PVF Insights

Nonresidential Construction Costs Seen Likely To Spurt

The latest Construction Inflation Alert issued by the Associated General Contractors of America warned of larger materials and labor cost increases in 2008 than have been experienced in the past 12 months.

"Nonresidential construction has had a banner year so far in 2007 and we've seen spending on nearly every segment increase compared to 2006, despite the plunge in homebuilding," said AGC Chief Economist Kenneth Simonson. "The materials cost surges that plagued the industry in 2004-2006 have slowed dramatically, and labor remains available in most markets."

Simonson warned that many observers expect that the end of the calm is coming soon, "The worsening slide in homebuilding and turmoil in the credit markets threaten some types of nonresidential construction. At the same time, some materials costs are beginning to turn up again, and labor costs have started to accelerate."

The cumulative increase in the producer price index (PPI) for construction inputs since December 2003 (28% through August 2007) remains more than double the 13% increase in the Consumer Price Index (CPI). Labor costs, in contrast, have risen at similar rates for construction and for the private sector as a whole.

The cumulative difference matters because the estimates for many projects now being bid, especially public facilities, were prepared in 2003-2005 under the assumption that construction costs would escalate at the same rate as the CPI. That divergence explains why some projects are being canceled, delayed or redesigned.

"The housing meltdown and the more recent credit market turmoil do have some spillover effects on nonresidential construction," noted Simonson. "Retail, suburban office and local government construction are especially affected by the drop in homebuilding, home sales, and property values, respectively. Tighter lending standards and financial firm layoffs will trim construction of offices and other income-producing properties, such as hotels and warehouses."

Meanwhile, the nonresidential industry has benefited from greater availability of specialty trade workers who have lately shifted from residential work. Simonson added, "But wages have begun rising more steeply for specialty trade contractors, suggesting that the number of workers suitable to switch is close to exhaustion. In the next several months, the rate of wage increases is likely
to reach 5-5.5%, up from a recent 4.5% gain."

Labor costs are likely to accelerate further as well if residential building begins to draw back specialty trade contractors in late 2008. "Construction wages could go up 5-6% annually for several years beginning in late 2008," suggested Simonson.

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