Inflation Drivers and How They Affect Your Project

Inflation Drivers and How They Affect Your Project

My estimating background has trained me to look for indicators that will predict the future cost for the design and construction of a construction project. Over the 50 plus years in the construction business, I have researched those trends and have developed leading indicators that have proven to be useful tools.

In the 1980’s, I found understanding the cost of 30 key materials and labor costs, enabled our adjusting a local data basis of construction costs.  This process enabled my firm to adjust local data basis’s around the world and successfully and accurately forecast project construction costs in more than 65 countries.

When analyzing the current leading trends and key factors, two indicators come to the surface as the root causes driving this round of construction inflation. While there are other issues impacting the marketplace, these are or will be the root causes that will require a change in policy to minimize the impact on the industry and our economy.

The key factors that will require a change in government policies are:

 

Energy

Approximately 4-5% of the cost of any construction estimate is the transportation of the labor force, materials from the manufacturer to the site, and onsite equipment.  This “estimating percentage” does not include the transportation costs from the source of the raw materials to the manufacturer. For example, the above percentage would not include wood products from the NW forestry operations to lumber supply yards or the transportation of Chinese manufactured materials shipped to US suppliers or assemblers of the final product. The impact of those transportation costs are included in the vendor quoted prices. Those costs impacts are on top of the 4-5% noted above.

During the last year, the cost of fuel has risen 46-50%, depending on where a project is located in the US. Everyone has an opinion for this cause. Green energy needs for conventual energy to be at a higher cost to reflect a savings; the change from the US as a net exporter of energy to a net importer, or the reduction of energy exploration and transportation pipelines. The cause for the governmental policy change is not being debated here, the need to focus on impact of those policies as it relates to construction costs is the target of this newsletter. The fact that a 50% increase in energy will increase costs for that component by at least 50% (plus markups) must be included in future estimates.

Including only the direct transportation costs, the cost impact to a project is an increase of 2 to 2 ½% on the total cost of the project. The additional cost from the suppliers, vendors and subcontractors increases that amount. Our advice to clients has been to include an increase to 8-10% for 2022 and 6-8% for 2023.

This has a negative impact on the projects in design but a more dramatic impact on projects in construction.

Demographics

Over the last two decades, I have spoken about demographics and its influence on the construction labor force. As a point of clarity, demographics is the study of what people do at certain periods of their lives and how each generation actions differ in those periods.

Chart shows that since 2009 – labor participation has decreased from 66% to 63% and after COVID 62%

The shrinking workforce is not a new phenomenon. Boomers have been leaving the workforce for more than a decade and the younger generations are electing positions in technology over construction. The above chart is for the economy in general and a view of construction must be overlayed to discern the specific impact on our industry. The lack of workforce translates into fewer people to perform construction activities.  Over two decades ago, the construction industry started to train and include women into the workforce both onsite and in management. This inclusion helped fill the industries labor gap.

 

Chart shows how rate of replacement of Boomers started to decrease in 2002 and in 2021 was a net zero gain. Starting in 2021 – the workforce will shrink in numbers by 1.5 million workers a year.

COVID has escalated the issue related to demographics. Older people are leaving the workforce and there are not enough younger people to replace them. This is compounded in the construction industry.

One of the COVID employment resets is that workers have grown fond of the new lifestyle working environment – setting their own work hours. Fourth quarter government statics indicate a trend of over 4.5 million people quit their jobs and left the workforce. They are leaving because they prefer their new lifestyle versus an office or jobsite for a prescribed period of time.

Effect on Construction Pricing

Labor and material costs must trend higher to account for the increased cost of doing business. This will force construction prices to rise causing inflation and escalation of existing contracts.

In the past, the Federal Government response has been to raise interest rates to slow the economy by making it harder to finance development resulting in a slowdown of construction.

What is not shared is the rise in interest rates will also impact the Federal Budget, already running at a deficit. Approximately one-third of the US annual budget is interest payments on the Federal debt of nearly $30 trillion dollars. With the current Federal Funds borrowing rates near 1%, the Federal Reserve’s projected in 2022, four increases to the Federal Funds Rate which will at least double the Federal Government’s current interest carry charges resulting in additional deficits.

This will spark discussions of increased taxes from businesses and citizens to cover the increase.

Client Recommendations

  • Where possible, spend the additional fees to lock in interest rate protection for all development loans.
  • All contracts with design firms, contractors, subcontractors, and vendors should be locked in with a lumpsum or Guaranteed Maximum cost for the project. The key is to transfer the cost management risk to the party that can best manage the risk.
  • Consulting professions – raise your rates NOW!! The path to bankruptcy is lined with firms that raised rates after the additional cost was experienced. Discounts can always be negotiated but increases in contract prices for the same work is difficult to nonexistent.
  • Interest rate sensitive development products (housing) should be carefully evaluated before starting.

 

 

 

Jerrie Parise

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