Arcadis UK Market View - Article 50

LIFE IN UNPREDICTABLE TIMES RISK AND OPPORTUNITY IN BREXIT-BRITAIN

Now that the UK has formally served notice of its intention to leave the EU, the real challenge associated with Brexit begins. As negotiations commence, an organisation’s ability to successfully respond to uncertainty is critical . For property and infrastructure, which rely on long-term investment planning, such high-stakes negotiations will further complicate what is already a challenging business environment.

Organisations need to plan for a range of post-Brexit scenarios, as well as for the intervening period – the ‘peri-Brexit’ period which will extend well beyond 2019 as sector-specific transitional arrangements come into play.

Peri-Brexit planning – the skill of responding to events as they evolve – will be particularly important for organisations involved in addressing some of the biggest issues affecting the UK, including housing, regional devolution and sustained investment in new infrastructure.

“FORTUNE IS LIKELY TO FAVOUR THE FAR-SIGHTED AND FLEXIBLE AS UK CONSTRUCTION ADAPTS TO THE REALITIES OF A ‘PERI-BREXIT’ BRITAIN.”

The strength and resilience of the UK economy has surprised many, with high consumer confidence, a weak pound and low interest rates countering any immediate negative impacts forecast to follow the decision to leave the EU. However, although recent Office for Budget Responsibility forecasts have been upgraded, the reality is that medium-term projections are weaker now than in 2016. With Article 50 now served, a trio of tricky elections due in the Eurozone this year, and another referendum on Scotland’s membership of the EU potentially on the horizon, the outlook is for continuing unpredictability. This triggers both challenges and opportunities.

Uncertain conditions could extend well beyond the agreement of the divorce terms in 2019. Other factors add complexity, including the stability of the Eurozone, changes to US trade policy and acceleration of UK regional devolution.

Positive management of uncertainty requires a particular skill set and combination of circumstances – particularly for property owners with long-term investments. The temptation could be to shut-up shop, either to reduce risk exposure or to wait for better buying opportunities. The danger is that if enough organisations react in the same way, then workload and pricing will fluctuate.

Sentiment currently points towards clients adopting a risk-averse stance. However, many have no choice but to build and maintain their assets, while overseas investors can benefit from Sterling’s weakness.

Delaying investment decisions could mean missing out on valuable opportunities. The willingness and ability of clients and suppliers to take on and manage risk is going to be a key attribute moving forward.

Potential Challenges to consider business outcomes The final shape of the Brexit deal remains hard to predict. On the one side, the UK’s hard-line stance means that sticking points are difficult to identify.

On the other, the willingness of the 27 states to negotiate a mutually beneficial deal is also unknown, as will be global conditions for free trade in a post-Trump world.

With prospects for greater instability in Europe and the US driven by an increasingly protectionist outlook, global markets could become more challenging – slowing down across the board, and thereby paradoxically increasing the UK’s attraction for business.

Our expectation is that transitional processes will extend beyond 2019 and into 2021. Clients, investors and their suppliers will need to be more flexible to adapt as the transition unwinds. Reasons include: • The approaching end of the current business cycle. Factors other than Brexit could contribute to changing market conditions.

• Government will be consumed by Brexit and have less bandwidth to deal with other issues affecting the economy, trade and investment.

• The imperative to focus on a wider range of international markets outside the Eurozone.

• The potential for unexpected opportunities that could be catalysed as Brexit unfolds.

For the property and construction industry, implications include greater volatility as suppliers respond to sectoral shifts in demand and to changes in supply chains affecting both labour and materials.

CLIENT • Greater risk associated with uncertain end-user demand.

• Greater exposure to external shocks e.g. currency.

• Volatility – ability to predict entry and exit into the market.

• Adaptability – ability to develop new solutions.

INVESTOR • Increased political, economic and market risk e.g. interest rates.

• Market changes affecting exit strategies.

• Changing deal map with new investment partners.

• Regulatory risk and opportunity.

CONSTRUCTOR • Demand risk – visibility and stability of pipeline.

• Project deliverability – resource and skills availability.

• Market volatility – price and cost risk.

• Regulatory risk and opportunity – standards and procurement.

CONSULTANT • Demand risk – visibility and stability of pipeline. Access to new markets.

• Regulatory risk and opportunity – standards and regulation.

• Innovation risk – challenge of new solutions to enable delivery.

• Adaptability – ability to respond to opportunity.

Big picture challenges will Brexit help or hinder?

There are three major challenges that will be key to solving the UK’s productivity puzzle. On top of the need to maintain delivery of the infrastructure pipeline, these are: • Solving the housing crisis.

• Attracting investment into infrastructure.

• Public-private partnership to leverage additional government support. Co-ordinated land-acquisition associated with garden towns and villages has enabled co-developers to achieve sufficient scale to obtain additional investment support for infrastructure.

UNLOCKING HOUSING CAPACITY Construction capacity constraints, partly due to labour shortages, will put a limit on the number of homes that can be built conventionally.

It is also clear that additional offsite manufacture capacity needs significant new investment to substitute these labour inputs.

• Maximising the impact of regional Steps taken to maintain the attraction of the UK to investors devolution. will be essential to sustain supply.

These will include access to land, funding support and decisive planning, as well as development across a range of tenures.

To operate effectively, and to deliver lower-cost pre-manufactured residential construction at speed, developers will need to introduce scale and certainty into their delivery plans.

Peri-Brexit scenarios mean that house-builders cannot rely on future capacity based on existing delivery models. Configuring demand to attract new investment and new capacity is one of the greatest challenges facing the UK over the next five years.

Opportunities to shape demand to attract investment include: • Client consolidation to achieve scale, including mergers in the Registered Social Landlord sector and with local government.

