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Construction Financial Perspective – March 2013

What’s it cost?

Inflation at the end of 2012 hovered steadily at levels that are low by historical standards. In January, inflation remains a non-factor in the aggregate but prices for several construction products have begun to break upward. Prices jumped for drywall, lumber and gas/diesel in recent months, with advances in the last 30 days making up most of the increase.

The Producer Price Index (PPI) for all finished goods rose 0.2 percent in January, according to the U.S. Bureau of Labor Statistics report of February 20. Prices for finished goods had declined 0.3 percent in December and 0.4 percent in November. The PPI for inputs to construction – a weighted average of the cost of all materials used in construction plus items consumed by contractors such as diesel fuel – increased 0.7 percent for the month and 1.3 percent year-over-year. The prices contractors said they would charge for new nonresidential buildings and subcontractors’ prices roughly matched the rise in input costs.

Prices for metals were mostly lower again. Copper was up 0.6 percent; aluminum rose 0.3 percent and steel prices declined 0.1 percent. Both steel and aluminum were down from January 2012.

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Because of the timing of the report – the data reported was gathered on January 21 – the pricing for oil and diesel showed little change from December or from the previous January. Since then, however, the price of diesel has spiked, rising seven percent to over $4.18/gallon over the highway. Demand for oil and diesel has hardly been growing during the typically slow month of February but supply has been dwindling, as several refineries have been shuttered. The nation’s biggest refiner, Valero, estimated that nearly 1 million barrels a day of refinery capacity has been closed on the East Coast or in the U.S. Virgin Islands in the past two years, which Valero said allowed it to increase profit margins.

Diesel has a direct and derivative impact on construction prices, as both construction equipment and trucks delivering products burn diesel fuel.

The more alarming uptick is for the materials that are being boosted by the increase in homebuilding. Among those gypsum prices soared 12 percent in January and 20 percent from a year ago and lumber and plywood rose 4.2 percent and 15 percent respectively. Smaller but significant increases were seen in insulation and paints. There have been concerns that the massive scale of the damage from Hurricane Sandy would create shortages and price spikes in residential products, especially since manufacturing capacity for these kinds of products was slashed during the recession. But the AGC’s chief economist, Kenneth Simonson, feels that the extended duration of the rebuilding will mitigate any impact on supply.

“Any price spikes will be short-lived and may have already occurred. I don’t think Sandy is having much of an impact of the price of materials,” Simonson notes. “I think what is driving up prices is the marked increase in demand for single-family housing and to an extent from multi-family housing.”

With the housing market rebound only in its infancy, demand for products like drywall, lumber, roofing and construction plastics should grow steadily over the next few years. Plant capacity exists in mothballs for many of these materials and can be restarted once volumes begin to approach the historical norms for residential building materials. In the meantime any price spike in residential products that also have non-residential application – like drywall, lumber, plywood and paint for example – will put unwelcome pressure on budgets for non-residential construction.

The recovering housing market and nascent commercial construction rebound will also put upward pressure on labor costs. Because of several factors – the steep decline in construction, the length of the downturn, the unfavorable immigration climate, to name a few – wages for construction workers have remained lower for long enough that a portion of the workforce left the industry. Combine that with the growing retirement of Baby Boomer workers and the additional costs from healthcare reform and conditions are ripe for increased labor costs above the rate of inflation.

For the balance of the 2013 building season, costs for construction should remain within the three-to-five percent inflation range that has been experienced the past few years, with the exception of residential building. For owners who have had projects on the shelf for several years, the increased input and labor costs may come as an unpleasant surprise in another year.

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