This year’s London prime residential development pipeline shows a 25% increase in planned activity over the next ten years. With 25,000 units in the pipeline and a combined sales value of £60 billion, the level of prime development now being planned and constructed is at an unprecedented high.
Interestingly, the annual growth in total units in the pipeline, at 25%, has fallen yet again (2013 saw an increase of 29% and 2012 an increase of 70%). This may indicate that the pace of new development opportunities being identified in Central London is continuing to reduce. This could reflect nervousness that London land pricing is now ‘full’ as more challenge and scrutiny is being applied to outturn viability forecasts, particularly in emerging prime locations. It also may suggest that the pipeline is starting to be worked through by developers rather than just added to.
With the strength of the London residential development market remaining central to the recovery of the UK property market and the wider economy, the overall increase in development activity from last year’s report is no real surprise. However, this volume of development, representing the very top slice of London housebuilding, barely scratches the surface of the capital’s housing output target set out in the Greater London Authority’s Housing Strategy. The total number of units identified in this report over a ten year delivery period would account for just 60% of one year’s required total delivery output in Greater London of circa 42,000 units. This is perhaps worth remembering in the context of the ongoing politicisation of foreign investment in London residential and the inferred negative impacts on the domestic sales and rental market.
The question we pose this year is not whether the level of purchaser demand is sustainable to absorb the increased supply levels, or even how schemes must be differentiated in order to sell. It is the more pressing question that developers and investors already active in project delivery are grappling with: “how do I secure the construction capacity needed to get my development built?”
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WILL DEVELOPERS WIN THE RACE TO SECURE THE SUPPLY CHAINAND DELIVERTHE PIPELINE?
25%INCREASE IN
UNITS ON LAST YEAR
25,000 UNITS£60 BILLION TOTAL SALES VALUE 12,000
(2014-2017)
10,000(2018-2020)
3,000(2021-2023)
Our report methodology has to include an element of conjecture as to how quickly schemes will progress, dependant upon planning, funding and sales factors. However, by producing a theoretical timeline, we are able to discuss the headline trends and shape of the ten year pipeline.
ANOTHER YEAR ON YEAR INCREASE IN NUMBERS - BUT WHAT IS SHAPING THE PIPELINE?
The familiar peak of potential units being delivered year on year that has been seen in previous reports continues to be a key feature and the expected peak around 2017 remains. Much of this peak is based on the premise that there has been a surge in schemes during 2014 progressing beyond planning consent and pure land trading into procurement and construction commitment that will start to deliver units in 2017 onwards. There is still an assumption on multi-phase schemes that they continue without pause and that funding is secured to underpin development. However, the increased levels of construction activity seen over the last two to three years could be dwarfed in the next three to four year period, based on the development activity that is beginning and thus, the reality is that many of these schemes may end up being pushed into the latter part of the timeline because of deliverability constraints. Interestingly, the 2014 estimated completion numbers are down from what was forecast only last year. This is perhaps a reflection of a more deep seated issue regarding project delays both in design and procurement as well as during construction, as
part of the wave of larger prime residential projects that were committed as far back as 2010.As with previous years, this year’s pipeline profile has been led by substantial growth in the lower sales value bands. Although we have raised the average sales value threshold by 8% (from £1,250/ft² to £1,350/ft²), a large number of new schemes have been captured in the £1,350/ft² - £1,700/ft² sales value bracket. Even with background inflation accounted for, there is a continuing trend of larger ‘regeneration’ style schemes in fringe locations around traditional prime areas, albeit, the rate of increase in this value segment has lessened as more and more of the development opportunities are identified and brought to market. There may also be the beginnings of a deceleration in the lower end of fringe of prime development planning as more developers and investors recognise the beginnings of a wider London recovery. It is clear that there is already a ‘bow wave’ of planned and actual development in the £1,000/ft² - £1,350/ft² sales value bracket which covers wider geographic areas. This is particularly noticeable in the less mature prime markets immediately
east of the City of London and in Docklands as well as further away from the River Thames within the non-riverside South Bank stretch. There is also increasing interest in the £500/ft² - £1,000/ft² segment of the market which is starting to capture much larger areas of Greater London, particuarly those that benefit from good transport connections such as those on the Crossrail corridor or around the London Overground network.The more land constrained super and ultra-prime residential value segments have seen much less growth due to the smaller lot size of these developments and the rarity of true trophy sites coming forward. However, there has been an above average increase in the value of some parts of the London market which has now pushed schemes into higher value bands and also contributed to an element of upward value migration within the previously identified projects. This is especially prevalent in Victoria and Pimlico, Midtown, Bayswater and Paddington and parts of Earls Court and Fulham. This ‘inner circle’ of fringe of super prime has seen some strong sales value growth fuelled by ongoing overseas investor appetite.
