Continued signs of stable economic growth indicate that the recovery is gaining momentum in many parts of the United States and Canada. Construction selling prices for institutional projects grew at a 6 percent annualized rate in 2012, on top of a 3 percent increase in 2011. Construction costs are expected to continue stabilizing and rising in many regions as market confidence and capital spending increase.
According to Vermeulens, increased commodity costs and project volumes will push capital spending closer to the Construction Cost Trend Line for the near to medium term in many markets. Prices are expected to surpass the Trend Line in 2014, repeating long-term cyclical patterns.
Government spending reductions could potentially slow institutional construction growth and temper future price increases, but these impacts are expected to be slight.
Construction Costs
For the past 25 years, construction costs have trended toward a 3.25 percent annually compounded escalation rate. In 2008 construction costs reached a peak and adjusted rapidly downward then stabilized for two years. Similarly, costs peaked in 1990 and 2001.
According to Blair Tennant, a project manager and cost engineer for Vermeulens, the rate of escalation in construction costs is indirectly tied to the goal of achieving an annual inflation rate of 2 to 3 percent and the monetary policies used to achieve this.
Data shows that non-residential construction prices have increased by 9 percent from their recessionary bottom. Vermeulens saw an average selling price increase of 3 percent in 2011; with another increase of 5 to 6 percent for 2012.
In addition to a surge in commodity pricing, the cost increase is attributed to contractors trying to regain lost margins in order to remain in business.
According to Tennant, the NYSE is a strong predictor of construction costs. The reason for the correlation is that improving equity markets provide capital for investment spending.
“Equity markets have moved sideways for much of the last two years,” says Tennant. “This is due to uncertainty with debt levels, default concerns, and minimal growth in the jobs market. As markets return to more stable growth levels this will lead to increased construction volume and prices.”
Construction Volumes
Construction volume is the number one driver of construction costs. This is because contractor bidding opportunities increase as project volumes and backlogs grow—which leads to higher bids.
Residential construction volume is now 32 percent higher than its most recent bottom in July 2011, while non-residential construction volume increased 14 percent. Total construction volume has increased 16 percent from its bottom in March 2011.
Another key indicator of volume is the AIA Architectural Billing Index (ABI). The ABI for February 2013 was 54.9—indicating the strongest growth in billing at architecture firms since the downturn.
“This indicates a significant jump in design activity for 2013 that will result in increased construction activity in 2014,” says Tennant.
Construction Employment
For the first time since 2007, there has been a prolonged increase in demand for construction labor. The latest data showed increased labor demands in 30 states.
Employment utilization rates are a better indicator of escalation pressure than unemployment rates. Utilization rates are calculated by comparing the ratio of current construction positions to the peak construction employment and allowing for a sustainable rate of growth.
“Generally, a utilization rate of greater than 85 percent will put upward pressure on labor costs,” says Tennant.
While the majority of states are below peak levels of construction employment, some—including Texas, Oklahoma, Louisiana, and North Dakota—are entering zones where labor rates can be expected to rise.
Looking Forward
Continued low interest rates and federal government bond purchasing will enhance the market’s ability to grow. According to Tennant, the sequestered spending cuts and other political influences will have a small effect, mainly on infrastructure spending. As global financial markets recover to pre-recession levels, institutional buyers can expect more stable construction costs in the near to medium term, with rising rates over the long term.
“For institutions with a defined demand who are building soon, data clearly shows that the low cost buying opportunity we recently experienced is coming to an end,” says Tennant.
By Johnathon Allen
