n construction sector report briefing october 2012 accountancy bricks and mortar 24 The erosion of capital allowances and changes to lease accounting are just a few of the barriers to 24 growth in the building trade, says James Allen
24 hen the economy catches a that the construction sector contracted by cold, the construction sector nearly 10% over the period. has flu’, declares KPMG After seasonal adjustments, the gloomy partner Andrew Marshall, results did brighten up somewhat. Whereas and unless you’ve been living initially it had been estimated that output in 24 Wunder a rock for the past year or so, news that construction for Q2 had shrunk by 5.2%, ONS the UK economy is not in its healthiest state revised this to -3.9%, a change which made a should lead naturally to the conclusion that significant contribution to the adjusted overall the building industry is metaphorically under GDP figures for the quarter – from -0.7% to an the weather, despite a slurry of strong pre-tax improved -0.5%. 24 profits announced over the summer. Such news clearly needs to be taken in According to research by PwC, over 5,500 context; a less negative figure is still a negative companies have gone into insolvency since the one and construction output is 9.5% down on third quarter of 2010, equating to more than like-for-like comparisons with 2011. 600 insolvencies occurring in each three-month The impact on the economy though – alluded Collectively, as period. Of course, whenever companies go out of to in the altered GDP figure – cannot be ignored. business, job losses follow, taking another batch of The construction sector contributes £2.84 to a nation, we are skilled tradesmen out of the employment market. UK GDP for every £1 invested and, together building 100,000 The housing sector typifies the situation. with its supply chains, currently employs around new homes a ‘Collectively, as a nation, we are building three million people. Not only that, but the UK year, which is 100,000 new homes a year, which is way Contractors Group argued in a 2009 report that way short of the short of the 250-300,000 that most estimate 92p of every £1 spent on the industry is retained we should be doing. That is to cope with in the UK. 250-300,000 that the population increases and demographic It is not surprising that the government is most estimate we changes we are seeing, with more single people putting so much pressure on the sector to pull should be doing for instance,’ explains David Orr, CEO of the UK plc out of the current recession. National Housing Federation (NHF). David Orr, CEO, ‘And, of course, if you are only building a third profit streams National Housing of the houses that are needed, there are only a But the experience of contraction and Federation third of the construction workers.’ insolvency is not faced by every construction Is the ‘flu’ that the sector is suffering from business. Companies like Carillion, which though, simply a bad case of ‘man flu’? Figures saw first-half profits for 2012 surge by 69%, for the first six months of 2012, published by is seeing the benefits of scaling down its UK the Office for National Statistics (ONS), showed business and focusing instead on overseas
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25 Construction in projects, while other builders are also profiting central London despite difficult trading. Hampton homes, Rouse partner David Sharp says: ‘Take Gloucestershire Taylor Wimpey – a major house builder – they (Barratt) have just posted large pre-tax profits [£100.6m] 25 Timber frame through to June, bucking the trend. It really is a student flats, London (Ocon) mixed message.’ West Burton Fellow house builders, Balfour Beatty and CGT power station, Bovis have also recently reported increases in Nottinghamshire pre-tax profits for the first six months of 2012. (Kier) Marshall says: ‘The construction sector tends Greenfields to slightly lag the rest of the economy, it has a housing development, much longer gestation period. The companies Hampshire (Barratt) might have a number of orders on their books they know will see them through for the time ability of people to play the development game being and so the picture looks fairly good for the in London is pretty much limited to those with big contractors at the moment. large equity checks, sovereign wealth positions ‘But next year might not be so bright, as or very strong balance sheets who can bring order books are maybe at 50% and normally you on board corporate debt,’ said Martin Jepson, would hope to be at least 60-70% by now.’ Brookfield Office Properties senior vice president Without doubt, the biggest obstacle stopping for development and investment. projects from being given the green light is the lack of funding. ‘Banks are just not interested in Finance options lending. Without a tenant committed or buyer for Aware of the lack of available credit, the Bank of the property from the outset, not one brick is laid,’ England and the government, set up Project Merlin says Sharp. ‘One in three lenders in the UK last in February last year, in an effort to encourage year did not invoice a single loan, not 1p.’ banks to lend to small businesses; 12 months on, The problem has become so bad that ‘the it was revealed net lending from the five main 26
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construction trends
trading conditions CIS
output falls as recession bites clamping down on cash in hand
Q2 2011 Q2 2012 The Construction Industry Scheme (CIS) Total construction is run by HMRC to monitor and regulate The volume of how subcontractors receive payment for construction output work, as the nature of the building trade in Q2 2012 fell by – requiring input from a variety of skills – 3.9% compared with often sees projects outsourced to smaller Q1 2012. Overall companies. CIS applies to sole traders, the 9.5% volume fell by 9.5%. self-employed, businesses and partnerships. If a business does not carry out building work as its primary function, it may still be classed as a mainstream contractor or ‘deemed contractor’ and will have to register with CIS. For example, if a business spends in excess 26 New work of £1m annually on construction operations over a three-year The amount of new period which nets some large businesses, local authorities, contracts won fell government departments and housing associations. by 4.6% compared A Unique Tax Reference (UTR) is issued to a subcontractor with Q1 2012, to ensure the right tax is deducted. If tax is deducted, a equal to a 12.8% subcontractor operating as a partnership or sole trader, can 26 12.8% year-on-yar fall. treat this tax as income tax on profits. Source: Pinsent Masons
