By Paul Bergeron | August 25, 2022 at 08:23 AMCBRE reported this week that it forecasts an increase in construction costs of 14.1% that likely will be the largest in several years, though relief might be on the horizon.
Developers point to higher labor costs and the supply chain as major culprits. They are sometimes forced to adjust projects and hope the subcontractor pool expands. Some say client and supply provider communication is critical to working through challenges.
The projected increase this year exceeds last year’s 11.5 percent rise and well outpaces the historical average gain of 2 percent to 4 percent per year. The anticipated 2022 gain is the largest since CBRE began tracking cost projections in 2007.
An ‘Entirely New Level of Complexity’
Kinjal Patel, general manager and senior vice president, Construction, for Lendlease in Chicago, tells GlobeSt.com that rising material prices are a significant contributor to the overall surge in construction costs.
“This volatility in pricing adds an entirely new level of complexity to planning and budgeting projects,” Patel said. “For certain trades, it’s not unheard of to see increases of 10% or more in a span of just six months. We’ve found that, in today’s ever-changing global landscape, tracking index or commodity price trends only aids with forecasting so much.
“You have to go a step further, keeping in constant contact with supply chain suppliers to understand their individual challenges and work with them on solutions. We’re also leveraging our national and global presence as an integrated firm with expertise not only in construction but also development and investment management, to consolidate information and help us better predict price volatility.”
Patel said that in this environment, client communication is critical.
“We are constantly updating our estimates with current information from our suppliers and subcontractor partners; if we see costs trending up for a specific material or trade, we’ll alert our clients and advise that we should do an updated round of budgeting for that element of the project.
“Whenever possible, we’re also pushing the extended project team to come to alignment on design concepts much earlier than they would have previously. This lets us start the clock sooner on bidding and awarding the project, which means we can lock in pricing and secure materials in the supply chain earlier – in some cases, even procuring and warehousing certain materials to ensure we have them available on schedule and at the price we budgeted.”
Projects Modified, Not ‘Put on the Shelf’
Michael C. Brown, executive vice president and general manager of Skanska USA’s building operations in Florida, tells GlobeSt.com that amongst his clients, there is a consensus that projects will be modified, if needed, “rather than put on the shelf to await more favorable market conditions. There is an urgency of getting these developments built, particularly essential ones like hospitals and schools.”
He said Skanska is able to meet this urgency with innovative solutions developed by its local, regional and national resources, helping our clients move their projects forward.
“Despite some of the material, labor and supply chain challenges the construction industry faces nationally and regionally, the outlook is certainly bright. These challenges are augmented only by the fact that there is an immense amount of work taking place which is good news for the economy, for our industry and for the communities we serve.”
Perhaps a ‘Moderating’ Cost Escalation
Jorge Serna, executive vice president of construction at Integra Investments, tells GlobeSt.com, “Looking at the trailing 12 months of construction costs, it is hard to argue that, overall, we have seen a double-digit cost increase.
“Looking ahead towards the next six months, however, we feel as though while some materials and labor components of construction will continue to rise, we also anticipate that others, such as lumber and steel prices will drop, hopefully yielding a much more moderate cost escalation eventually leading to a leveling off all around.
“As we enter the second semester of 2022, we also notice larger availability amongst the subcontractor pool, with more companies presenting bids for future projects, which is an improvement from the historical 18 to 24 months of labor shortage the market has been experiencing.”
Projects ‘Inevitably’ Delayed, Cancelled
Jeff Wilcox, Principal, Gantry, tells GlobeSt.com that construction costs continue to rise on the West Coast, however, prices have been moderating versus the spike in prices experienced in 2021 and the first half of 2022.
“Labor availability and labor costs continue to be the primary driver of cost increases with select materials staying expensive relative to historic norms,” Wilcox said.
“Rising costs of capital will inevitably lead to various development projects being delayed or canceled, which will ease the pressure on contractors’ backlog. This should normalize the YOY cost increases in construction pricing.”
He said there has been talk of construction costs decreasing going into 2023 and 2024, however “this expectation is unrealistic given the imbalance in the labor force that will not be alleviated in a short timeframe.
Aging Workforce Will Exacerbate Situation
Crystal Sunbury, real estate and construction senior analyst with RSM US LLP, tells GlobeSt.com that the construction industry has not been immune to labor shortages and global supply-chain disruptions.
“Inflation, federal spending and an aging workforce are expected to continue to exacerbate the labor shortage, which will continue to drive up the cost of labor in the near future as contractors continue to grapple with finding sufficient skilled labor to get projects within their backlog completed, and as construction spending increases as a result of the Infrastructure Investment and Jobs Act.
Sunbury said that global supply-chain disruptions, affected by China’s Zero Covid Policy and the war in Ukraine, drove up costs significantly over the past few months. Diesel fuel was up 71% year over year in July, while other key construction materials such as concrete pipe, plastic construction products, sheet metal and steel pipe were up over 20% for the same period.
“The good news is that supply chains are easing,” she said. “The RSM U.S. Supply Chain Index was back above neutral in July for the first time since the pandemic hit, following rebounds in inventories and capacity utilization. A normalized supply-chain will add much-needed relief for contractors and ease much of the material price pressures experienced over the last two years.”
She said the IHS Markit PEG Index, which measures engineering and construction costs (a reading in excess of 50 represents upward pricing strength relative to previous months) fell in July from 76.7 to 68.9, with the materials and equipment component at 63.4 and labor at 81.8.
The six-month index, which measures contractor expectations for the next six months, measured at 61.5 with the materials component at 52.7, as material pricing is expected to ease by 2023, and labor at 82.1.
“As supply chains ease, the primary concern for contractors will be finding skilled labor, which will continue to drive up wage growth,” Sunbury said.
Nicolas McNamara, director, cost consultancy for CBRE, said in prepared remarks that the construction industry thrives on predictability, “but we continue to grapple this year with numerous challenges and volatility, making estimating and managing costs more difficult. But demand for new projects remains strong.”
No Longer Expectation of Predicatable, Marginal Price Changes
Joe Santaularia, senior vice president, and Julianna Brooks, director of business development for Bradford Commercial Real Estate/CORFAC International in Dallas, tell GlobeSt.com that volatility and rapid inflation of construction costs have been a constant pressure over the past years, where historically the industry has operated on an expectation of predictable and marginal pricing changes.
“A large portion of the demand-side price hikes came from the hot housing and industrial market – with demand for both new builds and home improvement reaching historical levels,” Santaularia said. “The uncertainty in the office market caused a slew of project cancellations or holds, as the market fundamentals in the office space weren’t worth the risk.”
Brooks said she is starting to see these trends reverse, with demand for higher-quality office assets creating a surge in demand for construction services in the office sector, where previously that sector was lagging.
“The ‘flight to quality’ is replacing the hot housing market as a big demand event in the construction space,” Brooks said. “We are seeing historically long lead times, but the clients who are willing to wait.”
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