes the market is still competitive, but only for the right clients. “If a client has a good reputation, and is run well, it will still enjoy competitive terms. The quality of risk management across its portfolio will be a lot more important. A lot of insurers have voiced concern over void properties.”

In a sense, property owners’ insurance is more stable than construction – the same assets will still need to be insured. Even though their market value may have plummeted, for insurance purposes, it is the cost of reinstatement that matters.

With commodities much in demand around the world and oil prices soaring earlier this year, building costs became increasingly volatile and inflation was far outstripping the retail price index. But according to the latest figures from the Royal Institution of Chartered Surveyors’ Building Cost Information Service (BCIS), which provides cost data to the insurance industry, the gap finally appears to be narrowing. Its tender price index, showing the reinstatement costs for commercial properties, has dropped from a peak of 251 in the fourth quarter of 2007, to 243 in the third quarter of 2008, and the BCIS predicts further decline in the coming year.

Housing is less volatile, but the gap between the ABI/BCIS house reinstatement index and the retail price index is narrowing too.

There may also be a perverse benefit for insurers – as land values plummet and highly geared UK developers sell some of their assets, cash-rich new players may enter the market.

“It creates business,” says Doyle. “A lot of sovereign wealth funds are buying up property, which means new clients effectively coming in. It’s the same asset, but new business opportunities.”

Valuations and professional indemnity insurance

Professional indemnity (PI) insurers are preparing themselves for an avalanche of claims against surveyors, consultants and solicitors involved in property deals over the past few years.

As more people struggle to meet mortgage repayments and investment portfolios plummet in value, the banks will turn their attention to those who advised them on the deals in an attempt to recoup some of the cash.

Claims take about six months to reach legal action, so they will not peak until at least next year. Some firms, particularly those heavily reliant on valuations, will find it increasingly difficult to get cover.

“Underwriters are beginning to withdraw terms,” says Roger Flaxman, owner of PI adviser Flaxman Partners.

“Some don’t want to underwrite these companies at all, others are increasing self-insured excess or putting up prices. I think it will suddenly go next year.”

But as Britain descends into economic crisis, the question is whether anyone could reasonably have predicted the extent of the property crash.

“This is an extraordinary situation,” says Flaxman. “I think lawyers will be able to make a very clever case, saying you could have foreseen only to a certain extent. It’s fairly tricky.”

As a precaution, property companies, including CB Richard Ellis, have begun introducing “uncertainty clauses” into their valuations in an attempt to insulate themselves from the volatility of the market.

Valuations are based on comparisons with similar transactions and, as the market slows, the company claims there is too little information to produce reliable figures.

But Flaxman suspects this would fall foul of legislation on unfair contract terms. After all, what’s the point of engaging professionals if they won’t stand by their advice?

He doesn’t think it will reassure underwriters either. “Insurers are cynical enough to say ‘I don’t think it’s a very good protection’. If a surveyor is giving the lowest possible figure to cover their butt, that’s not right is it?”