26 Repair and employment maintenance Total volume of SME versus work was down big business 2.7% compared SME with Q1 2012, workers 26 The majority of (85%) 2.8% reflecting an 85% annual decline construction industry of 2.8%. workers are hired by SMEs as opposed to big business or the public sector. 26 There were widespread falls in the sectors, with the largest decrease volume of construction output in in new infrastructure, which fell by Other Q2 2012 compared with Q1. There a significant 8.6%. workers were falls in eight of the nine Source: ONS 15% Source: BIS
UK banks had fallen in every quarter for 2011. because cashflow in a construction company As a result, the Funding for Lending Scheme can change a lot throughout the year and private 72.4% (FLS) was launched in August, which provides leasing allows for more flexibility. For the difference an 18-month window of opportunity for banks in rates alone, it may be well worth doing,’ he adds. to borrow at cheaper rates for up to a four-year Public sector building projects are also having period, on condition that the financial institutions difficulties raising finance and, after growing the SME pass the preferential rates on to businesses and concern over the viability of private finance sector accounts individuals in need of credit. initiatives (PFI), the government put a temporary for 72.4% share of total ‘It is still early days, will it work, won’t it work? hiatus on what has become the standard turnover in construction Do the banks have the appetite to put their financing model for civil construction projects. Source: BIS balance sheet at further risk?’ asks Sharp. However, the PFI model is currently under review In the uncertainty, alternative sources of and the government is likely to publish revised funding are also being considered. guidelines before the end of the year. ‘US private leasing seems to be popular and ‘It has become an understood method of offers much better rates than banks do,’ says accounting and the government recognises Marshall. ‘Funding has to be quite flexible at times that it does need to spend on infrastructure but
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top six builders
Source: theconstruction index.co.uk
% % 2.45 2.37 £m £m operating margin 561.3 588.2 Operating margin Balfour 3.1% Pre-tax Beatty 3.0% profit 3.3% Carillion 2.8% performance Laing 0.9% O’Rourke 0.7% 2.8% Balfour Beatty reported turnover of Interserve £11,035m in 2011/12, twice the turnover 2.9% £m £m Morgan 1.9% 27 25,441 of nearest rival Carillion. At the same 26,357 time, an uplift in pre-tax profits lifted Sindall 1.8% share price. Of note is the tight operating 2.7% Turnover Kier margin for the top six companies. 3.0%
27 turnover 2010/2011 Pre-tax profit 2010/2011
Balfour 10,437m 201.0m Beatty 11,035m 246.0m 27 5,139m 167.9m Carillion 5,051m 142.8m Laing 3,313m 29.9m O’Rourke 3,545m KEY 23.4m 27 2,315m 64.1m Interserve 2010 2,320m 67.1m 2011 Morgan 2,102m 40.0m Sindall 2,227m 40.7m 27 2,099m 57.7m Kier 2,179m 65.6m £ £0 0 20002000 40004000 60006000 80008000 1000010000 1200012000 £ £ 0 0 5050 100100 150150 200200 250250
doesn’t have the cash to do so. There are only Thornton agrees: ‘The PFI model is doing its job, two ways of funding those projects though, people have got used to working this way. My either you pay for it yourself or you get someone guess is that whatever replaces it is not going to else to pay initially,’ adds Marshall. be hugely different.’ Sue Drummond, PFI specialist, partner at Rouse, sees the furore over the controversial Lease accounting procurement approach as akin to closing the Another accounting issue currently under gate after the horse has bolted. review, which could have a significant impact ‘Some of the early projects were not good and on the industry, if confirmed, is the proposed are coming under the spotlight as to how much change to lease accounting, which will see benefit the public are getting from these that we leases being brought onto the balance sheet. are tied to for 20-30 years,’ says Drummond. ‘But Marshall explains: ‘Leases for less than 12 PFI has evolved and some of the schemes are months will not be caught, but there are going fairly good now, so the question is, is there is a to be a lot of construction sites that will have better way of doing public/private partnerships?’ to think seriously about this. A lot of staff, site Phil Westerman, head of construction at Grant offices and vehicle fleets tend to all be 28
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planning refining and relaxing
The government, in an Framework condensed over In August, the government The Local Government effort to inject the struggling 1,300 pages of planning policy also announced a relaxation of Association rejects the notion construction industry with a to less than 100, but has rules requiring house builders to that the planning system is much needed booster, recently courted controversy due to supply a proportion of affordable holding the industry back, introduced several significant conservationist fears that the UK homes among their new builds, however, citing 400,000 changes to planning laws. countryside is less protected and so as to restart building on sites housing projects with planning The National Planning Policy green belt will be damaged. deemed unviable at present. permission granted.
revenue Total output by sector
There has been a slow return the year-end reached £111m. government and the Finance in that the former excludes the to growth, with 2011 year end Early estimates, indicate that the for Lending Scheme it is hoped double counting of turnover figures showing total output of difficult times are far from over will further stimulate the limited that occurs when multiple sub- £107m, almost back to pre- but with relaxation of planning growth already noticed. As an contractors are involved in a recession levels of 2008, when regulation introduced by the aside, output differs to turnover, single project.
