Construction SMEs have the foundations to build on in 2021
2020 was an extremely challenging year for UK businesses; with SMEs in particular being hit the hardest as the Covid-19 pandemic put the brakes on economic activity, causing significant supply chain disruption and knocking business confidence. But as 2021 gets underway, with the vaccination roll out providing hope that the pandemic will be brought under control, the medium-term prospects look a little brighter for SMEs. In construction, the market looks positive with housebuilding being the biggest driver for the sectors robust growth in 2020 despite the pandemic*, and for nimble and innovative SME housebuilders their strong foundations will be needed to tackle some of the upcoming challenges of 2021, notably the reality of Brexit and changes to VAT reverse charging and IR35 legislation.
The construction industry is beginning to look beyond Covid-19
As one of the least affected sectors by the Covid-19, the construction sector was fortunate as building sites only had to close for a limited time during the first lockdown last year. Although extra measures (and costs) had to be incurred to ensure that sites could operate in a Covid-safe manner, construction firms were fortunate compared to their counterparts in areas such as hospitality and transport. In both these sectors, the impacts of the virus have been much longer-lasting and more drastic.
We saw evidence of greater positive sentiment in UK Finance’s most recent SME Finance Monitor**, covering Q3 of 2020. Conducted prior to the emergence of the new virus variant and the latest lockdown, only 34% of construction respondents felt that ‘the worst is yet to come’, significantly down on Q2 when 63% felt that way. The proportion was much lower than in other sectors such as transport (48%) and retail (44%). Nearly half of construction decision makers (47%) described their overall mood now as positive, well up on just 19% in Q2 and only bettered by two other sectors, agriculture (56%) and business services (48%).
Along with business services firms, construction SMEs were also the most likely to say they were ‘planning for the future’, with only 17% of building firms saying they were still focused simply on dealing with the crisis. The data reveals growing signs of the construction sector beginning to look ahead and anticipate something much more akin to business as usual. The third lockdown is a setback in general terms for communities and the wider economy, but it should have only a limited effect on construction firms.
Our own experience is that our clients’ activity has largely recovered with turnovers returning towards where they were when the pandemic began. Businesses have used the various government support schemes to protect their position while their activities were severely curtailed. These have helped them get through this difficult period and the subsequent return of trading, which has also meant a return to accessing traditional forms of funding.
The SME Finance Monitor showed that over four in ten construction firms (42%) utilised external finance in Q3, a significant increase on Q2 (28%) which indicates a greater confidence among business decision makers. Indeed, the proportion of firms who said they were concerned about their ability to repay finance fell significantly too, from 39% in Q2 to less than one in five (17%) in Q3.
Confidence among construction SMEs has also been buoyed by the fact that housebuilding remains an ongoing national priority. Despite the new lockdown measures, the housing market has not closed down and schemes such as Help to Buy and the stamp duty holiday will stimulate buyer demand in the first half of the year. For small businesses feeling the strain of a new lockdown, the Coronavirus Business Interruption Loan Scheme (CBILS) remains available until March, so there is support for those that need it.
However, as we all know, life is rarely straightforward. There are some significant uncertainties and issues ahead especially as both UK and EU businesses adjust to the new trading rules. It’s quite possible that we’ll see some teething problems but it was a huge boost to businesses across the economy that a Brexit deal was agreed, the absence of any tariffs or quotas was a key win.
UK construction SMEs are perhaps more shielded from the possible effects of Brexit than other sectors as they generally do all their work within the UK. But that doesn’t mean there won’t be any impacts for construction firms. There could be some disruption to the supply of the £10bn worth of building materials imported to the UK every year*** as customs checks and paper work add a level of bureaucracy and possible delays in delivery. Bottlenecks at ports and transport hubs could cause significant disruption if businesses haven’t planned ahead. In our own recent survey****, nearly a quarter of construction respondents (23%) said they expected to find more suppliers within the UK due to Brexit. It will be interesting to see whether this proportion grows and what the pattern is over time.
Another important area related to Brexit, is the availability of labour. Many workers in construction are from overseas and a points-based system to live and work is coming into effect. Those already resident in the UK have until 30 June to apply to remain. Construction firms need to analyse the possible impacts of this on their business carefully and support staff caught by the new regulations through the process. Our survey indicated less than one in ten (8%) had ensured that relevant employees had applied for the EU Settlement Scheme (a figure that was similarly low across all sectors).
VAT reverse charging and IR35 changes ahead
There are other important changes coming down the track early this year too. One of these is VAT ‘reverse charging’ that is due to come into effect in March. VAT ‘reverse charging’ means that VAT-registered businesses within a supply chain in the construction industry will no longer charge or receive VAT between themselves. While they will still record VAT, they won’t actually pay it or receive it from each other. Only where services are to the ‘end user’ in a chain – likely to be the developer or main contractor – will VAT be charged and paid over to HMRC.
The cash flow implications of these changes could be significant. Many building firms and sub-contractors have become accustomed to receiving VAT, and indeed use it as a form of liquidity before they pay monies owed to HMRC at the end of the quarter. This money will stop coming in from March, putting cash flow pressure on businesses as they adapt to the new system. This change also coincides with the deadline to pay any deferred VAT from the beginning of the pandemic. For SMEs who have used these funds for day-to-day financing purposes, paying this sum back could put further pressure on cash flow.
Another important development is the prospect of changes to ‘off-payroll working’ rules (IR35) that will take effect in April. Under this change – similar to rules that have already been introduced in the public sector – contractors whose main or whole work is for one employer will need to be treated as full-time staff subject to PAYE deductions. The impact of this for employers is mainly administrative – bringing affected contractors on-payroll. The much bigger impact is on the individuals themselves, as they will see a drop in their weekly or monthly income due to tax and NI being deducted at source. It will be important to liaise with these individuals and make sure they are aware of the changes coming.
Preparation is critical
Considering all these factors together, it is clear that although the outlook is improving, there are a lot of hurdles ahead for construction firms to negotiate. Preparation is key. James Duffill, associate at building consultancy Naismith’s, commented: “Parts of the construction industry still appear to be ‘sleepwalking’ towards some of the changes that are now imminent. They certainly need to focus on what is coming and take the necessary professional advice. This is especially important given that we can expect to see something of a dip in work volumes in the early part of 2021 as the UK adjusts to the Brexit deal and as the economy adjusts to the inevitable eventual tapering off of governmental Covid-19 support.
The contracts already in place should see most construction firms through – but there may be some wrinkles along the way. We also expect a rise in disputes between firms as to who bears the costs for the extra safety equipment and measures put in place for Covid-19. Indeed, we have seen some evidence of this already. There will be plenty for construction SMEs to think about as the year progresses.”
Construction is one of the cornerstones of the UK economy and has a key role to play in the post Covid-19 recovery. At Aldermore, we’re committed to backing the industry through good times and bad and have a range of finance solutions specifically developed for construction SMEs. We look forward to working closely with clients in the sector throughout this crucial recovery period and grasping the opportunities beyond. Construction firms have proven themselves to be resilient, determined and adaptable during the Covid-19 crisis and we have every confidence that this will continue through the year ahead.
You can contact the Aldermore construction finance team on 03339997577 or visit our website aldermore.co.uk/constructionfinance.
**SME Finance monitor, an independent report by BVA BDRC, November 2020
***Department for Business, Energy & Industrial Strategy Monthly statistics of Building Materials and components. Commentary, December 2020. Coverage UK
****Research conducted by Opinium Research between 23 October and 04 November 2020 with a nationally representative sample size of 1,003 senior decision makers in UK SMEs
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