escalation and its impact on construction · escalation and its impact on construction. 1. 2 ......

January 30, 2020

Escalation and Its Impact on Construction

By: Dan Pomfrett and Brian Burton

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ESCALATION AND ITS IMPACT ON CONSTRUCTION

AbstractUnderstanding escalation can help project owners and other stakeholders navigate economic uncertainty and deliver projects with confidence. In this paper, Cumming team members Dan Pomfrett (Vice President and in-house economic expert) and Brian Burton (Research Administrator) define escalation and the factors that contribute to it, describe recent escalation trends as well as expected patterns for 2020, and provide some general advice on how to apply this knowledge to a construction project.


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U.S. CONSTRUCTION LABOR TRENDS

Source: U.S. Bureau of Labor Statistics Source: AGC Labor Survey - 2019

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National Construction Employment (2011-2019)

Trade Workers Unemployment Rate

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% of Contractors Having Increased Difficulty Filling Craft Positions over 2018

U.S. CONSTRUCTION MARKET OVERVIEW

MARKET SNAPSHOT Q4 - 2019

OverviewWhat is escalation and how does it affect construction? This brief paper provides answers to these questions, identifying the key aspects of escalation and how to apply this knowledge to your construction projects.

What Is EscalationFor our purposes, we define “building cost escalation” as the anticipated increase, over a defined period of time, in the cost of constructing a building. Building cost increases usually occur as a result of market forces and reflect increases in the cost of labor and materials. In general, escalation is indicative of higher levels of construction activity driving up prices.

What Should I Look Out ForThere are a number of factors that can feed escalation, but they can generally be categorized into two primary areas: labor and materials.

Prices for the materials used in construction can be volatile, and they are affected by factors at every geographical level from local to global. As shown in the chart below, material pricing in the U.S. continues to fluctuate, with dramatic changes in the last 12 months alone. Fueled by both supply and demand, pricing has also been driven by external sources such as the recent section 232 tariffs, political turmoil, and natural disasters.

By far the biggest driver of escalation in the construction industry is labor. For example, prior to the 2009 recession, the labor market was struggling to keep up with demand. Following the recession, the industry saw a substantial drop in labor, with multiple reports indicating that approximately two million workers left the industry at that time. In the 10-year period since then, construction volume has returned to pre-recession levels; however, the labor market has struggled to keep pace for several reasons: a lack of interest from the younger population, a large portion of the workforce reaching retirement age, and the migration of labor to locations with lower costs of living, among others. This has culminated in a skillset shortage across the U.S., with the overall market still 200,000 new workers below the peak of Q2 2006, despite adding an average of approximately 224,000 workers per year since June 2010.

Labor Materials

2.5%1.4%

‐0.1%4.2%4.0%

3.1%4.4%

2.0%0.8%1.0%

‐8.0%‐2.0%

‐10.1%6.4%

‐6.9%1.0%

‐4.8%0.6%

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‐15% ‐10% ‐5% 0% 5% 10%

Prestressed concrete productsAC paving mixtures and blocks

Asphalt roofing & sidingConcrete block and brick

Concrete pipeReady‐mixed concrete

Precast concrete productsBrick and structural clay tilePlastic construction products

Flat glassGypsum products

Insulation materialsLumber and plywoodArchitectural coatings

Steel pipe and tubeCopper and brass mill shapes

Aluminum mill shapesSheet metal products

Fabricated structural steelMetal bar joists & rebar

Construction machinery & eqpmt

Construction Materials Price Movement ‐ Last 12 Months

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Applying This Knowledge To Your ProjectEscalation is always a risk and as with any risk, should be understood, monitored, and planned for, so that any unwanted effects can be anticipated and mitigated. It is important to continually review market conditions from the inception of your project to its completion, as there will be fluctuations throughout the project lifecycle.

