3Q Cost Report - Housing Slowdown Undercuts Inflation
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| Photo:� Jose Antonio Lavado - FOTOLIA |
Contractors who have been battling a resurgence in inflation, starting with a doubling of steel prices during the spring of 2004 through the doubling of copper prices last quarter, finally got a break. During the third quarter, the decline in housing starts gained enough momentum to begin pulling down prices for some materials such as lumber, plywood and oriented strand board.
Even commodity prices appear to have behaved themselves during the third quarter. “The good news is that we have seen a significant drop in the price of oil, which has fallen below $70 per barrel,” says Julian Anderson, a principal with Rider Hunt Levett & Bailey, Phoenix. “We are also seeing the end of the speculative boom in commodity prices, particularly copper and aluminum.” For example, ENR’s survey of “Big Box” material prices shows prices for copper water tubing falling 18% this quarter after jumping 108% in the second quarter .
Related Links: But while upward pressure from commodity prices may be easing, bids from subcontractors are still driving up the cost of construction. “Subs were quick to claim the extra costs but I think [they] will be slower coming down,” says Anderson. “The market is busy and people are able to charge more.” As a result, he expects the Rider Hunt cost index to maintain its annual escalation rate of 10% for the next six to 12 months.
A study by Davis Langdon, Sacramento, also concludes that the real inflationary impact of volatility in the commodity markets during the past two years is the cost risk and uncertainty it has created for subs. “Bidders must include substantial risk premiums in their pricing,” says Peter Morris, a principal with Davis Langdon. “This in turn leads to bids that are significantly higher than might otherwise be attributable to changes in costs.”
In addition, Morris notes that “bidders have become very selective and costs have varied between projects bid at the same time by as much as 20%, based simply on how bidders viewed the attractiveness of the work.” He expects “escalation will continue to be high, but at a reduced pace from the past two years.”
A recent survey of 166 public owners by Phoenix-based PinnacleOne shows that owners are not buying the argument that inflation is slowing. On average, they expect construction costs on their projects to increase another 11.3% in the coming year, with most cit-ing oil, gas and steel prices as the major drivers on project costs. Nearly half say they have seen a decrease in the number of bidders on their jobs and one-third say they have delayed or canceled projects due to material cost increases.
Despite such concerns, the slowdown in housing is offering price relief for some materials. In September, ENR’s 20-city average price for 2 X 4s was 11.3% below a year ago. Plywood prices were down 4%. Prices in ENR’s “Big Box” survey show third quarter declines of 15% for oriented strand board, 5% for plywood and 0.5% for portland cement.
Cooling Off Period
Housing starts have fallen from a high of 2.12 million annual rate in the first quarter of this year to 1.77 million this quarter. The forecasting firm Global Insight, Washington, D.C., expects this slide to continue into next year with starts hitting an annual rate of 1.62 million by the third quarter of 2007.
“This is not a hard landing but it’s more bumpy than originally anticipated,” says Michele Halickman, the construction materials analyst for Global Insight. She expects both lumber and plywood prices to continue to fall for the next two quarter and that they will stay depressed through 2008.
The decline in housing also is having an impact on the cement market, according to the Portland Cement Association, Skokie, Ill. In the latest update of its forecast, PCA predicts housing starts in 2006 to decline 10.6%, followed by a similar decline in 2007. PCA expects the emerging weakness in the residential market to slow the growth in cement use from its current 5.6% to just 2.3% by year-end and 1.2% in 2007.
Cement shortages that hampered the industry for the last two years have disappeared, but this is due more to a surge in imports than weak demand from the housing market, says Ed Sullivan, PCA’s chief economist. A PCA survey shows only two states with tight markets this summer compared to over 30 a year ago.
“At best, demand will grow by two million tons this year but imports are up by 8.5 million tons over 2005,” says Sullivan. Most of the increase comes from a surge in imports from China, which took advantage of falling freight rates.
Weaker demand and rising imports will cap cement prices, says Halickman. After climbing 12.6% this year, cement prices will increase just 2% in 2007 and then fall about 1% in 2008, she predicts.