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Banks, Lenders & Investors Cash Flow & Forecasting Finance Turnaround

K2 Key Indicator: is the UK construction industry in terminal decline?

construction industry at workThere is no doubt that the UK’s construction industry is facing a number of pressures including a lack of funding, inadequate planning approval processes and a severe skills shortage.
In this first of a monthly Key Indicator series that looks at major industries and their future, this month I look at the construction industry.
In the November 2017 Budget, the Government set a target to build 300,000 new homes per year to address the country’s chronic housing shortage. This has been estimated by the lender Urban Exposure as requiring £20 billion-plus of new funding.
In January this year, the Government launched a new national housing agency, Homes England, in order to help achieve this target. Its aim is to bring together existing planning expertise and new land buying powers.

Financing new housing development

There is a distinction to be made between the smaller house-building companies (those building 100-150 homes per year) and the relatively small number of large concerns.
Despite the controversial profits made by some larger house builders from the Help-to-Buy scheme, the House Builders Federation (HBF) estimated that between 2007 and 2009 after the 2008 Financial Crash one third of smaller companies stopped building homes. This equated to a loss of 25,000 homes per year being built.
Since then, of course, a combination of massive losses post-2008, consequent risk aversion and the tighter Basel 3 regulations on bank lending to what are termed High-Volatility Commercial Real Estate Loans (HVCRE Loans) has made borrowing by developers much more difficult.  Basel 3 means that banks are now required to set aside 18% of capital as a buffer for these loans compared to buy to let property loans of just 4%.
Consequently, lending to developers by the big banks, particularly to the smaller construction companies, who cannot access the bond markets direct, has plummeted. In 2016, CityAM reported that UK banks had halved their lending to property developers, down from £32.5bn in April 2014 to £14.9bn in April 2016.
The lending policies are clearly daft given that Loan-To-Value (LTV) on development property is typically 60% whereas the LTV on buy-to-let can be 95%
This has led to the growth of specialist property lenders such as Shawcross, Close Brothers and Paragon, the first two of which won top awards in this year’s online publication Moneyfacts awards. None of these specialist lenders has incurred any losses for some years which begs the question about the banks’ understanding of the market.
As yet, however, these specialist lenders, along with newer entrants such as HCA, Titlestone and Urban exposure, have not filled the funding gap.
In the meantime, according to a Reuters report on a survey mid-2017, the directors of small British construction businesses have been plugging the funding gap with their own resources but this has been limited and not at the amounts required, hence a significant scaling back by small builders.
Still, UK Finance reported in February 2018 that while, manufacturers’ borrowing had expanded slightly, the construction and property-related sectors had contracted.
Meanwhile despite the 300,000 target and the new Government agency, the Government continues to push its Help-to-Buy scheme that has improved the profits for larger firms by pushing up house prices due to limited supply.

The construction industry, planning, Brexit and the skills shortage

It would be impossible to fairly assess the future of the UK construction industry without considering planning, Brexit and the industry’s skills shortage. I make no apologies for calling it a crisis, not least because that is what the Federation of Master Builders (FMB) called it earlier this year.
This was after its quarterly survey into skills revealed that companies are particularly struggling to recruit bricklayers and carpenters, but that demand for skilled plumbers, electricians and plasterers is also outstripping supply.
This is also pushing up wages, thus adding to the costs being borne particularly by the smaller businesses many of which are losing staff to larger firms.
It has been estimated that one in five construction workers in the housebuilding sectors is foreign-born with 17.7% from EU countries. Across the country, Romania is by far the most common country of origin, followed by Poland, Lithuania and Ireland.
There has been plenty of evidence that EU nationals including construction workers have been leaving the UK in large numbers, while fewer have been coming since the June 2016 decision to leave the EU.
A combination of rising hostility towards migrant workers, the tediously lengthy and uncertain process of agreeing the status of migrant labour during the Brexit negotiations and more recently the revelations by the Home Office of a “hostile environment” for immigrants despite them having lived and worked in the UK for years are not helping the UK plug its construction skills gap.
Planning consent has been for some time an issue causing delay by depleted departments drowning in applications and appeals. This along with the system of local and regional planning committees staffed by inexperienced councillors dealing with NIMBY local inhabitants and the lack of local and regional frameworks to identify land for housebuilding are all contributing to a sclerosis in the planning system.
Myopia and an absence of joined-up thinking seem, sadly, to have been the characteristic features of Governments for some time and despite the rhetoric it continues, which bodes ill for the future of the construction industry.
I am not however yet willing to drive the final nail into the industry coffin.  There is a chorus of voices from many sectors of UK industry warning against the foolishness that characterises much of the Brexit negotiating stance, and the volume of noise is rising as the consequences emerge.
Being an optimist, I hope that they will be listened to and sanity will prevail before it is too late.

