construction cost and market factors michael d dell'isola pe, cvs, frics senior vice president...

Construction Cost and Market Factors

Michael D Dell'Isola PE, CVS, FRICS Senior Vice President

Faithful+Gould

Michael D Dell'Isola PE, CVS, FRICS Senior Vice President

Faithful+Gould


• Michael D. Dell’Isola, PE, CVS, FRICSSenior Vice PresidentFaithful + Gould Orlando, Fl 32810

• Degree:– BSME

• University:– Tufts University, Medford, Mass.

• Years of Experience:– 40+

• Professional Field:– Cost management, value engineering, life cycle costing, technology and

industry best practices– Practitioner, author, educator and speaker

• Something you do not know about me:– An avid golfer and car nut.

Speaker Biography

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• From 2002 to a peak in 2006, overall construction spending increased by 35% or an average of almost 7% per year.

• After the peak year of 2006, spending then decreased by almost 35% through the end of 2011.

The construction marketplace in the USA experienced dramatic changes from 2002 through

2011.

• As a result of the dramatic drop in construction volume, exceptional competition has dropped bid prices 10%, 20% to even 40%.

• Construction volume remains constrained and bid prices remain very low

The period recorded the most significant

upward and then downward change

in the last 40 years.

Background

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4Construction Cost and Market Factors

Today’s Presentation

Introduction

Economics, Competition and Price

Construction spending and the cost of projects

• How does competition affect indirect costs?• Tracking Competition and Bidding• What drives construction volume?• Regional Variations• Long term issues to consider

Projections

• Bidding Factors and budgeting projects• Managing competition and dealing with low bids

Conclusions

Economics, competition and price

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Economics and Price

• Construction is a commodity• Unique projects• Tough to “build inventory”

Basic law of supply and

demand• Four to eight primes• Three to five subs• Reasonable competition• Mostly design-bid-build

The “Old Days”

• Limited bidders – primes, subs, suppliers, etc.• Numerous delivery methods• More negotiation

2006 marketplace(The Boom)

• Abundant bidders – primes, subs, suppliers, etc.

• Numerous delivery methods continue• More focus on price• Tough negotiating

Today’s marketplace

(Post Bust)


Construction Bidding and Estimating

• Maximum price that can win• Cash flow is a keyBidding goal

• Prime contractor(s)• Subcontractors• Lower tier subcontractors and suppliers

Bidders

• Estimating is a technical, empirical and predictive process

• Bidding is a business decisionEstimating and bidding

• Bids are only as valid as the scope and documents on which based

• Bids are only as valid as the bidders who prepare them

Important assumptions

Construction Spending and the Cost of Projects

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0

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1000000

1200000

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Year TOTAL CONSTRUCTION RESIDENTIAL NON-RESIDENTIAL

Construction SpendingJanuary 1977 to 2013 - Projected (Average annual, Millions)

TerroristAttack

HousingDownturn

Recession Recession


Breakdown of Construction Costs

Total Costs

Prime Contractor/CM

Mark-up

Subcontractor Mark-up General

Conditions

General Conditions

Base Wages

Materials Installation

Purchase Cost

Shipping & Handling

Taxes

EquipmentLabor

Operations Cost

Equipment Rental

Premiums

Fringes

Direct Costs

Taxes/Insurance


Factors Affecting Bidding

• Compensate for risks that cannot otherwise be controlled. • Mitigated by analysis, qualifiers, provisions and skills• Depth of general conditions staffing.• Risk transfer to lower tier subcontractors

Risk Premium

• Purchasing of subcontractors and suppliers. • Allocation of project overhead costs• Position and command of marketplace

Purchasing aggressiveness

• Internal staff, marketing and business development, insurances and bonding capacity.

• Track record is important Indirect Overhead Costs

• Superior construction methodology and more effective management strategies.

• Competition can create incentives for creative solutions. • The search for change orders…..

Technological/Informational Advantage

• Implications of winning a bid or not winning• Backlog as critical for long term success. • Future work potential and cash flow

Opportunity Cost

• Executive level decision• Cash flow may trump allProfit Margin


Impact

Each of these categories can affect a bid by 5 -10%

Collectively the total combined effect can exceed 30%.

