Escalating construction costs not likely to slow

Over the past 12 months we’ve seen increases in material supply costs as high as 40%, with the price of vital materials like structural timber and steel rebar up by 20%. The trend is clear – construction cost increases are going to continue. What does this mean for the future of the industry, and what can be done to mitigate the risks?

It’s certainly an interesting time in the construction industry, with the current volatile situation making it particularly difficult to forecast price increases, manage the supply chain, and address labour shortages. We’re hearing this message from clients, contractors, colleagues, and other consultants. It seems we’re all experiencing the same issues, which confirms what we already know – our sector is under stress.

Now more than ever, Quantity Surveyors need to stay abreast of the multitude of forces influencing cost fluctuations across the sector, understand its fluidity and acknowledge it will remain like this for some time.

If making sense of what this means for your construction project is challenging, this article will help you be better prepared for the year ahead. We look at the current trends and the factors behind cost and materials increases, and provide suggestions on how to mitigate the effects of cost escalations over the next couple of years.

Global forces driving prices up

According to Steel & Tube Procurement Update (August 2021), several forces underpin the global price curve at present:

1. Global construction is set to grow steadily in 2021 and 2022.
2. The global economy is expected to grow in 2021 at the fastest post-recession pace in 80 years, largely on strong rebounds from major economies.
3. The stimulus packages brought in by various countries will ensure that demand for construction materials and products remains high.
4. Global manufacturing continues to expand and will pick up further when supply shortages and bottlenecks free up and COVID-19 restrictions ease.
5. Shipping capacity and container shortages persist, and container costs are more than three times higher than a year ago.
6. Crude oil forecasts suggest increases out to 2025, so the cost of finished products and shipping of raw materials will follow.
7. Steel demand is set to grow in 2021 and continue to grow into 2023, outstripping crude steel supply, which in turn will increase the price of steel.

New Zealand’s market mirrors global trends

The New Zealand market generally mirrors the global trend of material price increases. The main factors influencing cost, and the drivers behind material price increases include the following:

Factors behind cost increases

• COVID-19
• Major labour shortages in many centres around New Zealand
• Supply shortages
• Regulatory compliance cost increases
• Health and safety compliance
• “Post Lockdown” working requirements contractors may introduce that will impact on productivity, such as turn-styles with swipe card in and out, restricting numbers of on-site labour, only fully vaccinated workers allowed on site
• Measures aimed at lowering carbon emissions will likely boost initial capital costs of construction
• Increased statutory holidays and sick leave provisions will also add to labour costs

Factors behind material price increases

• Higher transport costs due to rising fuel prices and demand on drivers
• Increased shipping costs due to rising fuel, container prices, port congestion, as well as general high demand with the current COVID delays
• Escalating prices of raw materials such as steel, cooper, coal and crude oil, with many contractors receiving weekly pricing schedules from their suppliers
• Lack of labour for manufactured products such as pipes and precast concrete.

Non-residential construction

For non-residential buildings, the current escalation rate in 2020 - 2021 sits between 3.5% to 5%.Most of the increases we have seen are spikes in materials cost around the 5% to 10% mark, noting that materials are 40% to 60% of the cost for a building element.

We are now also seeing evidence of labour cost increases, but these have been occurring at a slower pace than expected. Between now and mid-2022, due to current supply issues, we expect to see an approximate 5% to 7% increase. If supply issues are resolved, this may return to normal levels of 3% to 5%. The hope is that once COVID vaccines are more accessible and adopted worldwide, the following 12 months will start to recover as material prices stabilise and factories start to match the demand.

On the majority of projects Beca is involved in, we are hearing from contractors that they expect prices to increase in the short term. Their suppliers are unable to provide advice on where material and product pricing will be in the short to medium term, and they are receiving supplier escalation notifications on a weekly basis.

Horizontal construction

For horizontal construction (transport, infrastructure, water, stormwater and wastewater), material costs typically make up approximately 25% of project construction costs. Other costs include labour and plant, contractors’ P&G / margin, and contractors’ risk.

Over the past 12 months, material supply costs have risen anywhere from 5% to 40% depending on the material, and most suppliers expect prices to continue to rise into 2022. The average material cost increase is 20% (steel, copper, aluminium, bitumen, cement, aggregate, HDPE pipe, pipe fittings, transport, tipping costs).

If current trends continue, this means a horizontal project with a capital construction spend of say $100M with $25M in material costs will see an increase in material costs of $5M.

 

Mitigating construction cost escalations

To mitigate difficulties in forecasting price increases and supply chain issues, additional project planning will be important. Here are a range of key approaches to consider:

• Early notification to suppliers and contractors
• A focus on project programming and planning
• Identify high risk materials early and work with all parties to check availability
• Consider payment mechanisms that will assist with securing prices and supply
• Evaluate contract procurement type and method
• Carefully consider contract clauses relating to pricing or material availability, and activate contract fluctuations clauses
• Identify the potential for substitute products that are more readily available
• Allow sufficient contingency and forecast escalation allowances in budgets

Looking ahead to the future

Cost increases will vary from sector to sector, and from trade to trade. Due to the overall imbalance of demand to available supply, shipping container availability, freight times, and the complexities of COVID creating more pressure on supply chains, we foresee a market that continues to be volatile. We anticipate further material price increases in the short term and likely fluctuation at elevated levels for the medium term.

Pressure will remain for further upward movement in global and domestic material prices well into 2022, albeit at a slower momentum and of a smaller magnitude.

Our recommendations to manage this uncertainty include taking time to understand and embrace price changes so you can define project budgets that are more accurate and flexible.

Escalating prices should be aligned to global and domestic forecasts, so continue to engage with industry (main contractors, sub-contractors, material suppliers) to keep abreast of rapid changes. Advise your clients of any spikes proactively. And carefully consider escalation provisions and specific risk funding to allow for market volatility. 

Our clients trust that we have an eye on the future, including which elements will require early procurement and adjustment of contracts to mitigate supply risks.  Get in touch to get peace of mind in this ever-evolving market.