The 2019 Slowdown: Fourie Cost Consultants See Signs of Recession
Updated: Oct 21, 2019
Construction cost is difficult to track because regional market conditions overshadow annual escalation. Construction does not have a fixed price. It’s possible to bid 2 identical buildings at the same time, right next to each other, with different contractors, and get a cost difference of 20% or more. Further complicating the matter, there is no industry standard to track construction cost. Historical cost information varies based on the data gathered and by the individual who conducts the study.
It’s important for a Cost Consultant to track and accurately escalate construction cost to when the project will get bid and built.
As an estimator, I began my career by working for subcontractors and then general contractors, cost consultants, a director of preconstruction, and now I own my own cost consulting firm. To date, I’ve worked on over $20 billion in construction projects, located in 40 U.S. states and 10 countries across 4 continents. Webster’s Dictionary, defines an estimate as “to produce a statement of approximate cost.” A more practical definition for an estimate is “an accurate summation of a thousand errors.”
To develop my cost tracking model, I’ve gathered and updated data from many different subcontractors over the years, across a wide geographic area where my projects were located. I also use economic data from Ed Zarenski, the Turner Construction Cost Index, Beck Biannual Cost Report, and the Mortenson Cost Index. External data from Turner and Beck was the most heavily weighted.
The more I updated my historical data, dissected economic reports, squinted at graphs, compared, overlaid, and tried to figure out what happened in 2003, a more complete image of the construction market emerged.
Construction costs are currently at 21% above the inflation/GDP benchmark, a record high.
I began with the following assumption: Over a long period, construction cost escalation must fall in line with inflation and GDP growth. To test that theory, I took $100 and “construction escalated” it, “inflationed” it, and “GDP’d” it, dating back from January 1985 and then through to October 2019. I graphed the results below:
Notice the 2008 spike, which saw a rise from 2004 at about 7.5% per year to a high of 17.5% above the inflation/GDP benchmark. For the current “spike” we have seen another rise (from 2012) at about 4.5% per year to a record high of 21% above benchmark. Not even the drastic 12.5% drop experienced during the Great Recession would take us back to the benchmark numbers last seen in 2010-2012.
At this point you might be asking why the title, “The 2019 Slowdown: Fourie Cost Consultant See Signs of Recession”
The data shows that in 2019 construction escalation has been about 3.07% (approximately 0.95% above benchmark). This falls in line with my January escalation prediction and it is the slowest escalation we’ve seen since we started recovering in 2012. To put the 0.95% into perspective, the data shows construction escalation at an average pace of 2.75% above benchmark from January 2013 to January 2019.
The latest Architectural Billings Index (ABI), published by the American Institute of Architects, also shows a slowdown of the market for the last 2 reports. The ABI seems to be the best indicator for future construction market trends, the logic being that if it’s being designed today it’s likely to get built tomorrow. Traditionally, construction trends follow the ABI by about 6-9 months, so the ABI slowdown will be reflected in construction that starts this 4thquarter. Hopefully, the recent Federal Reserve cuts to the interest rate improve the ABI and curbs that trend.
In Florida, the latest Beck Report made an interesting observation of a 60% slowdown in south Florida due to high construction prices. Based on my observations, projects are being delayed and/or cancelled due to construction costs that are higher than expected.
We are entering a new reality of high construction cost and the market has started to adjust itself. Although market corrections may temporarily drop prices, barring an international catastrophe worse than the Great Recession, high construction prices are the new reality.
Although nobody can predict the future, it stands to reason that when the ABI slowdown hits, commercial construction starts, and less construction will bring prices down. Lower interest rates might counter those trends and housing might start to go up. We are also seeing the real cost effects of tariffs – were it not for those tariffs, construction cost would have shown a reduction already, a sign of recession.
The root cause of these record high prices is labor. I say this because commodities are still relatively stable and a little down from 2018. Productivity trends have historically shown productivity as stagnant or declining, but the U.S. Bureau of Labor Statistics adapted new measures and (suddenly) found that productivity growth is positive and relatively strong in 3 of the 4 industries they track. If these new measures are accurate, it attests to the impact of the labor shortage on construction cost.
Historically, both productivity and escalation were relatively constant; that is, until 2003 when escalation started its historic rise – possibly due to the implementation of the No Child Left Behind Act.
