Construction activity has slowed across the U.K., but hotel development is still healthy despite the uncertainties caused by inflation, Brexit and labor issues.
REPORT FROM THE UNITED KINGDOM—Brexit, subsequent inflationary pressures and increased supply are all causing headaches among the United Kingdom hotel-construction sector, according to sources.
In short, development costs are increasing. Jon Neale, head of U.K. research at business advisory JLL, said construction costs in the U.K. are on the rise across the board.
“The pound is more expensive now. More of the fabric for hotels and other developments tends to be imported from overseas,” he said, adding that the hotel industry’s emphasis on high-quality finishes, materials and luxuries results in being more exposed to cost pressures from imports.
JLL’s report “Long-term decline in construction activity tempered by recent growth,” which was published in the third quarter of 2017 in collaboration with construction research firm Glenigan, confirmed that U.K. real estate construction activity has decreased.
“Construction activity (remained) down on … with an overall decrease of 22.4% (year-over-year), including a decrease of 25.5% on new-build construction projects since Q3 2016,” the report stated. “This is reflected across all major sectors and the majority of regions. London and the South East has seen particularly sharp downturns, with activity currently 43.4% lower than this time last year.”
Neale said in JLL’s latest year-over-year numbers hotel construction has increased by only 0.6%.
Sources said they are quietly optimistic hotel construction will continue to grow despite road blocks, and one of the largest is labor.
Allan Wilén, economics director at Bournemouth-based Glenigan, said Build U.K., the principal lobbying organization for the U.K. construction industry, has expressed concerns about construction activity.
“(Build U.K.) effectively is reporting skill shortages and recruitment difficulties,” Wilén said. “It has said these problems have delayed the completion of projects. Fewer people have been bidding due to cost pressures.”
He said the general uncertainty surrounding Brexit has not eased those concerns.
“The industry is concerned that labor shortages will get more difficult as we move through the Brexit scenario,” he said. “In the immediate aftermath of (the) Brexit (referendum), already there was pressure, but traditional sources of labor from Eastern Europe are drying up. Added to this, (mainland) European economies are picking up.”
A skill shortage in general has an effect on costs, Neale said.
“Brexit is a new spanner in the works,” he said. “Anecdotally, we’re hearing that workers are moving back to (mainland) Europe. Simply put, they are getting paid more, or their money is worth more, in Germany, and that has an appreciation for projects in the U.K.”
Chris Galloway, group managing director of Beck Interiors, said costs will rise in 2018, but not by as much as they did last year. He, too, is hopeful for hotel construction.
“We remain very busy, but last year we had three proposals of around £60 million ($83.5 million) to £70 million ($97.4 million) that did not happen,” Galloway said.
He added that of those three, one is in development now, the second will start later this year and the last has no proposed start date.
“I am not sure that was due to the economy here or in those (hotel chain’s) economies,” Galloway said, “but so much did not happen last year, people are biting the bullet now and saying let’s get on with it.”
A little relief
If costs have not been hedged, then construction firms will need a 100% grasp of every project, sources said.
Steven McGee, divisional director of hospitality at construction services company ISG, said the survival of firms working in the field will come from having cost-value touchpoints at every stage of the supply chain.
“For any single hotel development, if it has the best designers, the best contractors, the best supply chain, then there will be pressure on the budget every step of the way,” he said. “It will be a finite pot. Apart from those few vanity projects, all others have to fit into the metric.”
McGee said that now more than ever construction companies need to hit their budgets at every stage of development.
“Full knowledge of any project is essential, so that at pressure points we’ll know if there is too much emphasis on one part of the development and then can chat with developers to wind back or offer other options,” he said.
But overall, McGee said he is confident about the U.K. construction sector.
“The outlook for hospitality is incredibly positive, with a mix of one-off (developers), high-net-worth individuals and institutional developers,” he said.
Wilén also said hotel development is in a better place than perhaps other construction sectors due to the global growth in travel demand.
“Hotels are one of the brighter spots, because of the weaker economy and the resultant boost for overseas visitors,” he said. “More projects going forwards. There was a little hiatus after Brexit, but there does seem to be positivity, especially for projects under £100 million ($138.7 million).
“The value of work started last year grew 17%, and we predict it will grow 11% in 2018.”
The cost of materials should also increase this year, Galloway said.
“We saw general price increases throughout last year, increases in all materials,” he said. “In 2018, we are expecting to see increases but not at the same levels. Increases at the same level this year simply would not be sustainable. Joiners’ and fixers’ rates increased at the end of last year, and that will continue.”
Supply and demand in regard to subcontractors is another factor, Galloway said, as they are increasing their own rates around availability and opportunity.
Pedal to the metal
Galloway said that costs in doing metal and duct work went up twice in 2017.
“Costs for that work went up between 8% and 10%, and if the contractor’s own margin is 10%, well…” he said. “Clients with budgets they have to meet, yes, they will be strained.”
Inflation affects the construction industry a bit differently, Wilén said, and the latest estimate in regard to inflationary increases in the construction sector from the U.K. government was 2%.
“That surprised me, as that rate is lower than inflation,” he said. “That could change. There are a number of pressures in the industry in the works, and there could be more pressure going forward.”
The biggest candidates are higher material and energy costs.
“Imported materials are 20% more, and even U.K. products will see this increase if they comprise imported components,” he said. “There will be a ripple effect through the system.”
Eyes on the prize
It’s critical for investors, owners, developers and hoteliers to be fully on top of every stage of the development and construction cycle, McGee said. Costs can be maintained if there are strong relationships in place between all stakeholders, he added.
“Talk at length to all those involved, and right from the start, about the costs and appropriateness of any idea or offering,” he said. “Right off, it is so important that the hotel is appropriate for its location, or everyone will be throwing good money after bad,”
McGee added ISG’s new hospitality division was set up to have even more focused coverage on cost pressures within hotel construction.
ISG is active in 24 countries, although it emphasizes U.K. development.
“One of our key selling points is that our supply chain has global reach,” McGee said.
The planning permission process also is undergoing change in the U.K.
McGee said contractors must be fully conversant with planning processes and every stage of the route to gaining permission.
“I find local authorities are generally open,” McGee said. “Apply, and then listen to advice. We can put a compelling case, but it is far better not to do that unilaterally but with stakeholders and brands who know their markets.
“Ultimately, there is a need for honesty, and that requires a culture in a team.”
McGee said the hospitality sector deserves a lot of respect.
“At the moment, the tender opportunity pot we’re looking at has in it 91 hotels, and there is quite a mix in that,” he said. “There are trophy assets, a huge number of midscale city-center projects and also new builds farther out into the regions.
“Any city-center project right now will come with cost challenges. The cost base is very different, and is evidently more expensive in London.”