Competition or the lack of competition is a major factor in how these issues are assessed and how the final bid is prepared

Competition explains why bids can vary so dramatically in different markets

Remember these impacts affect primes, subs and potentially suppliers


Effect of Competition on Prices

0.85

0.95

1.05

1.15

1.25

0 2 4 6 8 10 12 14 16 18 20

Source: Area Cost Factor Study, U.S. Army Corps of Engineers

Number of Bids

Bid Factor

2004 – 2008

Marketplace

Current

Marketplace


Relationship of Nonresidential Construction and GDP

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0%

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Total Nonresidential Construction GDP

Ye

ar-

on

-Ye

ar

Pe

rce

nt C

ha

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e


Regional Variations

Nearly all regional markets have remained competitive

• Florida• Nevada• California• Michigan

Some areas remain hyper-competitive

• Washington DC, parts of the northeast• Energy producing states

More moderate

• Where private investment is lagging, construction is likely lagging

Key


Summary – What drives volume and pricing

GDP drives

construction

spending

Construction

spending drives

competition

When GDP is robust, spending increases. When GDP

is weak, spending

drops

When spending increases, prices rise.

When spending

drops, prices drop

Caveats:• Major

additional increases in public spending

• Significant drop in supply – bankruptcies and downsizing

• Other events


Long Term Issues to Consider

• Even if there is a substantial increase in GDP, construction spending is a lagging indicator that tends to follow GDP increases by at least a year.

• This will tend to keep prices low even after a GDP increase.

Gross Domestic Product (GDP)

• Government “stimulus” spending is all but complete• While the overall impact on the industry is not yet clear, “grants” can have

a profound effect on localized activity and therefore pricing. Government Spending

• The increasing federal debt has the capacity to stifle private investment and also lead to general economy inflation of over 5% or more.

• General inflation would spill over to construction labor and material costs, raise prices and also increase the cost of capital to fund construction. This will tend to increase cost.

• Energy cost is now problematical

Inflation and Debt

• Many contractors, subcontractors and suppliers are barely managing cash flow and with recent bids offering modest if any profit, a large number may fail in the coming years. This reduces competition and will eventually increase costs.

Supply Constriction

• The economies of China and India, in particular, are still booming and will continue to compete for natural resources, contracting capacity and investment of capital. The net effect tends to raise prices.

Overseas Competition

• The move to negotiated contracts, design-build and integrated project delivery (IPD) all present significant advantages to owners but have the collateral effect of potentially reducing competition.

• Care must be taken to assure a fair price is paid.

Alternate Delivery Methods

Examples

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Project Examples

• Estimated at $400/SF in 2007 and put on hold• Bid in early 2010• 10 prime bidders• Low bid at around $200/SF• Some modest scope and quality adjustments

County Courthouse, Florida

• Bid in 2007, two bidders• 25% over budget, put on hold• Rebid in late 2009, 8 prime bidders• Low bid at 5% below original budget• Full scope and minimal quality adjustments

Federal Courthouse, Florida

• Originally bid in August 2008• Two bidders• 20% over budget and put on hold• Rebid in Early 2009• 8 bidders • Low bid at 20% below budget

School Project, New York

• Elementary Schools• One – Bid on late 2007• Two bidders• $155/SF• Other – Bid mid 2009• 13 bidders• $124/SF

School Projects, Virginia

Projections

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US Economic Forecasts by e-forecasting

U.S. Quarterly Forecast of GDP and Key Indicators June 2012

http://yhst-42614517947461.stores.yahoo.net/


Construction Industry Statistics ("Statistics Brain" Website)

Statistic Verification Source: US Census BureauDate Verified: 4.11.2012Construction Industry Statistics Annual RevenueUS Construction industry annual revenue $1.731 TrillionNumber of construction companies in the US 729,345Number of construction company employees in the US 7,316,240 Average construction company employee salary $45,200

Construction Company Type Statistics Number of CompaniesValue of Annual Business

Construction of Buildings 211,956 $748 BillionHeavy and civil engineering construction 39,439 $260 BillionSpecialty trade contractors 477,950 $722 BillionStates with the most construction companies NumberCalifornia 72,173Florida 51,143New York 43,409Texas 37,200Illinois 30,236Pennsylvania 28,505North Carolina 25,457New Jersey 23,142


