Rebounding Markets Drive Increased Near- to Mid-Term Institutional Construction Costs

Market Outlook 2013 Q4

End-of-year data from 2013 indicates that residential construction is on the rebound, with more than 1 million housing starts occurring in the fourth quarter. This is the first quarter that residential construction broke the 1 million mark since 2008. As a result, the national unemployment rate in the construction sector finally broke 10 percent at the end of 2013.

Non-residential construction remained stable at the end of 2013, strengthening across much of the nation, with institutional construction prices trending upward at an annual rate of 3 percent for low growth markets and 8 percent for high growth markets. Despite a healthy uptick in construction activity, architectural billings indicate slowing in the Northeast and Midwest. Total construction volume increased 22.5 percent from the bottom in March 2011, returning to the pre-housing-boom levels of 2003.

According to Vermeulens, improving capital markets will continue to support institutional demand, and capital construction prices will surpass the percent trend line in 2014, repeating long-term economic patterns. 

Construction Costs

For the past 25 years, construction costs have trended toward a 3.25 percent annually compounded escalation rate. In 2008, construction costs reached a peak and adjusted rapidly downward, then stabilized for two years. Similarly, costs peaked in 1990 and 2001.

According to Blair Tennant, a project manager and cost engineer for Vermeulens, the rate of escalation in construction costs is indirectly tied to the goal of achieving an annual inflation rate of 2 to 3 percent and the monetary policies used to support this.

Fourth quarter data from 2013 shows the economy continuing strong recovery momentum, led by a surge in residential construction.  Prices on institutional/commercial/industrial (ICI) construction projects increased an average of 3 to 8 percent in 2013, depending on location. Total selling prices have increased 13 percent from their recessionary bottom in 2011.

A stronger U.S. dollar and improved supply have stabilized commodity prices. As inflation in other sectors of the economy stabilizes, and real interest rates drop, cost escalation in the construction sector will continue to have room to increase.

Commodities and U.S. Dollar

Crude oil and the U.S. dollar have had an inverse relationship for decades, making a weak dollar good for commodity traders. However, over the past year, crude oil pricing appears to be shifting to a direct relationship with the dollar.

With the continued shift towards American energy independence, the commodity market may restructure to a point where the strong U.S. economy yields a strong dollar and subsequent higher commodity prices.

Construction Volumes

Construction volume is a strong driver of costs, because contractor opportunities increase as project volumes and backlogs grow, all of which leads to higher bidding.

Much of the market growth in 2013 was due to steady growth in residential construction. Residential volume ended the year 50 percent higher than its most recent bottom in July 2011, indicating that the recovery is in full swing.

Non-residential construction also had steady growth in 2013, closing out the year 20.7 percent above its bottom in March 2011. McGraw Hill is forecasting growth of 8 percent for 2014.

Labor Demand

Growth in construction activity nationwide has led to a prolonged increase in demand for construction labor for the first time since 2007, with increased labor demands in 30 states, resulting in the low construction unemployment rate.

The national construction unemployment rate has been cycling downwards, finally breaking the 10 percent benchmark at the end of 2013. According to Vermeulens, a continuation of this upward trend in job creation confirms an upswing that will lead to faster cost escalation in high-demand markets due to a shortage of qualified labor.

AIA Billings

Architectural billings are a key indicator for future construction volumes. According to the AIA, overall billings at U.S. architecture firms dropped in December, marking their second straight monthly decline and the first two-month downturn since 2012.

The slowing was concentrated in the Northeast and Midwest—where severe weather played a factor. Architectural firms in the South and West regions continued to show strong growth.

The sharpest declines were at industrial and institutional firms, as opposed to residential.

Looking Ahead

Moving into 2014, the economy is poised for a year of healthy growth. National economic growth is projected to be closer to 3 percent this coming year, compared to 2 percent in 2013, based on anticipated capital investment spending by businesses. 

Tightening of monetary policy—including the Federal Reserve scaling back on its bond-buying program—combined with slower construction growth in some regions, will likely reduce escalation rates in 2014 and 2015.

Construction prices are firm and increasing. With the current labor market capacity narrowing and continued increases in construction volume, construction cost will escalate closer to the Construction Cost Trend Line for the medium term.

By Johnathon Allen

This report is based on the Vermeulens Q4 2013 Market Outlook report.

Project Data
Completion Date: 
April, 2014
Location: 
Published 4-9-2014