Construction Inflation – Midyear Report
If you are using general construction cost indices that don’t track whole building cost to adjust the cost of your construction projects, you may be losing money.
Inflation in construction acts differently than consumer inflation. When there is more work available, inflation increases. When work is scarce, inflation declines. A very large part of the inflation is contractor margins. When nonresidential construction was booming from 2004 through 2008, nonresidential inflation averaged almost 8%/year. When residential construction boomed from 2003 to 2005, inflation in that sector was 10%/year. But from 2009 through 2012 we experienced deflation, the worst year being 2009. Residential construction experienced a total of 17% deflation from 2007 through 2011. From 2008 to 2010, nonresidential buildings experienced 10% deflation in two years.
Since 1993, long-term annual construction inflation for nonresidential buildings has been 3.5%, even when including the recessionary period 2007-2011. During rapid growth periods, inflation averages more than 8%.
Spending growth, up 35% in the four-year period 2012-2015, exceeded the growth during 2003-2006 (33%) and 1996-1999 (32%) which were the two fastest growth periods on record with the highest rates of inflation and productivity loss. Construction spending growth for the four-year period 2013-2016 will remain near the four-year high.
Material input costs to construction are down over the last year, but that accounts for only a portion of the final cost of constructed buildings. Labor is currently experiencing cost increases. When there is a shortage of labor, contractors may pay a premium to keep their workers. That premium is not picked up in wage reports. Potential labor shortages in an area might result in +8% to +10% inflation on labor cost just in the last two years.
Nationally tracked indices for residential, nonresidential buildings and non-building infrastructure vary to a large degree. When the need arises, it becomes necessary that contractors reference appropriate sector indices to adjust for whole building costs.
ENRBCI and ENRCCI are prefect examples of commonly used indices that do not represent whole building costs, yet are widely used to adjust project costs. An estimator can get into trouble adjusting project costs if not using appropriate indices.
The cost of new residential construction is up nearly 6% in the last year. It’s up 25% in the last 4 years. Several nonresidential building cost indexes are indicating construction inflation between 4% and 5% for 2016. For the last four years, nonresidential buildings inflation has been between 15% and 18%. Indices that do not track whole building cost would indicate inflation for those four years is only 10%. Don’t be caught short!
Non-building infrastructure indices are so unique to the type of work that individual specific infrastructure indices must be used to adjust cost of work. The FHWA highway index increased 7% in 2012, dropped 4% in 2013-2014, increased 4% in 2015 and is on track to decrease 4% in 2016. The IHS power capital cost indices vary by power sector. Pipeline and LNG indices are down more than 20% in the last three years. Coal, gas, nuclear and wind power generation indices have been flat for three years.
Anticipate construction inflation for residential and nonresidential buildings during the next two years leaning towards the higher end rapid growth rate of 6% to 8% rather than the long term average of 3.5%.
(edit 1-25-17) 2016 Nonresidential Buildings inflation measured by several indices is +4.5% to +5.5%. Residential Bldgs is +4.5% to +5.2%. Power indices are down an average of -5%, but industrial structures up +4%. Highway Index is -4%. See Table of Indexes for details.
This plot for nonresidential buildings shows a bar representing the predicted range of inflation from several sources with the line of the actual composite inflation. Note that although 2015 and 2016 have a low end of predicted inflation less than 1%, the actual inflation is following a pattern of growth above 4%.
In every estimate it is always important to carry the proper value for cost inflation. Whether adjusting the cost of a recently built project to predict what it might cost to build a similar project in the near future or answering a client question “What will it cost if I delay my project start by one year?”, whether you carry the proper value for inflation can make or break your estimate.
- Long term construction cost inflation is normally about double consumer price inflation (CPI).
- Since 1993 but taking out 2 worst years of recession (-8% to -10% 2009-2010), the 20-year average inflation is 4.2%.
- Average long term (30 years) construction cost inflation is 3.5% even with any/all recession years included.
- In times of rapid construction spending growth, construction inflation averages about 8%.
- Although inflation is affected by labor and material costs, a large part of the change in inflation is due to change in contractors/suppliers margins.
- When construction volume increases rapidly, margins increase rapidly.
- Construction inflation can be very different from one major sector to the other and can vary from one market to another. It can even vary considerably from one material to another.