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What is up with Construction Costs?

Financial Analytics_What is up with construction costs_1536x1040
 

“If clients are willing to select alternative materials and methods to aid with lead time concerns, we have been successful in keeping projects on schedule and on budget.”

Design + Construction Advisory Services
Colliers Houston

The recent surge in construction costs is a concern to anyone in the middle of or about to start a commercial or residential construction project.  Increased construction activity and COVID-19 induced supply chain impacts have put a strain on the availability of a variety of resources including steel, lumber, precast concrete, fire protection piping, and underground piping and conduit. This has impacted both the price of materials and lead times dramatically.  Colliers has a team of professionals in their Design + Construction Advisory Services who can help you keep your project moving forward, on schedule and on budget.  Let us examine the average historical costs and what has caused the unprecedented recent increases.

Turner’s Building Cost Index is determined by the following factors considered on a nationwide basis: labor rates and productivity, material prices and the competitive condition of the marketplace.  Below are two graphs illustrating the history of the index (annual average) and the percentage change in the index, through the First Quarter of 2021.  Interestingly, from 2013 to 2019, the annual increase in this index has exceeded 4%.  But, in 2020, this index only increased 1.8%, with a slight fall of 0.4% in the First Quarter of 2021. 

 Average Turner Cost Index_new

Change in Turner Cost Index_new

 

Kirksey Architecture has conducted an annual construction cost survey for Houston since 2008.  This survey provides a range of office building and interior costs in the market; however, to simplify the comparison, we have graphed the median costs in the ranges provided each year.

 Median Hard Construction Costs_new3

Source: Kirksey Architecture

From 2008 to 2020, the compound annual growth rates, by office type, has been as follows.

 Compound Annual Growth Rate 
 One-Story Flex Office Buildings  1.8%
 Low-Rise Office Buildings  1.1%
 Mid-Rise Office Buildings  1.5%
 High-Rise Office Buildings  1.6%
 Parking Garages  2.4%


These average increases are reasonable, given that the CPI index (U.S City Average for All Urban Consumers) increased at a compounded annual rate of 1.73%.  Notably, the CPI Index has recently surged, as the 12-month change in this same index from May 2020 to May 2021 was 5.0%.  However, economists believe this is a temporary impact of the reopening of the economy and will decline as the year progresses.

The cost for interior buildout has increased more rapidly than hard construction costs, with office space buildout increasing 2% to 4.8% per year (depending upon the quality of the finishes) and the cost of a fitness facility, conference center, and employee dining facility all posting increases of over 7% per year.

Median Interior Hard Construction Costs_New2 

Source: Kirksey Architecture

     CAGR     
 Basic Office Space    2.0%     2008 to 2020 
 Mid-Range Office Space    4.8%     2013 to 2020
 Executive Office Space    3.6%     2013 to 2020
 Furniture    2.1%    2014 to 2020
 Fitness Facility    9.6%    2013 to 2020
 Conference Center    7.1%    2013 to 2020
 Employee Dining Facility, Kitchen & Servery    7.5%    2014 to 2020

 

Note: the compound annual growth rates (CAGRs) above are provided from the earliest year reported by Kirksey Architecture to 2020.

More recently, costs and delays have gone up significantly, due to increases in materials cost and supply chain disruptions. The Producer Price Index (PPI) measures the average change over time in the selling prices received by domestic producers for their output. Consider the PPI for the following commodities:

 Increases in Producer Price Indexes
     Unadjusted Percent
Change to May 2021
from:
     May, 2020
(12 Months)
   April, 2021
(1 Month)
 Millwork    19.2%    4.8%
 Plywood    98.4%    14.0%
 Steel Mill Products    75.6%    2.4%
 Aluminum Mill Shapes    28.6%    2.7%
 Copper & Brass Mill Shapes    60.4%    8.0%
 Hardware Building Material, and Supplies Retailing    50.3%    7.5%
 Truck Transportation of Freight    15.8%    3.9%
 Lumber    114.3%    16.5%
 Structural, Architectural, & Pre-Engineered Metal Products       22.1%    18.8%

 

Source: Bureau of Labor & Statistics

These substantial increases have resulted from a multitude of factors, including supply constraints such as plant & mill shutdowns, weather events, port congestion, and political policies, coupled with an increase in demand. Here is a summary of the major reasons for this.