Today’s slower construction market might help alleviate our scheduling woes, depending on the duration of the slowdowns and whether we go into a deep recession. Demand remains high for both private and public projects. If construction prices drop and the inflation/GDP benchmark raises the bar, many shelved projects might start to make economic sense and be ready to move forward. While we may remain busy in a more competitive market, given the labor shortage there is no indication that labor costs will come down.
The short story: We require skilled labor. Our own industry training programs and vocational schools do not prepare enough graduates who are interested in our industry to meet the demand. And the situation is not improving, given that highly-skilled boomers are retiring. So, what can we do about it?
To combat the labor shortage, we need to support vocational programs, legal immigration, and women in construction. The best stone mason I have worked with came from Turkey and the best electrician from the Philippines. It is up to each of us to encourage and support every member of our team, regardless of their background. We must also break the stereotype that construction is a “man’s job” and encourage young women to learn a trade.
This market – of historic high prices and labor shortages – is the perfect environment for technological innovation, especially technology that improves productivity.
The construction industry is slow to adapt to new technology and methods, unless that technology is expected to deliver a clear advantage. Nail guns, circular saws, and cordless drills have all but supplanted hammers, hand saws, and screwdrivers on job sites. Most contractors on larger projects implement lean construction methods (such as the Last Planner system) to better coordinate construction activities. But not all technology offers clear enough advantages for the general market to self-adapt.
The broader context is important to this discussion. Every project is staffed with a unique assembly of subcontractors who each have specialized skills, backgrounds, needs, and abilities. Next-level technology that requires specialized training is more difficult to implement and is almost never universally adopted throughout an industry. This leaves subcontractors to consider if the investment in a new technology, with the associated training costs, offers enough advantages to warrant the trade-off. Despite the legitimate concerns, the current slowdown, with its high labor costs, might just tip the scales and spur enough technological innovation and uptake to improve productivity.
Broadly speaking, productivity counters the labor shortage. We must invest in technology and training programs to improve productivity to help offset the labor shortage that won’t go away anytime soon.
Aligned with this view, prefabrication is becoming more popular, as it enables project leaders to streamline the overall construction schedule with tight quality controls. More people are using BIM because it allows a much larger subcontractor base to be competitive when coupled with off-site fabrication. It can also reduce construction schedules by minimizing, if not eliminating, the shop drawing stage. Moreover, Global Positioning System labor and material tracking allows for more effective use of on-site resources.
But the largest influencer of construction cost, that is most often overlooked, is the bid process and selected delivery method. When well-executed, the traditional design-bid-build method will give you the best bid results. By comparison, the construction manager at riskdelivery method comes with a cost premium, given the limited (and often cherry-picked) subcontractors. Design-build tends to shift more risk to subcontractors who have limited opportunities to manage that risk. The bottom line is that many factors play into selecting the right delivery method for individual projects, not just cost.
Still, it’s surprising how little influence technology has in the bid room, where construction cost is determined. Sure, rulers and calculators have been replaced by digital takeoff and spreadsheets; the fax machines that replaced runners are all but gone; and most bids still come in at the last minute but via email. Technology handicaps are overlooked when subcontractors maintain a reputation for performing good, timely work at a competitive price.
To a certain extent, BIM has started to prove its worth in the bid room. However, its use is in varied stages of implementation with contractual risk being the largest hinderance. Once that contractual risk is either removed or fairly distributed among all parties, BIM can become a systematic game-changer. Bid management tools are inexpensive enough for the general market to self-adapt, not to mention, in the bid room, relationships and people skills, trust, and reputation exert heavy influence on bid numbers. In fact, they usually determine the winner.
Key takeaway: The best bid results come from competitive bids by educated and engaged subcontractors on: (1) a well-coordinated bid document set that has been (2) designed for the local market to meet a (3) realistic budget by a (4) cost information design team.
It is not an overstatement to say that the last 15 years have been the most transformative in our industry. No doubt, the next 15 years will be filled with innovations that we cannot even imagine at present. With historic high construction prices, like a balloon on a ceiling, we will continue to bump our heads, unable to go higher. It’s important to recognize that construction costs are not based on a defined price, but rather by forces outside of our individual control. Even so, we can optimize the process and collectively reap the benefits. What do you think?