VOICES FROM THE INDUSTRY: The world might be flat, but construction costs aren’t

For the most part, construction has been a local story, a story about local workers building buildings in our community. But the story isn’t so local anymore.

Global economic forces have begun to intersect with local issues at the construction site. The result: a significant and
ongoing increase in construction costs across central Indiana and the rest of the United States-an increase that shows no signs of slowing.

Through the first quarter of 2004, construction costs increased at a calm and predictable rate of 1.3 to 3.4 percent. At that point, the biggest driver behind the cost escalation was the availability of labor, the use or more dramatic designs and the increasing sophistication of building systems.

Then came the bad news.

By the end of 2004, various cost indices (Engineering News Record, the Turner Index, Dodge, etc.) told us what we already knew: the annualized rate of construction-cost escalation in 2004 had hit almost 10 percent. And there was nothing we could do about it.

Now, economists tell us those moderate inflation rates through 2003 were probably
a fluke made possible by the rare combination of cheap imports, affordable energy, a very strong dollar and a relatively weak global economy.

Now we’re back to reality-back to that flat world and the rise of the Asian economies.

In 2004, China devoured a huge share of the world’s raw materials. One obvious impact on construction was the near tripling of the cost of steel. Steel fabricators went broke, and bankruptcies stopped or delayed many projects.

That was followed by aftershocks in lumber, copper, plywood, insulation, gypsum wallboard, stainless steel and concrete products.

Other industry trends also have influenced the bottom-line costs for contractors and subcontractors. Safety programs, for example, have become more sophisticated-and more costly. And the growing trend toward more environmentally sound construction sites means more expenses. The paybacks from these programs include smaller claims and a cleaner world. But they come with a price for contractors.

Insurance and bonding represent yet two
examples of overhead expenses that have increased dramatically. Both items were routine business costs before 9/11. Now, however, the availability of both is a burden, especially for new or small businesses, many of which are WBE or MBE firms.

Looking ahead, most cost indices indicate that 2005 will have an annual cost escalation rate in the range of 4.4 percent to 4.8 percent. We’re told we’re back in a trade-off period when cost increases in concrete and copper will offset the cost decrease in steel. Please don’t believe it.

Central Indiana is about to enter a period of major construction. The midfield terminal at the Indianapolis International Airport will be rising from the ground, and we’ll soon break ground for the new stadium and Convention Center expansion. And don’t forget about all the new schools and houses. Yet we may not have the resources to handle this construction boom.

The skilled labor shortage in central Indiana has been well-documented. We just can’t replace our aging workforce quickly enough. We also have a shortage of local contractors that are financially capable of tackling large projects, particularly in the
mechanical and electrical industries. The cost of copper alone is driving many of the smaller companies into near bankruptcy, so growth is not an option.

In light of the bleak economic forecast, I have some ideas that might help all of us weather the storm:

Build your cost estimates on a system-by-system basis. Consider the impact of both material costs and commodity prices as well as the availability of labor.

Adjust your escalation allowances upward. Don’t be lulled into planning with that old 3-percent rule.

Consider a larger buy-out contingency for equipment purchases. Those will occur late in the project schedule, and by that time, the equipment may be priced in Euros.

Calculate your escalation factor using the full length of the project rather than the mid-point. Averages don’t work anymore.

When bidding, consider accepting the risk for the price of steel or any commodity up to the time the contractor makes his mill order or locks in the pricing.

Then, imagine the coming financial impact of the clean-up from Hurricane Katrina and diesel fuel that costs more than $3 per gallon.