Regarding labor, look for the relationship between the amount of labor demanded by the market and the number of workers available. If labor levels are trending up while demand is trending down, escalation will be lower than if labor is decreasing while the number of projects is increasing. With regard to materials, demand from projects is still going to be a primary driver of costs, but there are a number of other factors feeding in as

well. Transportation costs, trade barriers, changes to production levels, and the availability of raw materials will all have strong impacts on material prices and thereby on escalation. A common factor affecting both labor and materials is the volume of construction activity in a region. Growth in the number of ongoing projects increases demand for both labor and materials, which in turn increases escalation. Because of this, it is important to keep an eye on the number, timing, and types of projects occurring in the region.

Consideration should also be given to other market forces, including relevant political changes (such as mayoral voting or the passage of relevant new laws) and local requirements such as diverse business enterprise participation goals — these and other factors can all affect escalation.

The key takeaway from all of this is that there are four main factors feeding into escalation that ought to be watched throughout a project: labor levels, material costs, local construction activity, and local conditions. Keeping an eye on these factors will help you account for escalation throughout the life of your project.

The key factors to watch are labor and materials.

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Trends in EscalationEscalation can be influenced by time, location, project type, and sector, and therefore be evaluated on a project-by-project basis. Still, there are some trends that affect escalation across sectors, types, and locations, and which can be felt regionally or even nationally. We are going to discuss some of these broader trends below, focusing on national and then regional trends in escalation.

National escalation in 2019 averaged about 4.01%, which is solidly in line with normal baseline escalation in the U.S. This level of escalation is caused by natural increases in the size of the economy, as well as inflation and cost-of-living increases in wage rates. Disruptive events at home and abroad can push escalation away from this baseline, both upwards and downwards. If global supplies of raw or processed materials are threatened, escalation will rise as prices for the affected goods are driven upwards. Abundant supply can have the opposite effect, driving prices and escalation down. Even goods that are only indirectly involved in construction can have a significant impact on escalation rates. For example, crude oil prices can affect few projects directly, but increasing oil prices will also raise fuel costs across all markets, thereby increasing the cost of transporting other products. This gives oil a massively outsized influence on escalation. These trends in material prices are felt globally, but they can be mitigated or exacerbated by local factors and conditions.

At more local levels, trends in construction activity begin to matter more. The volume of activity in a city has a profound effect on local escalation by directly creating demand for labor there. This activity also affects the

surrounding areas as high volume pulls in labor from further afield, thereby reducing those areas’ local labor supply. This pattern is present in every city and town, with construction and labor activity reacting to local market conditions and creating trends that can be seen at higher levels.

Looking at escalation at the regional level, we can see the combined effects of both the more global material trends and more local demand trends. In 2019, escalation along the West Coast as a whole was about 3.78%, which is below the national average. The same is true for the Central region of the country, which averaged 3.89%. The East Coast, on the other hand, was modestly above the average, at 4.28%. The differences seen with even this broad breakdown underscore how varied escalation can be across regions.

When we look forward to 2020, we expect national escalation to rise to 4.56%, with the West region hitting 5.10%, the Central region rising to 4.41%, and the East climbing slightly to 4.34%. These increases are rooted in predicted average increases in the volume of construction activity in each region. The increased demand for construction labor will push up prices in the cities and towns where those projects are located, as well as in surrounding areas. Actual escalation rates will likely vary from these forecasts as the year goes on and conditions change. Local escalation can also vary wildly from regional or national averages. That is why it is critical to monitor your local conditions throughout the lifespan of your project, as they are the primary driver of local escalation.

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Dan Pomfrett Vice President | [email protected]

Brian BurtonResearch Administrator | [email protected]

Dan is a Vice President at Cumming, as well as our National Director of Forecasting and Analytics. He holds a B.S. degree in quantity surveying, is a certified member of the Royal Institute of Chartered Surveyors, and has more than 20 years of industry experience. He also researches and writes Cumming Insights, the company’s quarterly report that breaks down economic trends and projections for regional construction markets across the country. In addition to his work in economics, Dan has provided cost-related services for numerous high-profile clients, including international architectural firms, museums, cultural institutions, and private developers.

Brian is an economic researcher for Cumming, working on market and topic studies for the company and its clients. He has a Master of Arts in economics from the University of Alabama and is part of the team that writes Insights, Cumming’s quarterly economic report.

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