8-27-20 What impact will the pandemic have on Construction Inflation in 2020? Here’s Several inputs.
In April, and again in June, I recommended adding a minimum 1% to normal long-term construction inflation, to use 4% to 5% for 2020 nonresidential buildings construction inflation. Some of my peers were suggesting we would experience deflation. Only twice in 50 years have we experienced construction cost deflation, 2009 and 2010. That was at a time when business volume was down 33% and jobs were down 30%. Currently business volume and jobs are down 10% and by mid-2021 are forecast down 15%.
The Turner Construction Cost index for the Q2 is down 1% from Q1, effectively reporting 0% increase in the index year-to-date. But the Turner index year-to-date (avg Q1+Q2=1183) is still 3.6% higher than the average of Q1+Q2 2019 and 2.3% higher than the avg for all of 2019 (1156). So, while the index appears to show no gains in 2020, through the first six months it is already up 2.3% above the average 2019 index. http://turnerconstruction.com/cost-index
The Rider Levitt Bucknall Q2 2020 index is up 1.6% ytd, up 4.6% from the Q1+Q2 2019 average and up 3.1% above the 2019 average. https://s28259.pcdn.co/wp-content/uploads/2020/07/Q2-2020-QCR.pdf
The U.S. Census Single-Family house Construction Index is up 3.6% year-to-date through July. July 2020 is up 4.2% over July 2019. https://www.census.gov/construction/nrs/pdf/price_uc.pdf
Producer Price Index items for July construction reported by AGC on 8-11-20. Inputs to Nonres construction are down ytd -1.0% through July. Final Demand Nonres Bldgs is up 1.8% ytd through July. See https://www.agc.org/learn/construction-data/construction-data-producer-prices-and-employment-costs and https://edzarenski.com/2020/07/14/producer-price-index-year-to-date-june-july-2020/
R.S.Means quarterly cost index of some materials for the 2nd quarter 2020 compared to Q1: Ready-Mix Concrete 0%, Brick and Block +3%, Steel Items -2%, Wood products +3%, Roof Membrane +7%, Insulating Glass +6%, Interior Finishes -2%, Plumbing Pipe and Fixtures +7%, Sheet Metal +7%. https://www.rsmeans.com/landing-pages/2020-rsmeans-cost-index
U.S. manufacturing output posts largest drop since 1946. Think of all the manufactured products that go into construction of a new building: Concrete, steel, doors, windows, roofing, siding, wallboard, lighting, heating systems, wire, plumbing fixtures, pipe, valves, cabinets, appliances, etc. We have yet to see if any of these will be in short supply leading to delays in completing new or restarted work?
There have been reports that scrap steel shortages may result in a steel cost increase. The U.S. steel industry is in the most severe downturn since 2008, as steelmakers cut back production to match a sharp collapse in demand and shed workers. Capacity Utilization dropped from 82% to 56% in April. Now in mid-August, CapU is up to 61%, still very low. Steel manufacturing output fell by a third and is still down more than 25%. Until production ramps back up to normal levels there may be shortages or delays in delivery of steel products.
Since Q1, the cost of lumber has increase 120%, so expect residential inflation to increase faster than nonresidential. https://eyeonhousing.org/2020/08/average-new-home-price-now-14000-higher-due-to-lumber/ and revised http://nahbnow.com/2020/08/average-new-home-price-now-16000-higher-due-to-lumber/
Contractors have been saying they have difficulty acquiring the skilled labor they need. This has led to increased labor cost to secure needed skills.
But most important, this SMACNA report quantifies that labor productivity has decreased 18% to meet COVID-19 protocols. https://www.constructiondive.com/news/study-finds-covid-19-protocols-led-to-a-7-loss-on-construction-projects/583143/
Labor is about 35% of project cost. Therefore, just this productivity loss equates to 18% x 35% = 6.3% inflation. Even if, for all trades, the average lost time due to COVID-19 protocols is only half that, the added inflationary cost to projects is 3% above normal. I expect the Turner Nonres Bldgs index will reflect some added labor cost in the next two quarterly releases.
Post Great Recession, average nonresidential buildings inflation is 3.9%. For the last five years it’s 4.5%. Residential cost inflation averaged 4.1% and 4.5% for those periods. The 30-year average inflation rate for nonresidential buildings is +3.75%.
Almost every construction market has a weaker spending outlook in 2021 than in 2020, because approximately 50% of spending in 2021 is generated from 2020 starts and 2020 starts are down.
Typically, when work volume decreases, the bidding environment gets more competitive and prices go down. However, if materials shortages develop or productivity declines, that could cause prices to increase.
Add to these issues the fact that many projects under construction have been halted for some period of time and many more have experienced at least short-term disruption. The delays may add either several weeks to perhaps a month or two to the overall schedule, in which case management cost goes up, or it could add overtime costs to meet a fixed end-date.
We can expect some cost decline due to fewer projects to bid on, which typically results in sharper pencils. But we can also expect cost increases due to materials, labor cost, lost productivity, project time extensions, and/or potential overtime to meet fixed end-date.
I expect non-residential buildings inflation to range between 4% and 5% for 2020 and 2021, perhaps 5% to 6% for residential work.