Plant & Mill Shutdowns:

  • Generally reduced lumber mill capacity reduction, resulting from COVID-19 shutdowns and fears of a looming housing crash.
  • As a result of the winter freeze, the state administration in Texas executed an order banning the export of natural gas from Texas, affecting plant operations in the South and in the Gulf.
  • In June 2020, one of three domestic stainless-steel manufacturers, Allegheny Technologies Inc., began exiting the stainless-steel market, which reduced the number of domestic suppliers.
  • Union strikes beginning in April 2021 at nine other Allegheny Technologies Inc. plants (not related to stainless steel), further reduced the supply of other metal products, increasing both cost and lead times.

Political Policies:

  • International tariffs on numerous goods in the construction industry, reducing price competition.

 

   Trade Barriers Impacting the Cost of Commercial Construction
   Type of Material / Product         Target Country
  Cement   Japan 
  Ceramic Tile   China
  Hand Tools   China
  Plywood   China
  Prestressed Concrete Steel Wire   Argentina, Colombia, Egypt, Netherlands, Saudi Arabia, Taiwan, Turkey, UAE
  Quartz   China
  Quartz Countertop   India, Turkey
  Softwood Lumber   Canada
  Steel Concrete Rebar   Japan, Taiwan, Turkey, Mexico
  Steel Nails   China, Korea, Malaysia, Oman, Taiwan, UAE, Vietnam
  Steel Sinks   China
  Various Aluminum Products   Global, except Canada, Mexico, Australia
  Various Iron & Steel Pipe   Brazil, Canada, China, Germany, Greece, India, Italy, Japan, Korea, Malaysia, Mexico, Oman, Pakistan, Philippines, Romania, Taiwan, Thailand, Turkey, UAE, Vietnam
  Various Steel Products   Global, except Canada, Mexico, Australia
  Wood Flooring   China
  Wood Mouldings & Millwork   China

 

Source: United States International Trade Commission

Weather Events & Natural Disasters:

  • West coast wildfires which occurred in the Summer of 2020 dramatically impacted the supply of lumber.
  • Winter storms in Texas in February 2021 caused chemical plants to shut down, forcing manufacturers to allocate inventory and impacting downstream resin and PVC consumers.

Port Congestion & Transportation Issues:

  • Severe port congestion in both Los Angeles and Oakland have impacted global logistics. Wait times in LA for offloading have been up to 2-3 months. Hapag-Lloyd informed customers on May 28th, “Massive import volumes combined with labor shortages are the biggest drivers of continued congestion and vessel operations delays.” This logistics problem reduces international competition, increases lead-times, and raises prices.
  • The Suez Canal shutdown resulted in global logistical delays, followed by skyrocketing transportation and container costs.
  • The domestic trucking industry, impacted by a shortage of drivers, caused delays in
    material deliveries.
  • Additionally, the price of diesel fuel has been on the rise, making transportation more expensive. The US retail diesel price has increased 39% between early November 2020 and late June 2021.

Increased Demand:

  • An unforeseen surge in DIY home projects (more people working from home, getting stimulus checks, and not traveling), paired with continued growth in the construction sector, led to higher demand for construction materials.

United States Housing

  • Rock-bottom mortgage rates and COVID-19 concerns caused city dwellers to rush to buy and/or renovate homes in the suburbs.

 

 Annual Average 3Year Fixed Rate Mortgages_new

Source: Freddie Mac

  • Millennials are starting to hit their peak first-time homebuying years, increasing housing demand.
  • The winter weather in Texas knocked out production facilities and created a surge in demand for pipe to replace broken lines and other materials for repairs.
  • A substantial number of restaurants added outdoor decks and dining in response to Covid.
  • E-commerce and last mile distribution, as well as cold storage facility construction, continue to grow at a staggering rate. Amazon and other on-line retailers have been rapidly expanding their distribution centers, dominating the demand for steel joists, girder, and deck materials.
  • Beginning in February 2021, the Buy American Act, which includes a preference for domestic products on federal projects, imposed a separate and more strict set of rules for any product that “consists wholly or predominantly” of iron and/or steel, producing additional domestic steel demand.