28 KEY £m £m £m £m £m £m £m Housing £m 22,458 18,634 13,736 17,843 17,140 19,092 18,416 new work 20,169 Non-housing £m £m new work £m £m 17,031 16,614 28 17,488 15,976 £m £m repair and £m £m maintenance 53,079 46,757 52,273 52,994 Non-housing repair and maintenance
28 2008: £111,658m 2009: £96,639m 2010: £104,288m 2011: £107,115m Source: ONS
28 hired, so there is going to be a big shock as they financial statements will derive any benefit from will have to gather an enormous amount of data 92p the reporting recommendations outlined in the and then figure out what needs to be leased consultation document. and for how long.’ ‘At the very least we think that more time The time to start worrying about the measure would be required to come up with sound 28 proposals that were both workable for companies may not be just yet though, as according to of every £1 Marshall: ‘There was an exposure draft two spent in the and useful for other parties.’ years ago, which has since been revised and construction industry Despite reservations, Marshall has noticed we are now waiting for the revised draft. But is retained in the UK changes in the industry already: ‘To just get on the given its complexity, it is going to be given a Source: tendering process now, construction companies reasonable amount of time, so it will probably UK Contractors Group have to demonstrate their green credentials. be at least another three years before it actually ‘In the public sector, it has become a business ends up on the accounts.’ imperative already. But that’s the point, making A commitment from the government to everyone do it does force people to give it mandatory reporting of green house gas (GHG) much more attention and as a result you get the emissions by April 2013 is more of a certainty, changed behaviour the government seeks. however, though the Home Builders Federation ‘I do worry about the quality of data used (HBF), a lobbying group for the industry, though, as it is not the prime accounting data opposes the compulsory GHG reporting outright, and it does not necessarily come off the back of ‘given the unstable economic conditions and reliable systems.’ fragility of businesses’. ‘Against this background, the reporting Capital allowances framework that is being proposed is neither The lack of credit and constant tinkering sufficiently well developed, nor well understood,’ with regulations are factors that are, largely, says HBF’s financial director Michael Powell. struggles outside of the industry’s control, but ‘Implementing such a framework would one area where the damage is self-inflicted is pose a real problem for companies compiling that of capital allowances. their reports, but we think that it would also be ‘Allowances are an area that even today questionable whether even sophisticated users of HMRC is trying to raise awareness of, to try and
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geographic split KEY
£17,228m £14,603m regional turnover Scotland 2010 2011 Turnover remained relatively stable from 2010 to 2011, Turnover £m with by far the most dominant area for construction being London and the south-eastern corner. Source: ONS £26,639m £28,659m North East £ 8,152m £7,807m Northern Ireland £41,641m £38,527m Midlands
£21,407 £18,766m North West 29 £33,605m £29,904m East of England £7,608m £6,497m Wales 29
£256,985m £244,205m £18,120m £16,488m £46,585m £40,946m £48,945m £43,668m Total UK South West South East London 29
help stimulate both smaller as well as larger than the two-year time limit [to make a claim] to 29 businesses to use,’ says Jeanette Edmiston, build the property.’ technical manager at Portal Tax Claims, who For something which is in effect a partial was on the HMRC consultation panel on the refund on additions to a building, Edmiston is amendments to fixtures legislation. surprised at the lack of take-up: ‘I have been ‘What they [HMRC] are trying to do is make involved in this market for many years and there 29 the amount of allowance on a fixture on a is still quite a lot of ignorance about allowances.’ property constant, but quite often a claim is not Sharp has some practical advice: ‘It’s very made until a long time after the installation of important for new builds to get a chartered the fixture and it then becomes complicated and accountant onto the site as soon as possible people do not always keep records. and that they work with the chartered surveyor ‘We are encouraging businesses to make a to maximise the allowance. The shell of the claim as and when they incur an expenditure building might not be covered by the relief, but because HMRC are trying to add more the fixtures being installed as the property goes constraints. The new rules say that the owner up will be. of a fixture must have pooled the expenditure ‘We had a client who brought in the surveyor at some point prior to the sale of the property to literally see what was going into the walls as to a third party. Therefore, advisers need to it was happening, so he would have evidence to look at the capital allowances before a sale is substantiate his allowance claim. It’s very easy concluded to make sure everything that should to see that as it is being built, but difficult once it be done has been done. is all covered up with nice wallpaper.’ ‘They then have two years from the date of Assessing what the future holds for the the transaction to actually agree the election industry, Sharp concludes: ‘The sector is values and make a claim, but it is much more experiencing a u-shaped decline, it’s been prudent to do this immediately following the sale, going down and will flatten out. We are having looked at all of the issues and resolved expecting 2014 to be the year of growth, partly them during the sale negotiation process.’ because of the anticipated general election, She adds: ‘This affects the constructing of a when the government could decide to bring property because sometimes it can take longer some good news to the industry.’
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