Units per year (2013 vs 2014)
2014 2015 2016 2017 2018 2019 2020 2021 2022 2023
500045004000350030002500200015001000
5000
Units per year 2013 Units per year 2014
Number of units 2013 Number of units 2014
>£2,500£1,750 - £2,500£1,300 - £1,750
14000
12000
10000
8000
6000
4000
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0
Units per sales value threshold (2013 vs 2014)
2014
14
12
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02015 2016 2017 2018
Year
GD
V (£
billi
on)
2019 2020 2021 2022 2023
GDV per year
2014
5000
4500
4000
3500
3000
2500
2000
1500
1000
500
02015 2016 2017 2018 2019
Year
Num
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f uni
ts to
be
deliv
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2020 2021 2022 2023
Units delivered per year
The geographic distribution of the 2014 pipeline follows many of the patternsobserved in last year’s report. Again, circa half of the entire pipeline by unit count is located in either South Bank or the wider Chelsea and Fulham area. This is an ongoing reflection of the proliferation of larger regeneration style schemes which are commanding values at the lower end of the prime spectrum.
GEOGRAPHIC TRENDS
The largest single increase in unit numbers by area has occurred in the South Bank stretch from Battersea to Tower Bridge. The ‘turbo charging’ of the residential development market in these areas continues and we’re seeing some re-balancing of the historic large differential between sales values north and south of the River Thames in Central London. The ongoing concentration of more high-rise residential development in this area rather than anywhere else in London continues to drive premium values. This year we have also identified Docklands as a separate area because some isolated landmark schemes now fall within the value thresholds of this report.
“The estate must be adapted to the future direction of the university”
77054861
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1376780
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TOTAL UNITS
25,000
NUMBER OF UNITS PER AREA ANDPERCENTAGE INCREASE / DECREASE
SOUTH BANK | 7705 | +34%
CHELSEA AND FULHAM | 4861 | +6%
CITY AND FRINGE | 4176 | 45%
MIDTOWN | 1740 | +16%
VICTORIA AND PIMLICO | 1376 | -8%
DOCKLANDS | 780
KENSINGTON | 1157 | +18%
BAYSWATER AND PADDINGTON | 1088 | +13%
MAYFAIR | 612 | +11%
BELGRAVIA | 494 | -2%
KNIGHTSBRIDGE | 442 | +5%
ST JOHN’S WOOD | 323 | +45%
MARYLEBONE | 246 | -14%
The above diagram shows which areas are ‘punching above their weight’ when it comes to total GDV relative to unit numbers being delivered. Mirroring previous trends, the highest value areas of Mayfair, Belgravia, Knightsbridge and Kensington represent only 11% of total unit numbers but 32% of total GDV of the pipeline.