Result – Increased Prices and Major Delivery Delays:

  • The price of lumber increased 98.6% from March 17th to May 7th of 2021. According to the National Association of Home Builder’s, “lumber prices skyrocketed more than 300% between April 2020 and May 2021, causing the average price of a new single-family home to increase by nearly $36,000.”
  • The price of steel increased 49.5% from February 3rd to May 11th of 2021.
  • Glass manufacturers increased prices due to rising cost and shortage of raw material and labor, delay, and cost of logistics. The Producer Price Index for Glass and Glass Product Manufacturing increased 5.5% from November 2020 to May 2021.
  • Lead time delays of up to 40 weeks for structural Steel, decking, piping, and joists.
  • Insulation delays of up to 21 weeks caused by material and labor shortages as well as spikes in demand.

Recently, as plants and mills have restarted or ramped up production and some customers put off their purchases until the prices come down, the price of steel and lumber has tumbled. Steel prices fell 16% from May 10th to July 1st, and the price of lumber fell 58% from May 9th to July 1st. However, both commodities are still at levels considerably higher than they were pre-pandemic. Back in May 2020, the price of steel rebar hovered around 3,500 CNY (Chinese Yuan) per metric ton, 30% less than the current price of around 5,000 CNY. In most of 2019, the price of lumber was around $350 per 1,000 board feet, 50% less than the current price of around $700 per 1,000 board feet. While the shortage has improved in recent weeks and prices have come down, many of the price drivers still remain.

Price of Steel Rebar as of 7121

Source: Trading Economics, as of July 1, 2021

Price of Lumber as of 7121

Source: Trading Economics, as of July 1, 2021

The high demand means that steel plants and lumberyards still can’t build up inventory, and the entire supply chain remains under stress. If President Biden’s $2 trillion infrastructure plan is enacted, there will be additional demand for construction labor and materials. It would ease the supply strain if the federal trade officials would end tariffs and quotas that are raising the prices for foreign goods, but that is considered unlikely. With luck, we won’t have additional weather events which create reductions in supply and increases in demand. Nevertheless, with material costs expected to continue to be elevated at least through the third quarter of 2021, contractors and developers may have to adapt and make changes that could include cutting labor costs, lengthening project schedules, changing the types of materials used, and speeding up the bidding process, where it is possible. Customers will have to choose whether to wait for an indefinite period or accept the higher prices. Bart Morey, Senior Vice President with Colliers Houston Design + Construction Advisory Services, says “We have seen some pretty ridiculous budget and schedule impacts which have caused several clients to pause on new work. However, so far, we have not seen any projects which were underway in 2020 get shelved.”

 


Sources:

www.kirksey.com/insights/resources
www.dpr.com/uploads/Documents/Market-Conditions-Report_Q2_2021.pdf 
www.freddiemac.com/pmms/pmms30.html
www.bls.gov/web/ppi/ppi_dr.pdf
www.bls.gov/regions/mid-atlantic/data/consumerpriceindexhistorical_us_table.htm
www.cato.org/blog/how-us-trade-policy-contributes-our-insane-construction-materials-costs
www.freightwaves.com/news/californias-massive-container-ship-traffic-jam-is-still-reallyjammed
www.tradingeconomics.com/commodity/steel
www.tradingeconomics.com/commodity/lumber


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Marilynne Clark

Director, Financial Analytics | Houston

Houston

Bringing 32 years of experience in commercial real estate, Marilynne joined Colliers in 2018 to provide financial analysis to the company’s leasing and investment sales teams for all types of assets, including the following types of financial analysis:

  • lease renewal and relocation comparisons
  • mid-term lease renegotiations (“blend and extend”)
  • lease buyouts
  • sublease disposition/recovery
  • comparison of build-to-suit/designbuild to lease
  • lease vs. buy
  • own vs. sale/leaseback
  • landlord net effective rate and IRR
  • investor discounted cash flow analysis
  • direct capitalization

Prior to joining Colliers, she also specialized in advising companies regarding their financial analysis for commercial real estate requirements or investments for 17 years. Marilynne also has a background in commercial mortgage underwriting/loan originations and commercial real estate appraisal.

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