16 Jul Inflation

Last week, the Wall Street Journal reported that the second quarter inflation was at a forty-year high of 5.4%.  The core consumer price increase was 8.3% (excluding food and energy).

To the Construction industry, Inflation is a four-letter word.  Until recently, this word had slipped out of the construction vocabulary.  Currently, the Construction Market is in turmoil.  Contractors have been sharing with us their challenges to holding prices steady and shortages of materials and products which are affecting projects.  Labor rates will be the next challenge to be faced.  As stated in recent Industrial Trends (ITR) newsletter,

“We no longer need to theorize about where the inflation that is inherent to the depression outlook will come from. The Fed has laid the logs of inflation and lit the fuse.”

Privately, discussions are including projections of “double-digit” inflation, similar to the Carter years (40 years ago).  Many of the same conditions that existed then are upon us.

We have to ask ourselves, is this just a unique rise of inflation or is this a long-term trend?  The market reaction is driven by the fact that there are too few materials against the demand for them.

Material Pricing

Media headlines have already told the story of the cost of lumber.  One year ago, a thousand board feet of lumber (MBF) was $350/MBF.  Pricing had increased to over $1,400/MBF.  The industry is very proud that they have reduced lumber pricing by 40%, however, that still results in the cost of Lumber at $850/MBF – still a 150% increase in one year.

Other price increase includes:

• Reinforcing bars – more than doubled in cost
• Concrete materials increased by 25 to 30%
• Structural Steel mill costs have doubled

In addition to price increases, delivery times for products will affect your project.  Some examples of current project challenges:

• Bar Joists – 40-week delivery window
• Mattresses – 16+ weeks for delivery
• Appliances – 26 to 30 weeks for delivery
• Sheet metal – not available in quantities until the fourth quarter this year

Labor Component

Corporate America has over 9.2 million job openings, but businesses cannot find workers willing to work.  The Federal Government’s response is “just pay them more” (President Biden’s quote).  Unfortunately, that is not a real answer.

Federal projects use the Davis Bacon Act for dictating construction wage rates.  The recent Presidential Executive Order requiring all companies doing business with the Federal Government to pay a minimum wage of $15.00/hour will not significantly affect the construction industry as almost all wages exceed that amount.   However, the Davis Bacon wage scales are based on Union wage agreements.  Most Union contracts are typically negotiated in the fall of the year proceeding the increase.  It is expected that significant pressure will be placed on employers to accept significant wage increases far exceeding the planned 2-3%.

Additional Workers added to the Employment Force

What complicates the projection is the administration’s policy of allowing each month more than 200,000 people to cross our southern border.  With the Federal Government bussing them throughout the country it is only a matter of time before at least half of these people will want to work.  It is expected that Corporate America will look for ways to obtain “Green Cards” for these undocumented workers.  In the past, these workers were employed at lower wages than American workers.

Recommendations

• Negotiate Lump Sum contracts for construction work as quickly as possible.
• The Owner’s construction budget should include an escalation/inflation line item of at least 6-8% in 2021 and potentially 10+% for 2022.
• Expect interest rates to rise. Financing should be secured with fixed rates where possible.  During the Carter years, nobody believed that double-digit interest rates were possible.  When inflation enters double digits, interest rates will soon follow.
• Contractors and Owners should negotiate assistance for long lead purchases to minimize the impact on project schedules.
• Owners seeking project financing should lock in interest caps with their lenders.