Inflation, Escalation and Market Factors

Inflation is a function of the general economy

Usually measured by the Consumer Price Index

(CPI)

Is both national and regional

Escalation is the general increase in the cost of labor and materials of

construction

Generally follows inflation

But, may not, depending on the drivers (steel from 2004

to 2008, for example)

Market factors affect the cost of individual projects

Is a function of competition

Tends to be area dependent

Will often trump inflation and escalation


National Cost Indices

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2011

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Means 30-City Average ENR Building Cost Index Turner Building Cost Index

Co

st

Gro

wth

(2

00

0 =

1.0

0)


•When economic growth and construction spending are all in reasonable balance. This means an estimate based on material, labor and reasonable indirect costs ( a “fair value” estimate) will also reasonably predict bids

Bid Factor = 0

•This would indicate that demand for construction is in excess of supply and competition would be limited. The bid factor percentage would need to be added to the “fair value” estimate as a premium to predict the bids. The more dramatic the excess, the more significant the bid factor.

Bid Factor > 0

•This would indicate that demand for construction is below supply and competition would be enhanced. The bid factor percentage would need to be deducted from the “fair value” estimate as a discount to predict the bids. The more dramatic the downturn, the more negative the bid factor.

Bid Factor < 0

Bidding Factors and budgeting projects

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Annual Nonresidential Spending versus Bidding Factor

1970 – 2011 (Projections through 2014)

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Bidding Factor % Change NON-RESIDENTIAL


How will the market affect individual projects?

• Cost already factored in

• Changes, especially delay claims will be very aggressively pursued

Under construction

• Bidding within a year – expect a significant discount – 10%

• Up to 20% in depressed areas

• Beyond a year – consider up to a 10% discount

Under design

• Design-Build – early pricing may not reflect discounts

• CM & GMP – likely will not show pricing comparable to design-bid-build

• IPD – May be higher than DB

• Care to assure fair competition and a fair price

Alternate delivery systems

Advice on budgeting and delivering projects

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•They understand that prices are down and as a result, their expectations may be growing, •…and good markets cannot always overcome an increased appetite.

Owners are aware of the market to a greater

or lesser degree.

•The contracts that are used, provisions for local and disadvantaged business, paperwork requirements, payment history, bonding and insurance requirements, liquidated damages, schedule, access to the site, security limitations, environmental limitations and complicated General Requirements•All contribute to the marketplace’s response. •In spite of a highly motivated market, care should always be exercised on any and all of these provisions.

Owners also need to understand that to some degree they control competition

directly and indirectly through the perception of their project by the

marketplace.

Managing competition and dealing with low bids

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The bidding documents must be clear and represent the full scope of the work

• Even if they are for preliminary purposes and not 100% complete.

• If the documents are not clear and complete, then the low bidder will likely be the one who excludes the most or who makes the most limiting assumptions, making evaluation of pricing problematic.

• Good documents are an important component of any procurement process regardless of specific delivery method.

This process assumes one very important condition

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• GDP drives construction spending

• Construction spending drives competition

• When GDP is robust, spending increases - when GDP is weak, spending drops

• When spending increases, prices rise. When spending drops, prices drop

The relationship between economic activity,

construction spending and

pricing is clear:

Conclusions

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• They will likely continue for the foreseeable future.

• Intelligently factoring market conditions into estimating and projections of bidding is an important step in overall project delivery.

• Today’s marketplace continues to provide a great deal, but it’s a challenge and requires care

• Future is tough to predict, but it’s still unlikely to change for a year and perhaps two

The dramatic ups and downs of the

past years presented a number of challenges

• It’s a great time to have money to build

• Keep an eye on the construction market – especially in your local area

An intelligent approach to

budgeting and pricing is essential

Conclusions

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Discussion

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construction cost and market factors michael d dell'isola pe, cvs, frics senior vice president...

Documents

construction bidding

price construction

construction marketplace

construction volume

bust construction cost

background construction

overall construction

cost of projects