FRP - Resilience to recovery: The future of UK construction

Our 2024 Construction report unearths the views of more than 500 senior decision makers within UK businesses across the sector. The findings uncover both the opportunities and challenges facing the industry, along with the main ambitions and anxieties driving decisions for the industries key players.

Resilience to recovery: The future of UK construction Sector series

Resilience to recovery: The future of UK construction

Sector challenges Firm foundations

And with order books remaining relatively healthy, albeit against a more competitive backdrop, businesses will be looking ahead for further positives, including settled inflation and a much-anticipated interest rate cut from the Bank of England – both factors that would help boost client and consumer confidence further. Many firms will be moving onto the front foot to pursue growth – looking to secure new financing, new business and to invest in their people and their operations.

For more than a year, the construction industry has been hard-hit by the intense headwinds that have been felt across the UK economy. Sustained inflation – which has now begun to ease – has driven up project budgets while elevated interest rates have increased funding costs for developers and mortgage holders alike, serving to reduce demand for contractors. At the same time, supply chain disruption – a factor that has intensified in recent months due to challenges in global shipping lanes – and skills shortages have stretched firms’ ability to complete the work in their pipelines. Together, these issues have heaped pressure on businesses that are, in many cases, still saddled with high levels of debt from the pandemic period, with less headroom to absorb shocks. And for some, this has proven unsustainable. According to data from the Insolvency Service, construction saw the highest number of insolvencies of any UK business sector during both 2022 1 and 2023 2 .

Blueprint for action

In this report, we’ve gathered the views of more than 500 senior decision makers in construction businesses across the UK on what has defined their operating landscape over the past year, and what challenges, and opportunities they see ahead. We hope this will be valuable in showing where shared pain points sit, and to inspire firms to consider what else they can do to make sure they are able to fully capitalise on any and all opportunities that lie ahead. If this sparks ideas or questions from you, please don’t hesitate to get in touch.

Get in touch

Green shoots

Justin Matthews Partner Financial Advisory London +44(0)7759 537 315 justin.matthews@frpadvisory.com

However, the sector continues to be one of the UK’s most resilient. Indeed, since the start of 2024, we’ve seen improving conditions and demand, with optimism amongst firms reaching its highest level in more than two years 3 .

1 https://www.ons.gov.uk/businessindustryandtrade/constructionindustry/articles/constructionstatistics/2022 2 https://www.credit-connect.co.uk/news/insolvency/business/construction-insolvencies-continue-to-rise/ 3 https://www.pmi.spglobal.com/Public/Home/PressRelease/1604f755a8aa4888ae4b084caa5e883e

Resilience to recovery: The future of UK construction

Section 1

The year ahead Against a backdrop of long-term challenges that saw thousands of construction firms collapse during 2023, concern naturally continues to prevail across the sector.

Only under two thirds (64%) 4 were able to say they are confident in their ability to survive the next 12 months. 64% Firms in the South West (80%) and North West (76%) report higher confidence about their resilience. 80% Businesses in the East Midlands (36%) and the North East (55%) are particularly pessimistic about their prospects. 36%

Percentage of firms confident in their ability to trade through the next 12 months 4 :

1 2 3 4 5 6 7

Scotland | 64% North West | 76% North East | 55% Yorkshire & The Humber | 62%

8 9 10

9 10

Active enforcement

This concern likely lies in the industry’s tax burden, which is in many cases heightened in the post-Covid era. Almost two thirds (65%) of the businesses we surveyed said they were concerned that they might struggle to pay their tax liabilities this year. This rises to 76% in Scotland, Yorkshire, and the East of England. These fears will no doubt be heightened by a far more aggressive approach to enforcement by HMRC, which has recruited significantly as it works to re-build public finances in the wake of the pandemic. In the first three quarters of 2023 alone, for example, there was a four- fold increase in the number of winding up petitions issued by the tax authority against businesses compared to the same period in 2022.

4 ‘Very confident’ and ‘Somewhat confident’ answers combined

Resilience to recovery: The future of UK construction

A regional outlook

Michelle Elliot, Partner in Glasgow: “It will take months, if not years, for the full impact of these headwinds to play out. That being said, Scotland’s construction sector has always shown itself to be tenacious and creative in finding solutions to persistent challenges – and our findings show this tenacity in action.” Scotland

North West

East Midlands

South West

Simon Farr, Director in Manchester: “There are some real positives in our findings, including the fact that the majority of the North West construction sector expects to see both revenue and profitability increase this year. But at the same time, any improvements here may be overshadowed by the sheer force of pressure firms are under.”

