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If you are planning or managing a construction project, your most significant risk right now is likely material pricing, lead times, and supply chain issues. In this blog, we will take a deep dive into this topic from the perspective of the owner, and you will learn strategies to mitigate your risk, read real-life examples with alternative solutions, and find out when things are expected to improve.
Overview
Higher inflation is impacting all sectors of the economy and nowhere is this more evident than construction. Factors such as higher material prices, supply chain disruptions, and labor shortages are impacting the cost and timetables of projects in the local market.
Two Challenges We are Dealing With: Inflation & Supply Chain Disruption
Inflation
For the last two years, the construction industry has experienced unprecedented increases in material costs. From May 2020 to May 2022, the producer price index for all construction materials is up 51.6%, according to data compiled by Tocci Building Corporation using Bureau of Labor Statistics data. Another metric to point to: the average inflation rate for the ENR Building Construction Index pre-pandemic was 2.7%, then spiked to 12.5% in 2021, and now it has come down slightly to 8.5%.
According to ITR Economics, a firm that provides forecasts on long-term economic trends and best practices ahead of changing market conditions and has a 94.7% accuracy rate, inflation is expected to fluctuate through the rest of this decade at an uncomfortably high level. Prices are expected to plateau but will likely stabilize at a higher level, as illustrated in the chart below. Since 1969 the ENR Building Cost Index has shown a decrease in prices only once, during the Great Recession in 2008/2009.
So, what does all this data mean to the cost of your construction project? We recommend owners assume 8% inflation annually for projects not starting immediately.
Supply Chain
When you order materials on time, it does not guarantee you will get the material when you need it. For example, right now, air handling units have a lead time of about 52 weeks, which used to be a 6-8 week lead time.
There are multiple causes – the pandemic, Russia’s attack on Ukraine, catastrophic weather events, the computer chip shortage, domestic shipping options, and the global distribution logjam. The AGC’s most recent construction inflation report predicts there is little sign that the supply chain will consistently improve before 2023 – or even 2024 in the case of computer chips. While lead times for some items have shortened, deliveries remain delayed or unpredictable.
Supply chain issues become more prevalent during the planning of the job, specifically what materials we are using. For example, joist and deck is a commonly used building structure. It was challenging to get about six months ago because of the boom in Amazon distribution centers being built. Amazon bought in bulk, constraining the rest of the market. We knew this was going to be an issue on one of our projects, so we worked with the owner and structural engineer to change the design of the building to more of a conventional structure that was easier to get.
Another approach is to consider looking at what materials you can reuse. If you are remodeling a building, getting new doors in the space you are renovating is standard. On one of our projects, we knew that wood doors would be hard to get, so we saved and installed the old doors to gain occupancy and installed the new doors when they were delivered. A third approach is to do early bid packages or bring in early trade partners to release material while working on the final design to get their input on material lead times and potential pitfalls.
Choices You Have
I’m sure you’re wondering what choices you have as an owner if you need to build something. Do you wait? Do you redesign? Or do you just accept that you must pay more? Here is some information to consider as you evaluate:
- ENR did a survey going back 40 years that we referenced earlier. Only once in the last 40 years did material prices go below where they were before inflation and that was during the Great Recession in 2008/2009. If you look at this historical data, it would tell you that prices will very unlikely go down….but they will plateau.
- There is a business reason you are evaluating your project. That reason still exists. There is a value that your project will accomplish, and in many cases, deliver revenue and profitability back to you. We are advising our customers to move forward but to be more conscious about what the bottom line looks like to make it a successful project. Here are some factors to consider:
- How do you control costs and still get a building that allows you to start generating revenue?
- What is the value add that your project will do for you?
- What are the negative impacts to your business if you do not move forward?
It takes a team approach – from the end user, owner, architect, engineers, and contractor. One customer we are working with is doing a project that is part of a cultural shift to get people to stay on their campus, so the aesthetic appeal for their three-story building is extremely important. What we discovered through the collaboration process is that the third level may not be utilized for some time, so we can get the community asset with two floors for now and we can build out the third level after they start generating revenue.
Despite these issues, ITR is predicting 2022 to be a growth year for the construction market but will see volatility in the supply chain and inflation into 2023. You can use multiple strategies and tactics to mitigate your risk. These can include getting suppliers on board earlier, making other value decisions to offset the increases in materials, and considering alternate or reusing materials. If you want to talk about which strategies make sense for you, send me an email: George.cullen@jpcullen.com.
