Construction sector challenges expected during 2025

Next year is likely to continue the testing times the construction sector has experienced since the Covid-19 pandemic, with the industry set to face challenges across a wide range of issues. However, these challenges are increasingly well understood in policy terms and early steps are being taken to try to change the way in which projects are to be delivered with a desire to build a better and clearer future during 2025 and beyond.

Despite this optimistic view, there are a number of potential challenges the sector should be aware of as the new year approaches.

Inflation will remain a major factor for construction sector

This time last year it was anticipated that the sector would be heavily impacted by inflation. In terms of day-to-day procurement and contracting, this impact has perhaps been less pronounced than feared. There has not been a material up-tick in formal disputes between parties over the operation of price adjustments, but a range of procurements have been delayed because of pricing uncertainty and difficulties in firming up or fixing supply chain prices.

This trend is unlikely to change in 2025. Recent Office for National Statistics (ONS) data  indicated that inflation had risen to the highest level in eight months, with CPI for November 2024 up to 2.6% from 2.3% in October 2024.

This is clearly going to have an impact on interest rates. An early cut in rates in 2025 seems further away than ever. The infrastructure sector and construction industry are particularly sensitive to the cost of capital and borrowing. The economic headlines suggest that this will come down at a slower pace than envisaged earlier this year, with consequent impact upon the decisions being taken by employers and contractors alike.

Drivers for growth will not be reflected in headline growth terms

The early months of the new UK government were overshadowed by concerns about what was going to be in the chancellor’s Budget in the form of the gap in public finances. This was followed by the subsequent fall-out from aspects of the budget, particularly in respect of the headline 1.25% increase on employer National Insurance contributions. Despite that, the government has remained consistently “on message” that construction activity is going to be essential to national growth.

The UK remains a crowded island, and this is not going to change. Longer term UK population growth will support growth in housing and infrastructure. By 2036, the ONS projects the UK population will grow to 73.7 million - a 9.9% increase from the estimated 67 million in 2021 - and the size of the UK population aged 85 years and over is projected to rise by an additional one million to 2.6 million over the next 15 years.

In turn, that underpins undiminished political commitment to the sector, particularly in respect of home-building and the transition to clean energy, each driven by this broader population growth and pent-up demand.

Planning reforms are expected to help boost construction output in both housebuilding and infrastructure. In particular, the government hopes that its revised National Planning Policy Framework (NPPF) will deliver a surge in house building by constructing on ‘grey-belt’ - which is poor quality green-belt land.

As a part of the NPPF, the government has published a new housing target for England of 370,408 new homes per year. This includes 87,992 in London - a reduction of 11% over previous targets - and 70,681 in the south east of England - a 38% increase. This compares to the annual run rate of 229,942 of homes built in recent years – an increase of 61%.

The government also plans to spend up to £775 billion on infrastructure and construction over the next decade. The National Infrastructure and Construction Pipeline (NICP) outlines 660 projects that are part of this plan.

The government is also committed to doubling onshore wind energy by 2030, and to placing onshore wind and solar on the same footing as other energy development in the NPPF and supporting the reintegration of large-scale wind projects into the Nationally Significant Infrastructure Project (NSIP) regime. There also remains a considerable deficit in defence sector real estate and the built environment, thrown into sharp relief by the continuing political reassessment of NATO and the UK’s response to geopolitical challenges.

Sitting behind these ambitions are some difficult decisions around priorities in relation to procurements. There continues to be reference to the need for “shovel-ready projects” but new projects coming to market do not always seem to reflect this. Stop-start decision making and attempts to procure work from existing, and often inappropriate, framework contracts appear to be an endemic problem for procurers, weighed against broader questions of what “value for money” means in the context of public procurement.

Housing sector ambitions will prove a disappointment

The sector is expected to build in a way that is almost unprecedented. A number of housebuilders have expressed their lack of confidence that this is going to be achievable. For putative tenderers and contractors, the combination of recent tax changes and inflationary pressures would appear to be leading to a hiring freeze in parts of the industry and increased business costs.

This comes at a time when the UK faces a structural decline in the construction workforce. Construction productivity has fallen over the last decade which means it takes more hours to build the same output. This is likely to provide an additional constraint on sector activity in responding to the drivers for growth.

Appetite for tendering also remains patchy. The lessons of the last recession, and the ones before that, that “turnover is vanity, but profit is sanity” continue to be felt. Realistic expectations on what constitutes risk allocation in tendering processes and contracts, particularly given the additional requirements of the Building Safety Act, still seem to vary widely as does the appetite of the supply chain to take on more traditional requirements that may be unfavourable for contractors.

While the government’s commitment to planning reform has been seen by many as a positive development, these changes on their own are only going to take the industry so far in achieving the ambitious goals that have been set.

The role for project finance solutions will still be uncertain

All the indicators so far suggest that the government does not fundamentally believe that PPP/PFI offers best value for money. A likely increase in potential disputes and local authority complaints arising from the final furlong of PFI projects being “handed back” to the public sector is going to be unlikely to change the narrative in this respect.

There is an omission from the Treasury toolkit of anything remotely approaching a standardised approach to project finance which was a hallmark of the ‘New Labour’ years. The infrastructure provider model associated with Thames Tideway has not been revisited, despite having been seen as a successful contractual model. Funding models for a range of utilities appear to be struggling for an easily replicable and effective model – at a time when the regulatory model itself is coming under greater scrutiny.

The government’s change to the fiscal rules to allow greater government investment in infrastructure is a welcome change. However, in the long-term, the government will need to find ways to leverage private capital into public infrastructure to pay for the schools, hospitals, roads and railways needed to support greater productivity and a growing population. There has been discussion of unlocking the availability of funds from major institutional investors, but little detail. Previous forays into this area, such as the Pension Investment Platform, were relatively modest in their outcomes.

Bringing together and structuring pension funds is one step, but building the levels of capability to invest in infrastructure will take time to achieve. Inherently, pension funds do not like construction risk, and this is going to require some genuine innovation if it is going to be possible to “crowd in” private finance. International capital is highly mobile. The UK also needs to be seen by international investors as an attractive investment destination and this means that investors and infrastructure funds need to see high quality returns compared to other countries.

AI will increasingly make an impact

One key issue we continue to hear is that business leaders are recognising the fundamental impact that artificial intelligence (AI) is having on their businesses across the infrastructure and construction industry.

A priority issue for all infrastructure sector businesses no matter whether contractor, sponsor or client, investor or supply chain, is how construction risk is managed.

The use of AI in the design and construction of infrastructure provides many opportunities – but also provides many significant challenges. In particular, contract drafting and contract management for AI is busy playing catch up.

Decisions made about the design and construction of infrastructure assets across the life cycle of infrastructure programmes using AI will almost certainly provide fertile ground for disputes. Clear corporate governance and controls together with policies and guidance will need to be carefully considered and implemented alongside the use of AI for the design and construction of infrastructure assets. Creating clear audit trails of decisions made across complex and often globally dispersed project teams during many years and even decades is a huge challenge for the construction industry and will have far reaching consequences. This is compounded by significant external pressures on infrastructure programmes. Over the past four and a half years there has been significant disruption to construction resulting in significant consequences.

The implementation of clear governance and controls around the use of AI for the design and construction of infrastructure will be essential for our clients and a key part of our programme on examining the impact of AI on infrastructure and construction clients.