Matt Whitchurch, Partner in Bristol: “While it’s positive that the South West is the most optimistic part of the UK when it comes to the construction sector’s outlook, these figures are still highly concerning in the wider context. They reflect the significant, sustained effect of a perfect storm of pressures – from raw material inflation to elevated interest rates.”

Nathan Jones, Partner in Leicester: “The results across the Midlands are concerning, but particularly so in the East. It’s possible that what we’re seeing here in terms of splits in trading optimism, and revenue and profitability expectations are the knock-on effects of the decision to cancel the eastern leg of HS2.”

North East

Mark Hodgett, Partner in Leeds: “ Construction is one of Yorkshire’s most important sectors, both forming a significant part of the economy and underpinning the region’s ambitious development pipeline. For this reason, it’s concerning to see that such a high proportion of businesses are worried about the months ahead.” Yorkshire & The Humber

London

East of England

Allan Kelly, Partner in Newcastle: “Construction is a significant part of the North East’s economy, which makes these results all the more concerning. Many construction businesses were already strained by the disruption of the pandemic. Rising interest rates, surging inflation and weakened demand have taken a further toll.”

Richard Bloomfield, Director in Norwich: “These are incredibly concerning findings, and reflect the sustained pressure that the construction sector has been under. Factors like raw material price inflation, supply chain disruption and heightened interest rates have combined with heavy debt loads to stretch firms’ bottom lines.”

Justin Matthews, Partner in London: “High interest rates, weak economic growth, persistent inflation, supply chain disruption and delays or cancellation to infrastructure projects have exacerbated strain caused by existing, heightened levels of pandemic-era debt, testing business’ resilience to the limit.”

West Midlands

South East

Gemma Jones, Partner in Birmingham: “There are economic bright spots on the horizon, although challenging factors – like high interest rates and heightened input costs – are likely to persist in the short-term. That being said, it’s encouraging to see that sentiment in the West Midlands is broadly in line with the national average.”

Phil Harris, Partner in Brighton: “It’s unsurprising to see that such a large proportion of the South East’s construction businesses have concerns. However, with inflation continuing to ease – aided by the reduced energy price cap coming into force in April, there is a light at the end of the tunnel for those that have weathered the storm.”

Resilience to recovery: The future of UK construction

How to agree ‘Time to Pay’ with HMRC HMRC are typically a significant creditor for construction firms, across CIS, VAT and PAYE liabilities and are therefore a key stakeholder when a business is experiencing financial challenges. When it comes to outstanding tax liabilities, the good news is that, in our recent experience, HMRC remains supportive in agreeing to ‘Time to Pay’ agreements. These are carefully prepared, bespoke, plans that allow business owners to repay their arrears over an agreed timeframe. HMRC doesn’t agree to them lightly however. Businesses need to have a clear reason for not being able to meet their tax payments on time and, ultimately, a watertight commitment that will see the payments being made in full. It will also take a view based on recent compliance record and how good a company has been at paying its taxes in the past when weighing up whether further concessions can be made. If you think that your outstanding tax liabilities are unsustainable and that you would benefit from a Time to Pay agreement, early engagement is key. Demonstrating to HMRC that a Time to Pay agreement is part of an effective, wider turnaround strategy is critical, alongside ensuring that any agreements that firms enter are genuinely achievable – missing payments on a plan can, in circumstances, make matters worse.

A split field

Turning to revenue expectations for the year ahead, broadly similar proportions of construction firms expect revenues to increase (36%) and decrease (39%).

65% 39%

Firms surveyed in Greater London are more bullish about their potential, with 65% expecting to increase earnings, while just 12% of East Midlands construction firms are forecasting revenue growth in 2024. At the same time, data shows that London’s economy is forecast to bounce back higher than the rest of the regions as the UK returns to growth, supporting higher confidence in the capital. But the fact that there is no clear-cut view on the sector’s prospects for prosperity reflects a background of ongoing uncertainty and economic volatility, as well as greater pockets of activity in specific cities and regions. As a result, we’re seeing a similar pattern in industry appetite when it comes to future M&A and exit strategies.

