2004 and 2005 were two years marked by dramatic extremes for our economy and the construction industry. As a result, this period may be one of the most volatile on record when it comes to pricing of construction supplies, materials and services.
From the general contractor’s perspective, the good news is that America’s demand for new commercial and residential building has been on the increase in 2005. According to the U.S. Census Bureau of the Department of Commerce, as of August 2005 construction spending was estimated at a seasonally adjusted annual rate of $1,108.5 billion, 6.1 percent above August 2004. During the first eight months of 2005, construction spending amounted to $723.7 billion, 9.0 percent above the same period in 2004. From July to August 2005, the fastest growing segments of the construction industry were highways and nonresidential private construction, outpacing the rate of growth in residential and all other facets of public construction.
Demand for new construction is growing at a healthy, but not excessive rate, which should bode well for stable construction costs, right? Unfortunately, this is not the case. External forces have resulted in phenomenal rate increases for a wide range of integral construction supplies, raw materials and services. This fact has made the process for long term cost projections more difficult now than it’s ever been.
External Forces Drive Price Extreme Fluctuations in Construction Supplies and Raw Materials
In 2004, Steel was the primary culprit for increased construction supply costs. The largest factor influencing this was China’s burgeoning economy, which has driven phenomenal growth in their construction and manufacturing needs. China’s demand for steel in 2004 increased by 38 million tons; just their demand increase was as much as the total annual steel usage for Mexico and Canada . . . combined. This massive increase in demand, coupled with reduced supplies of raw materials and a weaker American dollar, drove the price for steel up 66% in one six-month period in 2004 and made long-term cost estimating for a wide range of construction projects virtually impossible.
As a result, in 2004 steel producers added surcharges or renegotiated contracts to raise prices and help offset their higher costs, or simply canceled orders they couldn’t fill. Steel’s spiraling prices finally peaked and started to reverse themselves in 2005, although they remain 20 – 30% higher now (mid- to late-2005) than their January 2004 levels.
Concrete also was in high demand in 2004 and 2005, driving up prices and lead times for this raw material as well. While concrete prices have not inflated as dramatically as steel’s, they have increased 10 – 12% between January 2004 and mid-2005.
Consumer demand and finite supplies also played a major role in the cost of gasoline and petroleum products over the past 12 – 24 months. In December 2004 oil sold for $37 per barrel. In September 2005 oil cost more than $63 per barrel, following temporary spikes in August that exceeded $70 per barrel. This resulted in price jumps of 50% for gas and diesel fuels, as well as significantly increased manufacturing and delivery prices for virtually every product and process in construction.
For the remainder of 2005 and into 2006, the greatest affect on construction costs may well be the result of natural – and not man-made – forces. This year Hurricane Katrina caused at least $125 billion in economic damage and could cost the insurance industry up to $60 billion in claims. Estimates for damage to infrastructure such as roads, bridges and the utility system in New Orleans alone exceed $10 billion. Thousands of businesses and more than 300,000 homes were damaged by Katrina, most of them beyond repair. Following Katrina was Hurricane Rita, which caused an additional $10 – 15 billion in damages in Texas and Louisiana.
In the short term, the repair process will place heavy demands on a wide range of building materials like lumber, steel, plywood, electrical components, glass, roofing materials, asphalt, carpeting, drywall and PVC piping, so costs and delivery times for these items are likely to increase nationwide. Skilled construction labor, particularly framers and drywall installers, will also be at a premium as far away as north Texas. Katrina will result in a temporarily reduced demand for concrete in the region as workers focus on repairs rather than new construction. This reduced demand may or may not translate into price reductions, however; New Orleans is the country’s largest port of entry for imported concrete, and with that city’s diminished functionality, available supplies will be reduced as well as local demand.
For the long term, Katrina’s impact on our nation’s oil supplies and continually increasing demand may have the greatest affect on construction costs. Several American refineries and oil delivery mechanisms were affected by Katrina; as a result, already-tight oil supplies were further diminished by the hurricane and the cost to manufacture and deliver products or operate construction equipment is likely to continue its rise. Adding refinery capacity in our country would take at least a decade so we have no short term solution to this problem.
Construction Costs Summary
When fundamental raw materials like steel, concrete and petroleum experience double-digit inflation rates, the amount of time for which material suppliers, subcontractors, general contractors and cost estimators can commit to pricing grows shorter and shorter. Established commercial construction companies like Bob Moore Construction have outstanding relationships with major subcontractors and suppliers, as well as the expertise to provide as much pricing information and commitment as possible. But the fiscal reality of the global economy and the ramifications of natural disasters shackle all participants in the building process when it comes to projecting construction costs, long term. When prices for core raw materials are increasing at eight to ten times the economy’s inflation rate, it is very difficult to commit to pricing several months in the future that is still cost-competitive.
Given that the volatility of raw materials and supplies will not be diminished in the near future, developers must seek out ways to compress the construction schedule and work with leading industry partners to increase the legitimacy of their project budget. For example:
- Engaging a general contractor or construction manager earlier in the process is a good way to control time in the initial planning phases, as these experts understand permitting and other legal requirements and can ensure all documentation is filed thoroughly and in a timely manner, reducing schedule delays early on.
- Approaches to construction like tilt-up construction and Fast Track have reduced the timetable for delivering a construction project considerably.
- Some building owners are taking a more active role in the design/bid/build process and are functioning as a team member to streamline communications and drive faster completion of projects as well.
Developers and business owners should leverage these approaches and work with general contractors who have the relationships with quality suppliers to maximize their ability to project and budget construction costs accurately through the end of the building’s construction process.