Construction Inflation May 2021 - "It's Baa-ak!"
So far this week, (it is Tuesday as I write this), I have had 3 in-depth conversations about construction inflation. Topics ranged from material cost changes to subcontractor’s ability to commit to pricing and delivery dates, and of course owners resistant to increasing costs. Those three conversations this week are reminiscent of inflation discussions from the late 2000’s and are more than I spoke about inflation all last year.
From 2000 to 2020, overall construction inflation was an average of 4.3% annually, based on the ENR published material and labor costs. This only partially captures the overall construction inflation as it does not capture changes in economic conditions for the subcontractors and CM’s and any changes due to changes in building technology, including the on-going trend toward off-site assemblies.
It also does not capture variances due to changing labor productivity, which has been declining. Actual overall escalation is harder to determine empirically, but probably ranges around 5%.
Somewhat interestingly, the average official consumer inflation rate in the US has been approximately half of the construction rate, at an average of 2.2% since 2000.
In this period, cost escalation has been driven by labor cost increases, with 90% of the increase attributable to labor, and 10% attributable to material cost increases. Please note that this does not consider construction market competition effects, and any changes attributable to changes in building systems, financing or delivery methods or building types.
Many projects that were put on hold in April and May of 2020 are now being restarted, resulting in increased demand in a greatly weakened construction pipeline.
The last year has seen significant indications of economic escalation in the greater economy as housing costs, oil prices, food prices and many other sectors are showing price increases and supply disruptions. The vast sums that the federal government has fed back into the system as stimulus payments to individuals and companies appear to be having an inflative effect on the greater economy.
Construction cost inflation has accelerated. The long term historic average of 3.5% may not be achieved for work contracted in 2021, but 2022 will likely show well above average inflation rates as cost shocks for various materials work through the pipeline, work methods adjust to new health and safety rules, and construction work loads return to full capacity from the degraded period of April 2020 through the end of 2021.
We are seeing significant price increases in critical construction materials. Wood products have traditionally offered stable material pricing but have doubled or more over the last year in multiple cases. Wood product prices are expected to moderate as inflation takes hold, as evidenced by no attempts in the wood supply industry to create additional capacity.
Mill steel prices are up from $400-500 per ton to over $1,200 per ton as of April 2021. Plumbers, steel erectors and HVAC firms are providing very-short guarantee periods with their bids, indicating their discomfort with rising material costs. Supply disruptions appear to be an issue for steel products as well. Note that structural steel costs impact commercial projects more heavily than residential, however multiple construction products are driven by steel prices through increased raw material costs, and increased construction equipment costs. Anecdotal information suggests a combination of pandemic related supply and manufacturing issues combined with a market shock as mothballed projects are restarted as the pandemic eases, and substantial disruptions in the retail marketplace that are driving new construction are some of the factors for these increases.
Oil prices have recently jumped, which is probably a temporary increase in what is an increasingly volatile price structure as the world moves closer to the end stage of the oil based economy. Construction activities are still heavily dependent on oil and energy prices.
At the start of the pandemic, analysts were split on whether the event would be inflationary – several expected to see deflation as the result of the reduced economic activity. Construction activity for 2021 is down overall and total construction volume in dollars will be below 2020 levels.
What to Expect:
1) Supply disruptions. Lead times are increasing on many products, so close management of supply schedules will be critical to minimizing schedule slippage. Contractors are likely to encounter difficulties in procuring materials at times, which will either result in declining margins (and probably performance), change requests for unforeseen costs, and slipping schedules.
2) For the near term, estimates created prior to 2021 are likely to be underpriced for trades utilizing lumber (framing, concrete, furniture/fixtures), and steel (structures, siding, piping, equipment, etc.).
3) Price spikes for various manufactured items as the production facilities and transportation modes adjust to rapidly changing market demand.
What is the “New Normal”?
Steel price will fluctuate based on demand and energy prices; lumber will be much less volatile but current prices will drive movement to less costly alternatives.
Current material price spikes including lumber, steel, oil and other products are unlikely to remain at their extreme levels and should trend back to historic norms as supply systems adjust to the activity level. Labor productivity levels will remain degraded, and labor cost should continue to inflate on its historic pace.
The good news is that the reduced project starts in 2020, have resulted in reduced non-residential construction for 2021, which acts to moderate inflation effects from these material price spikes, until demand resumes. Of course, the reduced workload is its own problem.
For benchmarking new projects, cost assumptions should include increased costs to reflect health and safety design changes, revised work methods with reduced productivity, and modest material price inflation, and as always, clients that are well-informed about the market conditions.
US CPI Data – US Bureau of Labor Statistics
US PPI Data – US Bureau of Labor Statistics
Labor and Materials Escalation – ENR Building Cost index
Construction Analytics – Ed Zarenski