Looking to profitability, again there is a diversity of expectation, with equal amounts forecasting an increase in profitability (39%) and a decrease (38%). London firms are, once more, the most optimistic, with 63% expecting to increase profits, while just 16% of East Midlands firms expect the same. It’s possible that the negative sentiment seen in the East Midlands reflects the decision to cancel the eastern leg of HS2, which was particularly poorly received in the region. Over a third of respondents told our survey they would consider merging with another business (36%), while a similar proportion said they might acquire a new business (36%), sell part of their business(es) (35%) or sell all of it (34%) over the next year. The fact that so many of our respondents indicated considering some sort of transaction in the next 12 months, shows the impact of current pressures on future corporate activity.

Get in touch

Simon Farr Director Restructuring Advisory Manchester +44 (0)7787 004 421 simon.farr@frpadvisory.com

Resilience to recovery: The future of UK construction Resilience to recovery: The future of UK construction

Resilience to recovery: The future of UK construction

Overcoming hurdles

What factors are underpinning firms’ optimism – or, in many places, lack of it?

When we asked about the biggest challenges they faced during 2023, firms commonly cited difficulty retaining staff (14%) and the increased cost of servicing their debts (14%). These issues came up again when we asked respondents what the largest hurdles for the coming year would be, and were cited by 11% of firms in both cases. However, they were both surpassed by political uncertainty (14%) – something that we explore in more depth in the final section of this report.

Key challenges in the next 12 months

Supply chain 12% | Supply chain disruption 12% | Supplier credit terms reduction 11% | Raw material costs

Finances 11% | Cost of servicing existing debt 9% | Cost of new funding/credit 9% | Access to funding/credit

Operating 13% | Energy costs 13% | Labour costs 9% | Land costs

People 12% | Weakend customer demand 11% | Labour shortages 11% | Retaining staff

Delays 12% | Planning delays 11% | Delays to major infrastructure 9% | Delays of contracts

Economic 14% | Political uncertainty 11% | High interest rates 10% | Insolvency of sub-contractors

Resilience to recovery: The future of UK construction

Rapid inflation has meant that some firms have risked trading at a loss as fixed price or longer-term contracts, which may have been agreed years ago and which have no provision for price increases, no longer reflecting the actual cost of delivering the work. While some contractors have avoided this by having price escalators built into contracts from the start, many others have been forced to go back to clients to attempt to amicably renegotiate contracts. And this is something that is set to continue.

Re-negotiation Selling assets

Payment relief

When we asked our respondents what steps they’d be taking over the next 12 months to preserve or improve their cash position, the top answer was contract re-negotiation (23%).

A fifth (20%) plan to sell off assets, including plant, in favour of leasing. While this releases cash and may be a temporary strategy for funding operations, it does mean that businesses could face a new monthly burden of finance costs.

Other strategies to protect cash position included electing not to pay pension additional contributions (21%) – a reference to enhanced director and/ or shareholder pensions, rather than regular employee pensions – and deferring VAT and tax (15%). These are both moves that may only provide short-term relief.

Chris Everett, Chartered Quantity Surveyor and Managing Director at CCi

“Looking back over the last year, there have been a range of causes for contractor disputes.

“The Building Safety Act is still generating fire-related and defect-related issues in both design and workmanship. For example, when defective cladding is being stripped off buildings, we’re finding shortcomings in fire barriers and compartmentalisation that has to be corrected. This includes both defective design and workmanship issues. “Modular construction is also proving to be a difficult industry. Because modules are made ‘just in time’, any delays on site mean the manufacturer can’t get them out of the door and their production stops. “And there is still a legacy from COVID, with projects that began in or before 2020 and 2021 now coming to an end and final account. That has led to some very complex disruption claims, which can be difficult to substantiate and resolve. “Inflation has also caused numerous disputes where contractors have sought to renegotiate unviable contracts, though this is now easing as escalation clauses are standard in construction contracts. However, there is the chance of negative inflation on some types of materials going forward, so firms should ensure that clauses only cover an upward escalation to avoid an obligation to return money.”

Section 2

Money matters

Contracts, costs and capital Perhaps the biggest challenge for construction firms in recent years has been the unprecedented increase in costs.

10 12

Resilience to recovery: The future of UK construction

Fuelling growth

At the time of writing, a more settled landscape in terms of interest rates and inflation means that the UK debt funding market is in a more buoyant place than it was 12 months ago, although the return of confidence is gradual. Anecdotally, invoice finance providers we have spoken to have reported more funding applications from construction firms. But the sector may well find lenders take longer to return to the market, even as interest rates and the cost of capital start to fall. In some cases, funding options are likely to stay more limited, as we’ve seen some lenders looking to exit the sector altogether.