COMPARISON BETWEEN GDV AND UNIT COUNT PER AREA
OUTPUT CONSTRAINTS ARE STARTING TO BITEAt first glance, the shape of the pipeline appears very similar to previous years, however there is a slight lag on anticipated delivery in the year as well as increases in the total volumes being forecast. This increase is underpinned by a raft of large projects which have been actively committed to construction in the last 12 months, perhaps at a rate not seen in the previous years of this report. This level of post-planning consent stage activity by developers and investors now progressing schemes into procurement and further into construction is also creating a growing concern, which we have previously noted, as to how this volume of high quality development will physically be delivered by the construction industry.
As stated in last year’s report, there is little evidence of Permitted Development Rights led ‘Office to Residential’ conversions contributing to any of the pipeline, even in those limited prime areas outside of the previously designated Central Activity Zone.
THE DELIVERABILITY CEILING As with previous reports, we have overlaid our year by year pipeline histogram with what we have termed the ‘deliverability ceiling’ which recognises the capacity constraints in the market, both in terms of financing and more particularly, human resources. This is creating a funnel through which the development pipeline needs to be filtered. We believe that no more than 2,500 to 3,000 units per year can be delivered in the prime London residential market, based on a high level review of industry capacity.
When looking at the resource breadth of the main contractor construction management and supervision market (Tier 1), the diversity of models means that this encapsulates both developer / contractors (including housebuilders) and conventional main contractor delivery. An assessment of the current distribution of work in this year’s pipeline suggested that there are currently only 20 players in this market, with far fewer able to take on larger projects. The ability of each of these organisations to deploy multiple residential completion teams from within their own resource, and subsequently from the trades, is the ultimate determinant of the number of projects that can be handed over on site concurrently, given the limit on the number of skilled
professionals and tradesmen available to execute the work.
The actual rate of construction handover that can be achieved by individual teams on individual projects varies dramatically (from one high quality unit per week to six or seven units per week at the lower end of prime). It is also dependent upon the exact specification and project logistics. This handover rate can be influenced by deploying multiple completion teams on one site, however, experience suggests this is a high risk strategy that still suffers from limitations in the rates of production that can be achieved.
We believe there are circa 10 to 15 competent Tier 2 fitting out handover teams (tradesmen and trade supervision) from each of the completion trades such as; specialist finishes, joinery, final engineering services, kitchen and bathroom fitters, working in the sales value range covered by this report on higher volume schemes. This excludes the niche builders operating in the private residence market. This also does not include the ‘shell and core’ trades where there is perhaps a greater available pool of resource that is shared by other construction sectors such as commercial.
Therefore, assuming a weighted average handover rate (drawn from the value distribution of projects on our pipeline) of, say, five units per week, this equates to a potential maximum output of 2,500 to 3,750 units per annum and we predict that the reality is towards the lower end of this range, say, 2,500 to 3,000 units.
2014
5000
4500
4000
3500
3000
2500
2000
1500
1000
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02015 2016 2017 2018 2019
Year
Num
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ts to
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deliv
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2020 2021 2022 2023
Units delivered per year
The deliverability ceiling
0
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This output constraint is what goes to the heart of current concern and is creating increasing competition among developers and investors to secure appropriate supply chains for their projects as soon as possible. The need to identify and commit high calibre Tier 1 management resource to one project from start to finish is the first issue being tackled and has been an area of considerable focus in the last 6 to 12 months for many clients. Total project ownership is a key feature of successful delivery and the emerging volatility in the professional services sector of residential construction resourcing is making this increasingly difficult for development clients who need to now make decisions based on individual capability and competence rather than corporate brand or price to protect the successful outcome of their projects.
