The moderate inflation rates experienced by the construction industry for much of the 1990s through 2003 may go down in economic text books as a fluke made possible by the rare combination of cheap imports, energy and money combined with a relatively weak global economy. Those conditions now are changing.
Strong demand overseas and the weak dollar are preventing imports from stepping in to cap domestic price increases. Oil prices have flirted with record highs for much of the year and the Federal Reserve Board is finally starting to nudge interest rates higher. In addition, the emergence of China as an economic powerhouse has shaken up global supply and demand, pushing up commodity prices and skewing international freight costs.
These new ground rules have let inflation back into the game and it put up numbers in 2004 that the construction industry has not seen since the 1970s. Inflation measured by 14 major industry cost indexes averaged an 8.7% annual increase through last October, the latest month available for all indexes. A year ago, this group of cost indexes averaged a 2.6% annual increase.
These increases were driven almost entirely by a broad-based escalation in material prices. A huge demand for scrap metal by China helped push steel prices to record highs in the first quarter and prices kept climbing through most of the year. Higher steel prices appeared to open the door for other materials, including double-digit price increases for lumber, plywood, copper, stainless steel, gypsum wallboard, ductile iron and PVC pipe.
Many of these higher prices are apparently being passed along to owners, judging by the large increases in selling price indexes, which measure what contractors bid for work.
The average annual increase for four selling price indexes was 9.2%, or about 1% more than the rate of increase for the group of general building indexes measuring labor and material costs. Just a year ago, selling price indexes were posting only a 0.5% rate of increase, 2 to 3% below that of the general purpose indexes, an indication contractors were cutting margins to win work. This is another big "rule" change.
"The shock of steel prices has psy-chologically shaken everyone," says Peter Morris, principal with Sacramento-based cost managing firm Davis Langdon Adamson. "A lot of owners are just starting to accept higher prices." He says they are seeing bids come in 20 to 30% over budget and that only about 5% of that increase can be attributed to higher material prices.
Bids are coming in much higher than can be explained simply by higher prices, agrees Jeff Browning, chief estimator for construction consulting firm PinnacleOne, Phoenix. "Five years ago we would get 12 to 15 bids on a $4-million job and now we are lucky to get two," he says. Browning cites a recent building renovation project in Southern California estimated at $6.5 million that came in at $11 million. "There was no steel on that job," he notes.
From Peak to Plateau
Worldwide, construction inflation also is making strong gains, according to ENRs annual survey of international construction costs conducted by Gardiner & Theobald Inc., London. G&T reports that building inflation in 23 countries averaged 5.2% this year, up from 3.0% in 2003 and 2.3% in 2002. G&T forecasts that international...