Pooling volume will help to extend reach and attract investment.

• Support opportunities for overseas investment. Some overseas developers are shifting their focus from single schemes to a more strategic approach to land assembly. This could potentially introduce new players into volume house-building.

• Freeing up SMEs to deliver smaller schemes should increase diversity and scalability.

We are seeing greater uptake of off-site methods in this sector, enabling smaller developers to increase capacity and improve quality.

ATTRACTING INVESTMENT INTO UK INFRASTRUCTURE The UK has long been an attractive location for investment, but the challenge is whether an increase in political and economic risk will affect its standing. Much of the UK’s attraction is aligned to low investor risk – meaning that the management of peri-Brexit fallout will play an important role in attracting new investors and ensuring that existing players maintain or increase their stake in UK assets.

The UK attracts more Foreign Direct Investment (FDI) than any other G7 country and has been particularly successful in attracting R&D and manufacturing spend.

Given the potential impact of Brexit on outward-facing FDI, investment in domestic assets including infrastructure and housing could become a more attractive platform to access the UK’s stable investment market.

National Grid’s proposed sale of 61% of its gas distribution business to a Sino-Australian consortium provides ample evidence of the attraction of a mature business with a stable income stream to overseas players, particularly given the reduced cost of UK assets following devaluation. Other projects which involve integration with EU markets, such as electricity interconnectors, could face greater challenges due to regulatory uncertainties. Similarly, devolved cities also need to promote themselves to international investors as safe-haven locations.

UK-based pension funds and insurance businesses will play a key role in the initial under writing of these new investments.

Assuming that appropriate powers and funding are in place to enable devolved administrations to develop the right investment programmes, the following steps will deliver optimum results:

MAXIMISING THE IMPACT OF REGIONAL DEVOLUTION

Regional devolution and Brexit sit awkwardly together, with the potential loss of funding from EU sources limiting the ability of some authorities to maximise their devo-deal funding. However, UK regions increasingly recognise that they are in direct competition New and potentially investable with European cities for skills, ideas that could be adopted in employment and investment. the UK include: Yet paradoxically, by reducing London’s role as a ‘gateway to • Mixed-use development Europe’, regional cities may associated with transport benefit from better access to infrastructure. This is a global markets. The success of common model in Asia and could Manchester in establishing strong be adapted to work in some of links with major investors from the UK’s most dynamic cities.

China and Abu Dhabi, for example, • Aligning affordable housing and highlights the benefit of being more infrastructure to deliver steady autonomous and outward-facing. investment returns in connection The steps required to create the with affordable and social housing economic, political and marketing for rent. infrastructure necessary to become • Promoting new asset classes a global player are significant, requiring a transformation of for the UK, including the leadership and greater collaboration. increasingly established PRS This includes commitment to market as well as regional long-term planning and investment, portfolios of high-grade a more entrepreneurial approach commercial buildings. to driving growth and, above all, tangible examples of joined-up working.

Devolution also has a key role in unlocking investment in housing and infrastructure. Local authorities should take a role in diversifying housing provision and are well-placed to sponsor the development of joined-up transport solutions – aligning new investment with plans for housing and jobs.

• Breaking the short-term political cycle. Metro-mayors and their delivery teams need to balance short-term delivery with the strategic imperative to support a 20-year transformation plan.

• Leveraging additional investment. Cities must be proactive in securing additional investment to realise the full benefit of the devolution deal, including overseas as well as UK funding.

• Furthering the UK plc agenda by taking a more active role in promoting the national economy as well as the immediate interests of the region.

“THE SUCCESS OF MANCHESTER IN ESTABLISHING STRONG LINKS WITH MAJOR INVESTORS FROM CHINA AND ABU DHABI, HIGHLIGHTS THE BENEFIT OF BEING MORE AUTONOMOUS AND OUTWARD-FACING.”

Life in unpredictable times entrepreneurial attitude, with both the client and supply-side prepared to accept their share of exposure to a more volatile business environment. Our concern is that, at least in the short-term, the animal spirits that support risk-taking have been dampened Depending on the nature of the and some parts of the UK deal reached in 2019 and the extent construction market could face of transitional arrangements, this a slowdown in workload and uncertainty could extend well into potentially a correction in prices. the next UK electoral cycle.

The post-Brexit opportunities However, clients and suppliers outlined in this paper are all who are able to look beyond the long-term developments which immediate risks associated with require joined-up solutions, often Brexit have been able to do good based on greater transparency and business. This has required an collaboration. Building a long-term viewpoint is essential if potential gains through digitally-enabled working, greater uptake of manufactured content and improved asset reliability and performance are to be secured.

Uncertainty associated with politics, terms of trade and migration will become a fact of life for businesses and public bodies operating in the period immediately before, during and after Brexit.

These unpredictable times have their downsides, but also plenty of opportunities. The chance to challenge the status quo doesn’t come very often, so it must be grasped when it does. Fortune is likely to favour the far-sighted and the flexible as UK construction adapts to the realities of a peri-Brexit Britain.

“THE CHANCE TO CHALLENGE THE STATUS QUO DOESN’T COME VERY OFTEN, SO IT MUST BE GRASPED WHEN IT DOES. THE UNPREDICTABILITY OF A POST-BREXIT UK HAS ITS DOWNSIDES, BUT ALSO OFFERS NEW SOURCES OF COMPETITIVE ADVANTAGE.”

Contact

Simon Rawlinson Head of Strategic Research and Insight E simon.rawlinson@arcadis.com

Will Waller Market Intelligence Lead E will.waller@arcadis.com

Simon Light UK Client Development Director E simon.light@arcadis.com

www.arcadis.com @ArcadisUK Arcadis United Kingdom

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