THE SUPPLY CHAIN RACE - PUSHING THROUGH THE BOTTLENECK
What is of more concern is the Tier 2 trade contractor bottleneck that is evident, given the prospective volume in the pipeline. At the moment, the peak of potential development activity in 2017 could be double what may be possible for the competent and qualified residential construction market to deliver at current capacity. Therefore, this suggests that many schemes may need to be delivered later to avoid this bottleneck, or will be forced to use inappropriate supply chains. These schemes also face the risks of tender price inflation and ‘cover pricing’ as trade contractors pick and choose which projects to work on. For many schemes starting on site in 2014, with potential delivery in 2016 to 2018, it is difficult for developers and main contractors to secure the supply chain to execute the fitting out works for two reasons: a lack of willingness by suppliers to fix prices early;
A POLARISED DELIVERY MARKET
As predicted in our previous report, we have witnessed a spike in construction tender price inflation in 2014 which is being driven not only by the buoyanttrade contractor market but also by ‘learning curve’ inflation whereby Tier 1 contractors are compensating for delivery lessons learned on the projects currently being delivered or recently completed. Some high end residential projects have been marred by problems in achieving the required quality within the original planned programme and this has led to
reassessment of the suitability of the supervisory teams involved, as well as the Tier 2 trade contractors and their supply chains. Going forward, this is likely to put further pressure on schemes as there is even more rigour, particularly from main contractors who are relative newcomers to high quality volume residential, to ensure their own levels of preliminaries and site overheads reflect the true demands of the project. The issue is increasingly in the hands of client side advisors as they to try to identify and drive out
‘over compensation’ where the client is getting poor value from an undue level of comfort being inserted into resourcing and logistics assumptions.
The polarisation of the delivery market is evidenced by the current contractor allocation of projects in the pipeline. Of the near 200 projects identified, only 60 of them have a Tier 1 developer / contractor or main contractor appointed. Of these, there are just over 20 companies, suggesting a significant bias towards just a few
well known players - particularly on the higher construction value projects where funding parameters sometimes dictate the need for sufficient covenant and balance sheet strength. More significantly, of the projects already allocated, half of these have gone to less than five large main contractor / house builder companies.
or the lack of detailed design on which to base a final price without excessive risk transfer or refusal to accept that risk. This apparent Tier 2 supply chain capacity ceiling is potentially being suppressed as an issue on many projects as fitting out procurement is being deferred until after Tier 1 contractors are appointed or shell and core works have been procured.
CIRCA 20 Tier 1 contractors
CIRCA 10-15 Tier 2 fit-out completion teams (per trade)
2,500 - 3,000maximum achievable
units per annum
4,000 - 5,000 units per annum at peak
(theoretical)
“There is increasing competition among developers and investors to secure supply chains for their projects as soon as possible.”
The reality for the businesses with the largest secured residential workload is that there are signs of increasing staff volatility and retention and recruitment challenges. Valued resource is now moving between companies and projects and there appear to be few newcomers to the industry. This is creating increased risk around project continuity and knowledge transfer that could ultimately impact on delivery. The ability of the major players to source multiple delivery teams, as well as their intended Tier 2 fitting out supply chain, is the biggest immediate threat to project delivery. As the larger companies reach their maximum bandwidth, there will be pressure to look much more laterally at main contractor alternatives. There will also be a need to explore hybrid models that potentially involve direct or shared risk procurement of the fitting out trades alongside the use of main contractors who are more comfortable with shell and core type works. However, this will introduce more client side risk and will need to be carefully analysed in terms of price fixity, overall construction programme impact and separate contract interface management. The greatest latent problem is of clients retaining the implied risk of not being able to obtain bona fide prices from competent trade contractors with spare capacity to deliver in perhaps up to two to three years’ time.
A SIGNIFICANT THREAT TO DELIVERY
INNOVATION IN PROCUREMENT IS CRITICALThere is one significant barrier to delivery capacity being increased in the London prime residential market; the size of the specialist high quality fit-out trade contractor sector. This moves the debate from the people managing the trade contractors to the physical execution of the work itself by competent tradesmen and direct operative led supervision. As the need to diversify supply chains grows, procurement innovation will also be required to overcome the limiting constraints. The only real variable, except the introduction of new, fully trained and experienced fitting out resource across both Tier 1 and 2 contractors, is the use of a more diverse list of main contractors for shell and core type works with other, more direct measures being used either in collaboration with or separate from shell and core led contractors. There will also be more consideration of off-site solutions that are less labour intensive.
