5 Tips to Forecast Construction Costs with Inflation in Mind

January 19, 2022
construction crew framing a house

Learn from a top construction economist

There has always been a strategy to forecasting future construction costs, whether it is material like lumber, or the volatile labor wage market. But as various rates of inflation take their effect on the construction industry as a whole, using accurate and current construction cost data.

Construction Economic Analyst, Ed Zarenski, partnered with 1build to share five tips for contractors and developers to estimate better during inflation. With this knowledge, your team can take the first step in making profitable decisions.

Weigh the Pros and Cons of Your Pricing Index

An index is typically used to compare a completed project to an upcoming similar project.

There are many construction pricing index options, including The Commercial Construction Index (CCI), the ENR Construction Cost Index and Building Cost index, and Dodge Construction data. Learning to read and interpret that data can give you the insight you need to forecast your project rate and hiring needs. Here are three things to remember as you get started:

  • The construction starts metric is not the same as construction spending. Think of starts as a project award, but the money won’t get spent until construction is underway over the next 24 months.
  • Construction starts must be adjusted for the share of market captured. You cannot simply use the starts data directly to predict what the economic spending will be over the next years.
  • Cash flow over time must be applied to get spending.

Spending Forecast for 2022

Forecasts start out with all construction data, but an expert economist will compare the share of complete data, which changes every year. Construction spending data might capture 50-60% of starts data each year. Most contractors will look at a spending forecast and assume those numbers indicate business volume, but when calculating for inflation, revenue is not business volume because it includes inflation.

In 2021, residential new starts were up 21% and was one of the highest performing years in a decade. So, if the level of activity increased in 2021, you can imagine that builders secured a large volume of bids, thus making them very busy and moving new starts into the 2022 backlog. This means spending is up, starts are up, and backlog is up. That momentum will slow down a little bit in 2022, but with so much work, the industry will maintain a high level of work, even if residential construction starts slow down over the next two years.

Learn What’s Inflation and What’s Not

It is important to understand what numbers in your estimate are affected by cost inflation and that not all rising costs are caused by inflation.

Inflation is the change in cost of the same component over time. But what are some price changes that cannot be categorized as inflation?

  • Increased improved quality of materials is not inflation.
  • Increased quantity is not captured in inflation.

Some of the most common causes of inflation include:

  • Labor availability, wage rate, and productivity
    We are hearing from contractors across all trades that it is difficult to find sufficient skilled labor. But jobs are increasing, so contractors are hiring. But who are they hiring? If they are hiring less-skilled labor, productivity is going down and overtime hours will increase. Then that productivity decrease is stacked on top of the current wage rate to affect overall labor costs.
  • Material availability, demand, and cost
    Material availability is the ability for you to secure necessary materials on time to close up your project or to finish it on schedule. And this applies to not only cost of materials, but also to availability of materials and bid activity. If there are materials like windows, gypsum board, or asphalt roof coatings that are unavailable, it makes it difficult to meet your schedule and estimated price.

The same rate of inflation we saw in 2021 is not predicted to carry into 2022, and costs should not continue to climb at the same rate. That does not mean costs will go down, it means the rate of increase is decreasing. There will likely continue to be increase of costs, just not to the extent we saw in 2021.

Track Effects of Input and Output Indices

Following national data to forecast pricing for your construction business only works well if you have framed each kind of data in the right way. Input indices point to the materials and energy needed to build, while output indices show what prices are after production and sale.

Input indices (Input indices do not include margins)

  • Local labor and material costs
  • PPI Materials

Output indices (Output indices do include margin)

  • Selling price
  • PPI trade cost
  • PPI building type

Watch these Specific Materials in 2022

  • Lumber. Prices for lumber increased at the end of 2021, which has an impact on the price of products that use lumber for the first part of 2022.
  • Copper. Copper is predicted to become the new lumber, and while we aren’t sure what the total increase will be, you will certainly want to keep an eye on its price.
  • Glass/Glazing. You may think of glass and glazing as what is reported in the Producer Price Index, but the most costly component of glass and glazing is actually natural gas, which is up 150%.
  • Roofing Assemblies. Some materials for roofing assemblies are being delayed by supply chain disruptions, with some lead times being as much as eight months out.

Use a Local Cost Database

While most cost index data is national, a localized cost database, like 1build has created and continues to improve, will incorporate specific local material and labor costs. Because of the ongoing local assessment, it would far outweigh any national-level index that you could use. We know that the change in the material and labor costs in Dallas are not the same as costs in Atlanta or Boston. If you can have a specific local cost index, it will be the most accurate data.

If you are ready to learn more about construction costs and how they are affected by inflation, the entire webinar recording with Ed Zarenski, and 1build CEO Dmitry Alexin, is free to view.

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