Whenever there is major economic disruption like we’ve seen in 2020, one of the main questions inside the construction industry is “What will happen to pricing?” For commercial buildouts, no single factor drives construction pricing. However, there are several economic forces that have varying degrees of influence. Here are five that pack the biggest punch:
- Supply & Demand: Construction pricing is highly sensitive to the forces of supply and demand. Cutting pricing is inherently risky and can equate to a lot of work for little or no reward. Thus, when demand is high, construction pricing increases to reduce this risk. When demand decreases, however, contractors are willing to pursue riskier projects at reduced pricing to keep their businesses moving forward.
- Backlog: Backlog is the amount of construction work currently on the books. When the economy is strong, backlog and pricing increase creating a buffer. This buffer causes a lag in how construction is impacted and how it reacts to current economic conditions.
- Labor Costs: Construction is labor intensive. It’s difficult to pull wire, hang pipe, or lay block without skilled labor. Because of this, a large portion of construction costs are determined by labor expenses. Wages increase as available skilled resources decrease in relation to demand. You also need to factor in cost of living. This explains why the cost of construction is higher in New York City, Northern California, and other regions with a higher cost of living and high demand.
- Commodity Pricing: Commodity pricing also plays a role in determining construction costs. When oil prices go down, so do petroleum-based products such as insulation, asphalt, and roofing materials. When steel prices increase due to new tariffs, the cost of joists, metal panels, and pipe increases accordingly.
- Local Market Disruption: Rapidly growing markets often have a shortage of skilled construction teams and the depth of labor to keep pace. This creates a false security of demand for local resources that often then drive pricing to position their capacity. Without expanded supply chains and national vendors, the local market pricing can significantly impact the typical cost of a project compared to national averages.
Because the construction industry typically lags the economy, an economic inflection does not equate to an immediate reaction. Instead, prices hold steady while the industry works through its backlog and assesses the economic situation. Then, as backlog levels begin to deplete, contractors are willing to take more risk and lower their pricing to secure additional work.
Once the forces of supply and demand, backlog, labor costs, and commodity pricing reach a new equilibrium, construction pricing will level off, maintaining a new baseline until demand begins to increase once again.
Typically, it takes 6-18 months for costs to react and start coming down. Then, specific commodities impacted by the recession will further drive pricing and schedule. In the case of COVID-19, we expect to see the cost impacts from 1, 2 and 3 above come to fruition in 2021.
In the end though, project success is ultimately determined by working with a proven national design-build partner that can minimize risk and maximize returns by:
- Defining clearly the scope of work and dollarizing your decisions early
- Disrupting local market pricing through national pricing and vendors
- Locking in firm pricing and transferring risk
- Developing creative solutions
- Condensing the overall project timeline
- Consolidating responsibility to keep clients focused on running their business
Please reach out for more specific information as it relates to construction pricing for your market and/or industry focus.