Building on Brexit

The impact of Brexit on the construction industry and the House of Commons Briefing Paper

It was reported on 27 October 2016 that UK GDP grew by 0.5% in Q3 – that’s 0.2% stronger than official forecasts made before the referendum decision in June. The stronger than expected growth was driven by a 0.87% expansion in the services sector and analysts have suggested that the result shows there is little evidence of a pronounced effect in the immediate aftermath of the vote. However, all other sectors contracted in Q3 including construction which fell by 1.4%, the biggest fall since 2012.

On 11 October 2016, the House of Commons issued a Briefing Paper on the implications of Brexit on the housing market and construction industry. It has reported that immediately after the referendum decision, confidence in the economic outlook of the construction industry plummeted below the 50.0 no-change level to the lowest since early 2008.^[1] August and September 2016 showed modest improvements (driven primarily by a recovery in residential building and a renewed rise in civil engineering activity), yet commercial construction declined for the fourth month running, the longest period of sustained decline since early 2013.

The housing market has a significant impact on the demand for house building and, in turn, the construction industry. Despite speculation that Brexit might lead to significant falls in house prices, there has been little indication following the vote that this has been the case. Indeed, the Halifax House Price Index for September 2016 showed a slight rise in prices of 0.1% and Nationwide reported a rise of 0.3%. An upturn in housing demand contributed to a rise in new work in September for the first time since April.

However, other aspects of the industry appear to be feeling the impact of the vote.

Labour

The UK construction industry is heavily reliant on migrant workers from Europe due to insufficient numbers of new and existing skilled workers entering the construction sector from the domestic UK market. As of June 2016, 12% of British construction workers were of non-UK origin and with UK unemployment at a low of about 4.9%^[2], the labour and skills shortage in the construction industry cannot be resolved domestically. The federation of Master Builders has said that "It is now the Government's responsibility to ensure that the free-flowing tap of migrant workers from Europe is not turned off…"^[3] However, immigration was one of the main arguments put forward for leaving the EU. It is therefore unclear how this tension will be resolved.

Imports and Exports

The UK is partially reliant on imports from the EU, particularly from Germany, Italy and Sweden. In 2014, 53% of goods and services were imported from the EU. Exports to the EU are also a key part of the UK economy with 45% of the UK's exports in 2014 being to the EU. Depending on the withdrawal agreement negotiated by the UK Government, export tariffs may apply to exports to the EU which is likely to reduce overseas demand for UK goods and services.

Exchange Rates

Currency fluctuations have a significant impact when there is reliance on the import and export of goods and services, particularly in an industry where margins are notoriously tight. The weakening of the pound has contributed to a sharp acceleration in cost inflation with suppliers acting quickly to pass on higher imported raw material costs. Whilst including exchange rate clauses in construction contracts is a possibility allowing for a renegotiation on price if an exchange rate fluctuates beyond a set number of percentage points, such clauses were certainly not common place before the Brexit vote.

Changes in Law

Typically contractors take the risk when there is a change of law, particularly in PFI and longer term contracts. However, there is a significant lack of clarity as to how the process of leaving the EU will work - not helped by last week's High Court ruling that the UK government must consult MPs before triggering Article 50.

Much of the law in the UK is European law and there is no clarity as to if and how various pieces or parts of legislation will be repealed and when. This uncertainty makes it difficult for contractors to take this risk, particularly given the margins they work on, and it will make change in law clauses more difficult to manage.

Social Housing Sector Intervention

The British Property Federation has called on the Government to consider a range of tax reliefs for Build-to-Rent development including Community Infrastructure Levy relief, relief for modular construction and stamp duty relief. The House of Commons Briefing Paper reports that the social housing sector has grasped the opportunity and offered to step in to build 300,000 more homes over the period of the next parliament both for ownership and rent.^[4]

This would necessitate a policy shift away from the government's aim of increasing home ownership. However, there have been indications that Theresa May is willing to consider this in order to boost overall supply. The think tank, Capital Economics, has forecast savings of between £102 billion and £319 billion from reductions in Housing Benefit that would derive from the development of 100,000 new social rented homes a year as fewer claimants would be living in the more expensive private rented sector.