Indeed, when we asked firms how easy it was to obtain funding in 2023, compared with 2022, just over half (51%) said it was harder and only 31% said access had improved. 02 Funding challenges

Challenge responses

Financing options

Financial guarantees

Access to funding

Respondents who said it was harder to obtain funding cited a range of reasons for the funding challenges they faced, including the higher cost of capital (35%), which reflects an environment where interest rates are now at a 16-year high, as well as the withdrawal of Government funding support after the pandemic. Higher cost of capital

Construction firms are currently using a wide range of financing options, from business overdrafts (27%) and bank loans (25%) to asset-based finance (24%), private equity investment (23%), equity funding (22%), invoice finance (21%) and business credit cards (21%).

And around a quarter have provided corporate financial guarantees (27%) and personal guarantees from directors and / or board members (24%), which will no doubt be weighing heavily on these individuals, especially with reports of trade credit insurance being pulled.

A third (33%) of those that experienced more difficulty accessing funding flagged this lower risk of appetite from lenders. And similar proportions said they had experienced increased scrutiny of their projected (34%) and existing financial performance (33%) when seeking funding.

What steps, if any, will you take over the next 12 months to preserve or improve your cash position?

Andy Garton, Director of Groundwork Contractor, Corbyn:

“The main thing that developers and contractors want is cost certainty. That’s been hard to come by since COVID; the cost of money, the cost of land, the build cost, planning delays and changing regulations have all combined to create a bubble of uncertainty. As a result, we’ve seen a number of businesses, including long established ones with great trading histories, that have had to go into administration through very little fault of their own. “Activity is picking up again and that should continue to increase, though the tendering process is becoming more competitive, with firms softening their prices to grow their order books. The biggest challenge we now face as an industry is the knock-on effect from those collapses on the trade credit insurance markets. “Credit insurers have become particularly risk averse, which is understandable, but they seem to be applying a blanket policy to the sector, rather than looking at firms on a case-by-case basis. It’s a very difficult situation for firms to manage when they are trading on established terms and then suddenly need to find liquidity to support debt funding and support project delivery.”

17%

20% 20% 18% 23% 21%

Reduce investment in tendering

Re-negotiate existing contracts

Extend terms with suppliers/ lengthen payment times

17% 16% 16% 15%

Permanent reduction in headcount

Divest of assets (e.g. plant) in preference of leasing Change suppliers to cheaper alternatives Director/shareholder injection of funding

Increase pricing

Refinance or borrow money

Build price escalators into new contracts

*Respondents were asked to select all that applied.

124

Resilience to recovery: The future of UK construction

The resilience and performance of any

Supply chain strategies

business is dependent on the strength of its suppliers

But this is perhaps even more the case in the construction sector, where subcontracts are an inherent part of project delivery strategies, and where the reliable availability of raw materials can choke or entirely stall a project’s progress.

It’s encouraging to see that over two thirds (69%) 4 of the firms we surveyed said they were confident that all businesses in their supply chain would trade through the next 12 months. And businesses are taking proactive actions to further mitigate the effect of supplier failure on their own businesses. This includes shortening their own payment terms (38%) to require suppliers to pay them sooner – a move that could put additional pressure on their supply chains.

Other measures include swapping financially weaker suppliers for stronger ones (34%), enhancing due diligence and performance monitoring (34%), tightening credit procedures (34%) and diversifying their supplier base (32%). These are all prudent measures at such a testing time. And – to the point of supply chain resilience – it may be that some of the firms that told us they would be looking to acquire another business may be targeting key suppliers in a move to ensure they have a reliable pipeline of inputs for when activity starts to ramp up again.

*Respondents were asked to select all that applied.

15 17

Resilience to recovery: The future of UK construction

Section 3

Political uncertainty and government support At the time of writing, the prevailing view is that a general election will be called some time towards the end of 2024. And our results show that political uncertainty around this is having a direct impact on business’ plans. Just over three-quarters (76%) of the firms we surveyed said it was causing them to delay investment or causing their clients to delay commissioning new work. Some of this is likely to stem from the fact that key policy positions from the major parties are still – in many cases – being developed, including in areas like infrastructure and the green economy. Added to this, even once the result of the election is known, it will still take some time to see how much of what is planned can actually be delivered and how markets and the economy will fare – factors that will particularly affect the outlook for residential and commercial operators.

