Inflation: The Impact on the Construction Sector

Construction Sector

How rising prices are affecting construction companies

Many developed economies are experiencing rapid inflation. Construction companies are feeling the effects as well — essential materials and skilled labor are becoming more expensive, and supply chain pressures and shortages make it harder to secure construction materials.

The prices of lumber, steel, and many other construction materials have skyrocketed. A disruption in the supply chain caused by the COVID-19 pandemic was at the root of the problem, but new challenges continue to put pressure on prices, including geopolitical risks. Construction materials are also in high demand as government-led infrastructure projects increase.

Skyrocketing costs impinge on slim margins

“Due to competitive salaries elsewhere, the available construction workforce is shrinking as skilled workers retire or face local restrictions related to travel and move into other professions,” says Benjamin Stenson, CEO & Founder, Norsemen Home Remodeling.

There has been an increase of 66% in steel prices, major spikes in softwood lumber prices, and a price increase more than 500% in oriented strand board (OSB) – a wood product essential to the structure of a building. Contractors and developers are being adversely affected by the dramatic price increases. In many cases, they are forced to absorb the increased costs, cutting into their already slim margins and affecting their liquidity as a result.

There is also a lack of clarity about future costs, which is complicating the bidding process and affecting contractors’ competitiveness. In the UK, for example, bid prices will increase by 8.5% this year, up from 6% in 2021.

In addition to increasing fuel costs, many pieces of essential heavy equipment – such as bulldozers, cranes, and backhoes – run on fuel, which is further straining contractors’ budgets.

In recent years, the construction industry has faced labor shortages and increasing wage costs. Due to the broader economic pressures, this challenge is unlikely to be resolved anytime soon. Labor pricing can have an acute impact on a project’s profitability since wages can account for over 50% of the overall construction costs. This is according to Alex Federo, Co-owner of FTW Concrete Contractors.

What does this mean for the construction industry?

Since most contractors operate on slim margins, increasing costs are impacting the bidding process. Since recent price hikes have been steep, estimating future costs has become extremely difficult, as they could be several times the original estimates by the time the work begins and more by the end. It is often unclear when a project will be completed due to delays in getting materials to site due to supply chain challenges.

Most countries place contractors at risk of inflation. In these situations, incorrectly pricing costs into a bid can have catastrophic effects on their budgets, especially for fixed-price contractors. Due to this, increasing numbers of construction companies have encountered financial difficulties and even gone out of business as a result.

A growing concern about the bankability of projects is making it difficult for contractors and developers to secure funding for their projects. Funders will generally be more cautious when offering funding to projects that have high value, complexity, or long build times in a high inflationary environment. Thanks to Aaron, Owner of A&M Construction.

5 actions to address inflation

A number of actions can be taken by contractors and developers to reduce the impact of inflation on their operations. These include:

  • Consider how inflation – whether it is for materials or labor – could impact the final cost of the project. “Be realistic about the increased costs and adjust your bidding process accordingly. In order to account for future price uncertainty and increased costs, contractors may also adjust their bidding methods by adding contingencies to pricing models”, says Smithe Sodine, Founder of Smithy Home Couture.
  • Engage stakeholders in risk sharing. Discuss potential challenges with project owners and consider sharing the risk of inflation under contract conditions, whether through alliance-style agreements or alternative contract terms for new and existing contracts. In some countries with long periods of high inflation, such as Latin America, this already happens.
  • As construction materials become more expensive and harder to obtain, completion timelines may have to be changed both for ongoing projects and for new bids as a result.
  • Assess your supply chain’s resilience when faced with both price increases and delays by reassessing your material procurement procedures. Balance the benefits of stockpiling essential materials against storage and security costs to determine whether it is beneficial to budget and schedule.
  • The final cost of a project will be influenced by higher material and labor costs. You may need to adjust the sum insured in order to minimize the risk of being underinsured due to higher rebuild costs. The valuation process can be assisted by your construction insurance broker or advisor, and your policy limits can be determined. Thanks to Sean Philips, Content Director of Ship Tracking.

The views expressed in this article are those of the authors and do not necessarily reflect the views or policies of The World Financial Review.