The Credit Crunch Bites

4 Jun 2008

How will the credit crunch impact on the Scottish construction industry?

The last quarter of 2007 saw the impact of the so called credit crunch bite directly where it was most visible, in the residential housing market. Speculative lending by US banks spiralled into a rapid, panicky deceleration that resulted in a loss of financial confidence and stability so widespread it led to the run on the Northern Rock. In February both Nationwide and Lloyds TSB announced a return to 1970s mortgage borrowing conditions, requiring a 25% and 10% deposit respectively before they would offer a mortgage. At the other end of the construction chain, Prospect investigated whether the construction industry across all sectors would be adversely hit by the downturn in fortunes, and if the outlook was as pessimistic as a cursory glance at the headlines may suggest.

Scotland’s micro-economic dynamics, which saw it weather the worst of the early 1990s recession may once again protect the construction industry from too much adverse fallout, says RIAS chief executive Neil Baxter. “Scotland is always better than the general scene in the UK. The history over recent decades shows that Scotland slows down more slowly and tends to suffer less in the dips. It is not so bad,” he told Prospect. “Having talked to colleagues in the south, a lot of them are suffering and feeling the effects of a real downturn. Scottish architects are still fairly optimistic and buoyant. It may be that the timing is different and the slowdown is coming, but certainly it has not come yet.” However Baxter anticipates that there may be downward pressure on construction contract bids as a result of undercutting from Northern Irish contractors, seeking work beyond their borders due to their own market contraction.

“The Northern Irish have noticed a considerable dip, but that is probably because they have come from a position of over inflated buoyancy. So when the slowdown comes, the brakes come on a lot harder,” he says. “The only way you can judge this is by looking at what the pattern was previously. The 1990s downturn was tough for a lot of developers, but the construction industry generally remained buoyant and reasonably stable in Scotland. We have a very interesting micro economy in Scotland. There are all sorts of factors - not least the Barnet formula - that play into it, and you end up with a situation where we are a little more protected.”

Ryden property consultants agree that it is too early to tell exactly how the credit crunch will effect both house construction and commercial property construction. A Ryden spokesman told Prospect that at this stage there was no evidence of any slowdown in the forward planning of building projects, nor any downturn in the market for buyers of new homes on the residential front. “They are going to continue to build new houses across the country, and there doesn’t seem to be any lack of people to take them up on them. They just seem to be able to crack on building regardless, albeit over a phased period.” However, Rydens anticipate that underlying trends in the cost of materials may impact on longer term planning.

“People are going to start looking harder at what phases and outcomes are going to be further down the line. The cost of building is going up. The cost of labour and materials are on the rise. Is there going to come a point where the land values that they are prepared to pay are going to fall off because it is no longer sustainable?” Rydens also add that the medium term construction work commissioned for the 2014 Commonwealth Games may impact on construction costs, as the additional subsidised work places additional pressure on the limited resources of the trade across Scotland. “Both Glasgow and Edinburgh could be in the doghouse. Government, local and central, are punting a lot of money into projects. Private client work still has to find the same workforce, builders and contractors to do their work. It is going to be very difficult.” “They are both going to struggle in terms of getting enough contractors and resources in place to do what needs to be done. There is already an issue with resources as it stands.

” Baxter however argues that the impact of the Games will be negligible, given Scotland’s economic shielding. “The commonwealth games - in terms of its overall proportion - is fairly modest,” he says. Alan Robertson, managing director of Jones Lang LaSalle agrees with Rydens’ view that the rising cost of construction materials is a more pressing threat to construction projects, and in fact other economic factors, such as the recent and predicted cuts in interest rates will stimulate construction, rather than suppress it. “The increase in building costs is having more of an impact on making borderline schemes non-viable. The credit crunch may come to the point where building schemes are jeopardised, but we haven’t seen that yet,” he says.

“In the office market in Edinburgh, occupier demand has not suffered as a result of the credit crunch, and there isn’t a great supply. Those organisations who own sites for developments are still proposing to proceed. Although there is nervousness, interest rates are falling, which lowers development costs and makes development more likely to happen. If the credit crunch lasts and leads us into a more noticeable economic downturn, then we could see occupier demand suffering, expansion plans put on hold, and even redundancies as businesses contract.”

While reluctant to place a timescale on when any further contraction may be felt, it seems likely that the next eighteen months will be pivotal. If rental or buyer demand falls off precipitously in that period, it is likely to signify a longer term economic downturn. The key barometer, says Robertson, is occupancy demand, both in the commercial and residential sectors. “I think development will only stop happening when there is clearer evidence that occupier demand has suffered. We need to go further into this downturn before there is evidence of that,” he says. “Office rents in Edinburgh and Glasgow are rising, which might make towns like Livingston and Falkirk more likely to attract occupiers. I wouldn’t say that the regional towns are disadvantaged through the credit crunch.”

Mark Kirke and Lindy Patterson, partners in the construction arm at solicitors Dundas and Wilson both agree that there is little to no evidence of a credit crunch now, and by 2009 or 2010, when any anticipated downturn may be expected to bite, the economic climate may have changed positively.

“From what we are seeing day to day, and the discussions we are having with employers and contractors, everybody has a busy order book for the coming year,” says Kirke. “Consistently we keep getting the same message. The order books for any of the contractors are all very healthy for 2008. It would be wrong to say it is biting now. That just isn’t our experience. Partner Lindy Patterson agrees and remains cautiously optimistic about the outlook. “We are not seeing any sign at the moment of a slowdown in construction work,” she says. “There is so much work and activity ongoing and committed to at the moment. Everybody is concerned about what might lie ahead, but hopefully it remains just a concern, rather than a reality.”