Construction Inflation
Usually construction budgets are prepared from known “current” costs. If a budget is being developed for a project whose midpoint of construction costs is two years in the future, you must carry in your budget an appropriate inflation factor to represent the expected cost of the building at that time. Why the midpoint? Because half the project cost occurs prior to that point and half occurs later than that. The balance point for spending is 50-60% into the schedule. Construction inflation should always be calculated from current cost to midpoint of construction, or in the case of converting an older actual cost to a future budget, from midpoint to midpoint.
Any time a construction project is delayed or put on hold to start at some future date, construction cost inflation must be calculated and added to the previous budget to account for the unanticipated cost increase due to the delay. Of utmost importance is using appropriate cost indices and forecasting future cost growth to account for the difference in original budget and revised budget.
The level of construction activity has a direct influence on labor and material demand and margins and therefore on construction inflation.
- Long-term construction cost inflation is normally about double consumer price index (CPI).
- Although inflation is affected by labor and material costs, a large part of the change in inflation is due to change in contractors/supplier margins.
- When construction volume increases or decreases rapidly, margins change rapidly.
When construction is very actively growing, total construction costs typically increase more rapidly than the net cost of labor and materials. In active markets, overhead and profit margins increase in response to increased demand. These costs are captured only in Selling Price, or final cost indices.
General construction cost indices and Input price indices that don’t track whole building final cost do not capture the full cost of inflation on construction projects.
Consumer Price Index (CPI), tracks changes in the prices paid by consumers for a representative basket of goods and services, including food, transportation, medical care, apparel, recreation, housing. This index in not related at all to construction and should not be used to adjust construction pricing.
Producer Price Index (PPI) for Construction Inputs is an example of a commonly referenced construction cost index that does not represent whole building costs. The PPI tracks material cost inputs at the producer level, not prices or bids at the as-built level.
Engineering News Record Building Cost Index (ENRBCI) and RSMeans Cost Index are examples of commonly used indices that DO NOT represent whole building costs yet are widely used to adjust project costs. Neither includes contractor margins.
It should be noted, there are far fewer available resources for residential inflation than for nonresidential inflation.
One of the best predictors of construction inflation is the level of activity in an area. When the activity level is low, contractors are all competing for a smaller amount of work and therefore they may reduce bids. When activity is high, there is a greater opportunity to bid on more work and bids can be higher. The level of activity has a direct impact on inflation.
To properly adjust the cost of construction over time you must use actual final cost indices, otherwise known as selling price indices.
Selling Price is whole building actual final cost. Selling price indices track the final cost of construction, which includes, in addition to costs of labor and materials and sales/use taxes, general contractor and sub-contractor margins or overhead and profit.
Refer to National Inflation Indices for comparison to several national selling price indices or various Input indices. National reference indices are useful for comparison. Few firms project index values out past the current year, therefore all future projections in these tables are by Construction Analytics.
1-18-23 Construction Analytics PPI Tables and Building Cost Index
Construction Inputs to Nonresidential Buildings dropped for five of of last six months, now down 5.2% since June, but still up 7.2% since last December. However, the average index for 2022, when compared to the average for 2021, is up 15.7%.
The average growth for the year accounts for all the peaks and valleys within each year and is the value carried forward into the index tables and charts. A glaring example of the difference between Dec/Dec tracking, or year over year, and annual average tracking, is Steel Mill Products which is down 28.7% Dec22/Dec21, but the annual average for 2022 is still up 9.0% from the average 2021. In fact, the last three years show Dec/Dec combined inflation is +71%, but the annual averages for the last three years show total inflation growth of 87%. Annual averages should be used to report inflation.
Residential inputs are down seven of the last eight months, down 7.1% since April, but still up 7.1% since last December. The average for 2022, when compared to the average for 2021, is up 12.7%.
Several major cost components have been on decline the last few months: Lumber/Plywood, Steel Mill Products, Fabricated Steel, Steel Pipe and Tube, Aluminum and Diesel Fuel. Of the 15 items tracked here, 10 declined in the last quarter. Concrete is the only product that has not posted any monthly decline in 2022. Costs are still high, but are moving in the right direction after 1st quarter 2022 costs that averaged +7% (28%annual) to +8%. Historically, most cost increases are posted in the 1st quarter and the least in the 4th quarter.
If inputs costs remain where they are right now as we start the year, input costs for 2023 will finish the year at -2% Nonres and -4% Residential. If we were to post small but steady cost increases of 0.25%/mo for the rest of the year, we would end with both Res and Nonres input costs up 4% for the year.
Final Demand PPI, or Selling Price, represents contractors bid price to client. Includes labor, material, equipment, overhead and profit. Labor includes change in wages and productivity. Every three months (Jan, Apr, Jul, Oct) BLS performs an update survey to correct these Final Demand indices. For the past six quarterly updates, about 80% to 90% of the change in the index was posted in the update month. Therefore, Final Demand indices should not be referenced monthly. These are quarterly indices. January is an update month. PPI Final Demand for Jan index is basically the correction for Nov and Dec. The index should NOT be compared mo/mo. The best you could do is compare qtr/qtr, but making sure to use the correct update month with two other months, (Jan +Dec+Nov)/(Oct+Sep+Aug) The table shows the slowing progression from a 20% annual rate of gain for all of 2022 (avg nonres bldgs), to 5% the last two qtrs to only 1.8% the last qtr. Slowing is good.
The final demand PPI index for 2022 nonresidential buildings is substantially higher than Construction Analytics nonresidential buildings cost index reported in the index tables. These PPI values are but one of the references used to develop construction analytics building cost index.
Current and predicted Inflation rates updated 1-18-23:
- 2020 Rsdn Inflation 4.5%, Nonres Bldgs 2.6%, Non-bldg Infra Avg -0.3%
- 2021 Rsdn Inflation 13.9%, Nonres Bldgs 7.4%, Non-bldg Infra Avg 7.9%
- 2022 Rsdn Inflation 16.1%,Nonres Bldgs 12.9%, Non-bldg Infra Avg 13.8%
- 2023 Rsdn Inflation 1.9%, Nonres Bldgs 4.0%, Non-bldg Infra Avg 4.3%
Current and predicted Inflation updated to Q4’22 3-3-23
- 2020 Rsdn Inflation 4.5%, Nonres Bldgs 2.4%, Nonbldg Infra -0.3%
- 2021 Rsdn Inflation 14.0%, Nonres Bldgs 8.0%, Nonbldg Infra 7.9%
- 2022 Rsdn Inflation 15.8%, Nonres Bldgs 12.2%, Nonbldg Infra 13.8%
- 2023 Rsdn Inflation 2.2%, Nonres Bldgs 4.8%, Nonbldg Infra 4.7%
Construction Analytics Building Cost Index and other industry references
Tables and Plots updated to Q4’22 2-6-23:
In the table above, dividing the current year by the previous year will give the current year inflation rate. All indices are the average rate for the year.
Also in the tables above, all reference indices data is gathered, then all are normalized to a common base, 2019 = 100. This allows to see how different indices compare.
How to use an index: Indexes are used to adjust costs over time for the effects of inflation. An index already compounds annual percent to prevent the error of adding annual percents. To move cost from some point in time to some other point in time, divide Index for year you want to move to by Index for year you want to move cost from, TO/FROM. Costs should be moved from/to midpoint of construction, the centroid of project cost. Indices posted here are at middle of year and can be interpolated between to get any other point in time.
Tables and Plots updated to Q4’22 2-6-23:
Tables and Plots updated to Q4’22 2-6-23:
Tables and Plots updated to Q4’22 2-6-23:
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