“While their value and aims are recognised and supported by the industry, post-Grenfell safety measures are having a big effect on some developers, particularly in urban areas. For example, any new buildings over 18 metres tall now must have two staircases. “Not only is there the time and cost to do the redesign, but adding another staircase also means you lose net saleable area. Even though there will be a ‘grace period’ before these regulations are enforced, there will be many developers who have got schemes where the maths now just doesn’t add up, and I expect the sector will be feeling the impact of this over the next year or two. “At the same time, most large organisations, whether they’re contractors or developers, have a number of historic legacy projects, some of which will be impacted by the investigations and remediation work that has been done post-Grenfell. That will include both tall buildings and housing, where fire stopping historically hasn’t been installed correctly or the wrong materials have been used. Developers are having to go back and put things right – at their cost – which may affect investment plans elsewhere. “Separately, such widespread reports of political uncertainty also reflect the impact that elections have on big decisions, such as planning or infrastructure investment. Politicians are likely to delay anything that could be divisive or politically ‘dangerous’ when there is an election looming. In the period leading up to any election there’s also a period of purdah, where big decisions are put on hold. In this environment, firms may need to pause on their strategies while they wait for this landscape to unfreeze.” Ross Faragher, Property Development Consultant and Interim Executive

Resilience to recovery: The future of UK construction

Shaping policy We asked firms what legislation would negatively impact their ability to progress projects this year.

So, what would construction businesses like to see the government prioritise to support its future prospects? Reflecting the diversity of the sector, firms have a lengthy wish list, led by investment in skills (16%) and modern methods of construction (MMC) (16%). And – in line with part of why political uncertainty is causing such widespread concern – clarity on future policy direction, which they can plan around, is key. Firms want a more defined national industrial strategy (16%) and national energy strategy (15%).

R&D Expenditure Credit/SME tax credit schemes 43% flagged the recent merger of the R&D Expenditure Credit and SME tax credit schemes. This was announced in 2023 as a move to simplify existing innovation support avenues, but there were concerns that the change was rushed through and came too soon after disruption caused by earlier reform – frustration that looks to be reflected in these findings.

Top measures construction firms would most like to see from government Increase in investment Strategy and support

Further clarity on national industrial strategy Further clarity on national energy strategy Further clarity on national transport strategy Greater / new support for first- time homebuyers

Greater investment in construction skills

16%

Building Safety Act

New / greater investment in modern methods of construction Additional investment in housing development New / greater investment in digitalisation (including AI)

16%

15%

Over a third (37%) mentioned the Building Safety Act, which was implemented in the wake of the Grenfell Tower fire and adds a range of new design considerations for developers and delivery partners.

15%

14%

15%

12%

Funding and reformation

Tax reductions

Section 106/Section 75

Freeze / further reduction in Fuel Duty Tax credits for ‘green’ plant Zero VAT-rating for residential refurbishments More direct support for R&D / tax breaks for R&D spend

Greater funding of sector regulators

14%

15%

Similar numbers mentioned Section 106 (35%) and Section 75 (34%) obligations – the Scottish equivalent to Section 106 – which some firms feel challenge the financial viability of projects at a time when margins are already under pressure.

Reducing operational costs (other than through AI/automation) New / greater funding / support for retrofitting Additional infrastructure commitments

14%

15%

12%

14%

12%

14%

*Respondents were asked to select all that applied.

Resilience to recovery: The future of UK construction

This report lays bare just how difficult and volatile the operating landscape is for UK construction firms. Establishing momentum While there’s good reason to believe that many of the underlying economic challenges – factors like inflation and interest rates – will improve this year, they won’t be fully alleviated. And long-lasting, stubborn issues that have weighed on the sector for years, from skills shortages to late payments, will persist. In the immediate term, resilience will continue to be the watchword for management teams. But opportunity will also be in many firms’ sights. Our findings show a sector that is proactively working to manage the impact of current and future risk, and fuel new growth. This proactivity – in action, but also in planning – will be key to their future success.

And, whether it’s resolving operational challenges, managing outstanding tax liabilities or securing new funding, we’ll be here to help. If you’d like to discuss any of the issues raised, please don’t hesitate to get in touch. We’d like to thank the respondents and our partners who generously participated in our survey and shared their experiences and expectations.

Get in touch

Matt Whitchurch Partner Financial Advisory Bristol +44(0)7912 297 788 matt.whitchurch@frpadvisory.com

A survey of 502 UK business decisionmakers (manager and above) at construction firms with at least 50 employees, conducted by Censuswide on behalf of FRP between 29th February and 5th March 2024. Censuswide abides by and employs members of the Market Research Society and follows the MRS code of conduct and ESOMAR principles. Censuswide is also a member of the British Polling Council. Methodology

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April 2024

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