A RELATIONSHIP LED APPROACH TO PROCUREMENT IS KEYThe largest commissioning clients in the prime London market are realising that, in order to underpin project deliverability, they must have a portfolio wide approach when engaging with
their supply chain. Although this will not always alleviate the issue of market driven tender price inflation, it will at least ensure that those developers and investors with established relationships and trust are in the best position to secure the scarce talent required, particularly in the key areas that make the difference between a successful and unsuccessful project.
However, this issue creates a risk for new entrants to the market who have no proven track record or established commercial or personal relationships with the London residential supply chain. Some of the new players have very mature delivery models in their home markets but will not be able to deploy these in London without wholesale transplantation of resources which is, for many reasons, impractical. Hybrid models, where some materialsare supplied from overseas markets, are already being considered for some schemes and large-scale importation of labour and professional resource from overseas Tier 1 or 2 contractors may eventually occur through joint ventures or alliances with established UK businesses. This alone will not solve the scale of the capacity issue the market is facing in the short-term.
IMPACT ON BUILD COSTS
The consequence of the market conditions highlighted above is a considerable variability in levels of tender pricing from both Tier 1 and Tier 2 contractors. It is clear that, during 2014, the selling price to developer clients has effectively de-coupled from the cost base of executing the work. Nothwithstanding the noticeable upward pressure on labour day rates for craftsmen and increased
material / commodity pricing, the quotes now being received on bids across projects is being driven by top line supply and demand forces and subjective adjudication. This may affect the ability to forecast pricing as it is dependent more now on order book, desire to work on a particular project or with a specific client than the input cost of the work itself.
Over the last 12 to 18 months, the industry has been coming out of a long- term deflationary / static tender price market. The five years prior to that saw much more benign bidding behaviours and a greater willingness to fix pricing on longer term projects due to lack of inflation or capacity risks. Since then, we have seen ‘super inflation’ as benchmarks, established on prices fixed in 2010 to 2012, have had to be adjusted by much more than the long-term annual trended rate of tender price inflation.
An element of the ‘learning curve’ inflation referenced above is due to delivery issues on the current projects being delivered. It is important that these issues and consequential cost impacts and the true cost of delivery, at the required quality, to programme, is identified. This is a key challenge for client side advisors where cost
overruns on projects are seen mostly on the bottom line by Tier 1 contractors, without due consideration to why there was an overrun. There is a risk that the next wave of projects will have an artificial premium, based on fear of repeating losses. The focus should be on the calibre and experience of the site management team, not the quantity employed or the float inserted in the programme.
The greatest volatility being seen in pricing is at Tier 2 trade level. Again, it would be very easy to accept current levels of tender returns as a true representation of the market. The reality is that there is large variability in the price levels being received, which is a function of how well project supply chains are being pre-qualified. Many are so busy that they will not provide a ‘sensible’ price, others will decline, yet those with a window in their order book will give a fairer
representation of the true price for the work.
The largest risk of artificial inflation of the selling price is in the high demand fitting out completion trades. The ability to shop around and find substitutes is much more limited without danger of engaging inappropriate resource that require the very best Tier 1 supervisory teams. This makes it even more important to drive value for money from high quality Tier 1 management and appropriate identification of competent trade contractors based on a full market review, not just based on historical relationships that are potentially perpetuating higher levels of inflation by consistently going to the same supply chain, even when capacity is exhausted.
2014
5000
4500
4000
3500
3000
2500
2000
1500
1000
5000
2015 2016 2017 2018 2019Year
Num
ber o
f uni
ts to
be
deliv
ered
2020 2021 2022 2023
Bui
ld c
ost i
nflat
ion
9%
8%
7%
6%
5%
4%
3%
2%
1%
0%
Build cost inflation forecast
“The ability of the major players to source multiple delivery teams, as well as their intended Tier 2 fitting out supply chain, is the biggest immediate threat to project delivery.”