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Banks, Lenders & Investors Cash Flow & Forecasting General

Is Creative Destruction being stifled by risk aversion?

Breaking the wall K2 Partners Business Blog

In his 1942 work, Capitalism, Socialism and Democracy, the economist Joseph Schumpeter introduced the idea of Creative Destruction as an essential ingredient for sustaining long-term economic growth.
In a nutshell, it is the entrepreneur and his or her innovation that acts as a brake on, or actually destroys, established companies, thus protecting an economy’s health by allowing new companies and ideas to rise.
Schumpeter’s thesis was that while healthy capitalism is about constant change, inevitably the drive for maximum productive performance, if successful, will tend to kill competition and thus the system contains the seeds of its own destruction. Therefore, the entrepreneur and innovation are essential to capitalism’s healthy survival.

Managing capitalism in a global marketplace

Over time, ever since the Great Depression of the 1930s both political action and economic theory, have been evolving, prompted in part by the distressing consequences to many individuals when things “go wrong” in countries’ economies.
So, for example, Keynes’ solution to the Depression was that governments should step in with deficit financing, stimulating projects that could be started quickly to provide people with work and pay, which would stimulate economic activity and be paid off by increased tax payments. Equally governments, such as in the US, moved to regulate excessive risk-taking and speculation in the financial sectors to prevent a recurrence.
Gradually Governments took more responsibility for people’s welfare, in health, education and for stimulating employment. This has contributed to a shift in the balance of power from the employer to the worker.
A failure to manage the resulting imbalances and the consequences for national economies eventually led to disenchantment with the mixed economy and a return to completely unregulated free market capitalism, aka Neoliberalism, as promoted by Margaret Thatcher in the UK and by Ronald Reagan in the US.
After the 2008 Financial crash and the difficulty countries have had in recovering the question in the mature economies of the 21st Century, therefore, is what place capitalism has in our current and future society, especially in a now-global marketplace.

The businessman is no longer an entrepreneur or hero

Businesses constantly complain about the time absorbed and constraints imposed by “Government red tape”.  But we would argue regulation has moved further from things like Health and Safety regulation and employment protection into trying to regulate in a way that prevents risk.
Consequently, businesses are focusing on dealing with red tape and bureaucracy rather than on doing things, or getting out and selling. Dealing with red tape is disproportionately expensive in time and money for the SME compared with the larger companies and therefore inhibits their capacity for growth. Even in the larger companies there has been a rise in the professional manager whose chief aim is to look for safe returns and short term decision-making that protects her/his bonus and job. There is a lot of dysfunctional activity going on but not the kind that encourages risk taking.
Is state legislation helping businesses or compounding this problem?
It is only human to want to prevent further toxic economic shocks to people’s economic stability and wellbeing but if Schumpeter is right unless the correct balance is stuck it could well lead to the demise of capitalism.
It might be an unpalatable fact but knowledge is best gained by experimenting and learning from failure. The quicker and more failure, the quicker and greater success.