Construction Inflation – Midyear Report
General construction cost indices and Input price indices that don’t track whole building cost do not capture the full cost of construction projects. To properly adjust the cost of construction over time you must use actual final cost or selling price indices.
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 margins, wholesale, retail and contractor. 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 averaged 3.5%, even when including the recessionary period 2007-2011. During rapid growth periods, inflation averages more than 8%.
Spending growth, up 40% in the four-year period 2012-2015, exceeded the growth during the closest similar four-year periods 2003-2006 (37%) and 1996-1999 (36%), which were the two fastest growth periods on record with the highest rates of inflation and productivity loss. Growth peaked at +11%/year in 2014 and 2015, exceeded only slightly by 2004-2005. Although spending growth slowed to only 6.5% in 2016, Construction spending growth for the four-year period 2013-2016 totals 39% and remains near the four-year high. It’s expected that 2017 spending will increase 6.3% and maintain a consistent high four-year level of spending.
Material input costs to construction went up +2.4% in 2016 after a downward trend from +5% in 2011 led to decreased cost of -2% in 2015, the only negative cost for inputs in the past 20 years. Inputs costs are expected to rise +3% in 2017. But that accounts for only a portion of the final cost of constructed buildings.
Labor input is currently experiencing cost increases. When there is a shortage of labor, contractors may pay a premium to keep their workers. All of that premium may not be picked up in wage reports. Potential labor shortages in an area might result in +8% to +10% inflation on labor cost just over 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 on average 6%/year over the last four years. It peaked at 8% in 2013 but dropped to 3.4% in 2015. It’s been back up over 5% for 2016 and 2017 to date. Anticipate residential construction inflation for 2017 and 2018 between 5% and 6%.
Several indices for nonresidential buildings have averaged 4% to 4.5% over the last four years and all are indicating construction inflation of 4.5% to 5% or more for 2017. For the last four years, nonresidential buildings inflation has totaled nearly 18%. Input indices that do not track whole building cost would indicate inflation for those four years is only 10%, much less than real final cost. For a $100 million project escalated over those four years, that’s a difference of $8 million, protentially underestimating.
Don’t be caught short! Anticipate construction inflation for nonresidential buildings during the next two years leaning towards the higher end rapid growth rate of 5% to 6% rather than the long term average of 3.5%.
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 dropped 5% 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, and wind power generation indices have gone up only 6% in six years. Refineries and petrochemical facilities have dropped 6% in the last 4 years. Most input costs to infrastructure are down from the post recession highs, but most have increased in the last year. All infrastructure indices through midyear are indicating 2% to 4% increases for 2017.
This plot for nonresidential buildings only shows bars representing the predicted range of inflation from various sources with the line showing the actual composite final cost 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%. The low end of the predicted range is almost always established by input costs, while the upper end and the actual cost are established by selling price indices.
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% total for 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%.
- Nonresidential buildings inflation has average 3.8% since the recession bottom in 2011. It has averaged 4.2% for the last 4 years.
- Residential buildings inflation reached a post recession high of 8.0% in 2013 but dropped to 3.4% in 2015. It has averaged 5.9% for the last 5 years.
- 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.