MARKET OUTLOOKThis report coincides with an element of continued uncertainty regarding confidence in the London residential sales market. This is mainly promoted by various macro-economic and politically influenced factors but concerns over the fundamentals of the market, especially at the lower end of the prime value range, are being driven more by a growing realisation that long-term affordability ratios are out of balance. This has been the case for some time for home ownership but perhaps has more relevance to this report in terms of rental affordability. A large amount of the demand for the lower segments of the prime market is driven by yield focused investors looking for continuous income returns as well as capital appreciation. As capital values have increased, the ability to raise rental levels in parallel will hit a glass ceiling of domestic market led rental affordability and this in turn has created more reliance on capital value appreciation to drive total returns. As questions remain over the sustainability of recent levels of sales value inflation, the fragility of this market is brought into focus. The 2014 to 2015 sales launch season will be a critical barometer of continued market sentiment.
Offset against this risk is the continuing awareness that there are large amounts of international finance looking to invest in London and the internationalism of equity flows creates interesting opportunities for the London residential market. As the Chinese property market cools and more Asian based developers and investors arrive in London, this could generate more ‘mass market’ demand from these regions. However, as supply levels are already forecast to increase rapidly, this will perhaps help to stabilise pricing and sales velocities rather than fuelling an ongoing inflationary bubble through under supply.
The Government’s role and impact on the dynamics of the market will be watched with interest post-election and it will be crucial that the message received by international markets is that London is ‘open for business’. It must also be recognised that the affordable housing delivered directly or indirectly by the current international demand, will be critical to the attainment of the Greater London Authority’s Housing Strategy and the
associated ambitious housing output targets. As previously stated, the total number of units in this year’s pipeline is inconsequential in terms of total required housing in London. Also, the schemes listed in this report will have a disproportionate impact on the associated funding or physical delivery of affordable housing that will play a role in addressing overall London housing shortfalls which should be offset against the perceived negative sentiments associated with a foreign investor driven central London market.
There is the possibility of dilution of some of the international investor (as opposed to owner occupier) interest in the central London prime residential market as investors look at other areas either in Greater London or perhaps even further afield in the UK. However, the reality is that the unique characteristics of the central London market continue to give it an advantage, as long as sentiment over rental levels or sales value stability stays positive.
SUMMARYThe delivery challenge facing developers and investors has never been greater. The cost / value sensitivity that formed the main theme of last year’s report is now perhaps being overshadowed by the imperative of achieving supply chain security.
The labour capacity constraints that are starting to affect the delivery of the next three to four years of development are leading to the realisation that some projects may be undeliverable in quality and programme terms unless they get to the front of the queue to secure the right resources. Some of this might be driven by the price paid but it is increasingly likely that softer issues such as relationships, mutual track record and trust, as well as the way in which risk is managed and transferred, will start to have an increasing impact on who wins and who loses in the race to secure capacity.
CONTACT
CONTACTMark FarmerHead of DevelopmentT 07831 244 646
For advice on how we can help you navigate the development and investment challenges ahead in the London residential market, please contact:
www.arcadis.com/residential
METHODOLOGYThis research excludes the value of transactions in the existing properties market and only counts the top slice by value of development in prime central London locations. The research is based on a ‘snapshot’ analysis of new private residential development projects currently being built or planned for delivery in central London through to 2023. It uses an estimation of development programme, total unit numbers, saleable area and sales values to assess the total number and value of units being delivered per annum in this market segment for the next 10 years. It only includes projects with an average sales value of greater than circa £1,350/ft², it also excludes affordable housing unit numbers as well as one off personal residence and smaller projects. It is not an exhaustive analysis of all schemes in the public domain but illustrates the clear profile of the future development pipeline.