We know construction has faced a myriad of challenges over the past couple of years brought on by the pandemic. The industry grapples with turbulent prices, a scarcity of skilled labor, and rising borrowing costs. It goes without saying that this leads to rising construction costs, skewed project timelines, and the inviability of projects.
Pre-pandemic levels is something we write a lot about, as if its a place we can go. That era is over, for construction and other industries. It serves as a memory, a signpost for comparison, not a time we can return to.
The reason is that the cost of money is different now. What does this mean? It refers to rising interest rates and inflation and the ripple effect they have on the actions we take in construction. The ripple effect is the cost we pay for the increased cost of money.
I want to delve into the complexities of the current landscape, looking at the impact of the cost of money on the construction industry and what that means in the short and medium to long term.
Increases in material prices and labor have hindered project viability. indicated that about 82.5% of construction materials experienced a significant cost increase since 2020, with an average jump of 19%. This surge in prices has been observed in key construction materials such as wood (16%), steel (22%), concrete & masonry (15%), electrical conduit (12%), and insulation (11%).
The scarcity of skilled labor is an endemic problem in the industry. Its a driving factor behind the increase in construction costs as firms are forced to offer higher wages, raises, and bonuses to attract and retain workers. The result? Human capital is more expensive resulting in a higher cost for goods and services.
This surge leads to delays and termination of projects as developers and contractors reassess their budgets and financial viability. This is especially true in the residential sector. , and half are saying theyre building fewer units. Canada already faces a housing shortage so this alarming trend wont help cool the affordability of homes in the medium to long-term.
In the United States there was a in residential construction starts in 2023 so far. Completed homes have also decreased by . Couple this with higher mortgages for home buyers, what do you get? More slowdown.
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Inflation doesnt seem to be cooling either, which at least for the short to medium term, means that costs will remain high. This will push smaller contractors to the brink as their profit margins shrink and their costs continue to rise.
Yet, despite all of this theres a rise in construction spending. An increase doesnt necessarily mean that , but that theyre charging more for the services theyre already providing. Is this good? It does show confidence in the economy. It also acts as an indicator that inflation needs to be controlled, which leads to interest rate hikes. Construction is tied to borrowing costs because the vast majority of contractors dont have the cash on hand to build projects out of pocket.
By most accounts, theres confidence in the industry because of the steady backlog of projects. The Construction Confidence Index (CCI) provides an indication of the outlook of construction owners for sales, profit margins, and staffing. ABCs Construction Confidence Index in August remained above 50, indicating that construction owners still expect growth overall for sales, profit margins, and staffing.
Specifically, the CCI for profit expectations was 60.8, staffing expectations were 64, and sales hopes were 63.9. This indicates a positive outlook among construction executives.
This outlook is particularly true in infrastructure. The backlog in this sector increased for the third straight month and, more than 18 months after the passage of the $1.2 trillion Infrastructure Investment and Jobs Act, . The spending here isnt expected to peak for another four years as more infrastructure projects get awarded.
Dampening this positive news comes from Washington D.C., as some contractors have claimed the rules around how the money is or vague. Large-scale projects seem to be reserved for unionized firms, pushing out competition from nonunion contractors, and driving up service prices which are . Prices would also increase in the private sector, as nonunion firms have a smaller volume of projects to bid on (as well as the size and scope of these projects). In order to make a profit theyll have to charge more, leading to an overall decrease in construction starts as well as work in general.
Why all this focus on housing and infrastructure?
In my view, these two construction sectors bear the biggest cost when it comes to the daily lives of the general public. The ripple effect of their success or slowdown can shift behavior on a large scale.
For example, if thousands of people are having their new housing or apartment builds canceled, it adds stress in the short term as individuals go through the process of getting their money back. People will also have to find housing as their original plans collapsed, which is an additional cost. In the long term, confidence in builders diminishes and the fundamental problem, a housing shortage, is only exacerbated.
Infrastructure has far-reaching consequences for the quality of life of the country. For one, if taxpayer money, which funds the IIJA, is bogged down in bureaucracy, or used inefficiently, therell be hundreds of important projects that dont get the attention they need. This means bridges, roads, water and energy projects that wont serve the public effectively. The ripple effect of this is massive as it degrades foundational aspects of our society, like clean drinking water. It also degrades peoples ability to get to work.
On the other hand, the effective use of these funds can help revitalize decaying towns and provide jobs for years to come, creating a rising tide that helps lift all boats.
And thats what this is about, the increased cost of money has, at least in the short term, made the tide recede. Under normal circumstances, this would all make more sense, but the smoke from the pandemic is still clearing. And it’s clouding exactly what we need most at this important juncture, a little bit of certainty.