Sustained growth over the past 18 months has pushed new construction prices above the long-term trend line for the first time since 2009, according to third-quarter economic data. Capital construction prices are now trending at an annual escalation rate of 4 to 8 percent, depending on region, with northeastern and southern states showing the greatest increase. Regional labor demand is also driving up project bids in midwestern states. Construction unemployment rates have returned to between 5 and 12 percent, which will increase labor costs similar to the cycle experienced between 2004 and 2007.
Non-residential construction spending remains steady at a growth rate of 6.6 percent since its bottom in 2011. Current forecasts by McGraw Hill are predicting an 8 percent growth rate for 2014, which will build on the 4 percent increase in 2013.
According to Vermeulens, federal tapering of quantitative easing and improved consumer confidence will continue to push project costs at, or above, historical trend lines in 2015.
Construction Costs
Steadily increasing construction prices have recovered to the long-term trend line. Current indicators support stable construction growth through 2015. As inflation across other sectors of the economy levels off, construction costs will continue to increase with regional fluctuations.
Construction price increases for 2014 are ranging from 4 to 8 percent, depending on location.
According to Blair Tennant, a project manager and cost engineer for Vermeulens, the rate of construction cost escalation is indirectly driven by the federal goal of achieving an annual inflation rate of 2 to 3 percent and the monetary policies used to achieve this.
The current consumer price index of 1.7 percent is running below the 2 to 3 percent target range. This will continue to drive relaxed federal monetary conditions that provide stimulus for continued construction growth.
Construction Volumes
Construction dollar volume is the number one factor for construction costs, because bids increase as contractor opportunities and project backlogs grow.
Residential dollar volume is 56 percent higher than its most recent bottom in July 2011, while existing home inventories have dropped to 4.8 months (compared to 5.6 months in July 2014 and 12.5 months in July 2010).
Non-residential construction remains steady at an average growth rate of 6.6 percent since its bottom in 2011. Infrastructure spending also continues to be stable. McGraw Hill is forecasting dollar volume growth of 9 percent for 2014, building on the 5 percent increase in 2013.
Steady residential and infrastructure growth are expected to impact future institutional prices by increasing regional demand for labor and materials.
AIA Billings
Architectural billings are a key metric because they indicate expected construction volumes nine to 12 months in advance.
For the third month in a row, architecture firms nationwide reported an uptick in billings in August. An index score above 50 indicates growth. While the current national billing index of 53 is slightly lower than July’s 55.8, the country is showing its strongest growth rate since 2007, with all sectors growing regionally (Northeast: 58.1; South: 55.1; Midwest: 51; West: 52.5).
Though growth for residential and commercial firms has been strong, firms with institutional specializations have experienced soft billings for much of 2014. Only in the past few months have they started recovering from the stall.
Labor Demand
As unemployment rates return to long-term averages, stabilizing at around 10 percent, regional imbalances in labor capacity utilization are also leveling off.
Labor capacity utilization is calculated by comparing the ratio of current construction employment to peak construction employment, and allowing for a sustainable rate of growth.
A utilization rate of greater than 85 percent (yellow) will begin to put upward pressure on construction labor costs. In the past year, 40 percent of states nationwide have warmed to either a yellow or orange, as have the nation’s top 20 cities (by GDP).
Looking Ahead
Due to strong growth in 2013, construction prices rose above the long-term trend line in 2014, repeating long-term cyclical patterns. Recent tightening of fiscal and monetary policy, and slower growth in some regions should ease escalation rates.
Looking ahead at 2015, expect a stabilizing of costs consistent with a declining quantitative easing program, as government spending reductions and reduced monetary stimulus temper price escalation. The rate of construction employment should be sustainable, while capital construction price increases will continue at around 4 to 8 percent depending on location.
By Johnathon Allen
This report is based on the Vermeulens Q3 2014 Market Outlook report.
