The Bank of England raised interest rates by 0.50 percentage points today to 4.00 per cent. This increase, which is in line with market expectations, is the tenth rate increase since December 2021 and we now have the highest base rate since November 2008. Market forecasts indicate this is expected to be one of the last increase before a period of stabilisation. In this article we explore the likely impact of the interest rate rises on the construction industry.
The most immediate effect of today’s increase will be felt by those firms with high debt burdens. A large amount of corporate debt held by firms in the construction industry is linked to the base rate (typically SONIA) and is variable. The rate increases implemented over the last year are likely to have led to a near doubling in the overall interest charged on this debt. This will have an immediate impact on cashflow and profitability for firms who have borrowed money. Those with a high debt burden and/or minimal profit margins will be hit particularly hard.
Signs of company distress can already be seen in the market, with the number of corporate insolvencies reaching the highest level since the global financial crisis in 2009. Data from the ONS reports a total of 22,109 corporate insolvencies in 2022 (an increase of 57% from 2021 and a 75% increase when compared to 2020). Last year the construction industry experienced the highest number of insolvencies of all sectors at 4,143 cases (19% of overall cases), which is an increase of 60% compared to 2021.
Main contractor and/or supply chain insolvency is an ever-present risk to construction projects and is particularly devastating to projects when it occurs mid-project.
Undertaking robust financial due diligence on contracting parties is vitally important – both at the start of a project and ongoing during the life of a project. Some early indicators that a contractor or sub-contractor is facing financial challenges include:
Increases in requirements for advance payments / deposits
Inflated interim valuation submissions
County court judgments, high court claims, or winding up petitions being lodged
Lack of staff / labour on site
Late / delayed payments to the supply chain
Late filing of accounts to Companies House
Market rumours regarding the contractor’s financial position
Difficulty obtaining performance bonds
Removal of agreed credit terms with suppliers
Rising interest rates are also likely to impact project viability. In the real estate development market, a large portion of projects are debt funded. The recent base rate increases have led to a near 4.00 per cent increase in the interest charged on development finance alone. In addition, a more cautionary approach by some lenders has increased the lenders’ margin, which results in an overall increase to borrowing costs of over 5.00 per cent. Combined with the high level of construction cost inflation, the profitably of projects will be squeezed, and developments with low profit margins are likely to be shelved in the short term.
We have reported previously that there are tentative signs that construction inflation is stabilising and we have supported the forecasts that inflation will significantly reduce during 2023. Today’s rate increase, which aims to tame the high level of inflation that has hit the construction industry particularly hard since the COVID pandemic, is another indicator that construction inflation will stabilise.