Construction Industry Cost Escalation: Riding the Price Wave

Construction Industry Cost Escalation: Riding the Price Wave

We are in the midst of a classic good-news-bad-news situation. Yes, the economy has largely recovered from the Great Recession, but the rebound has bumped up prices across all market segments. Construction is feeling the pinch as tightly as any industry.

Unfortunately, public school districts are not immune to cost increases. This is true not just in the Northern California districts with which we work; it’s a reality throughout California and across the entire country. One of our responsibilities as construction and program managers is to help our clients – school districts and others – deal with rising costs and do what we can to accommodate and contain them. The first step is understanding what’s occurring in the marketplace to drive prices upward.

Here is a quick overview from our perspective:

When public entities (such as school districts) endeavor to fund their construction through sources such as general obligation bonds, they must determine an amount for that bond that can be realistically supported by the community. At the same time, they must plan to apply that funding to a scope of work that best addresses the needs defined in the district’s master plan. These scopes of work and budgets are sometimes built on cost estimates frozen in time. A bond measure passed in 2016, for example, might contain a master plan originally developed in 2014 for work scheduled to be completed in 2018. Without escalation calculations applied, these project cost estimates would no longer align with market realities. Even bond construction programs where escalation was applied early are feeling the pressure of rate influx occurring between the budgeting and construction phases. Frankly, the market has escalated at a rate that could not be foreseen in 2014, 2015 or 2016.

Cost escalation in the Bay Area market is the result of many factors, some of which are universal and others are specific to this region. The supply and labor shortage has affected all markets since the economy has improved.  Recently, it has been exacerbated in our region due to a re-building effort following the 2017 wildfires.

Another dynamic is a rise in funding sources, allowing money to flood back into both public and private construction projects. The call for labor, supplies and consulting services has increased significantly in just the past few years. For example, 199 more California school districts passed general obligation bonds in 2016 than in 2014. Proposition 51 alone brought $9 billion to the statewide public school construction and renovation marketplace when it passed in 2016. All of this financial support is great for schools and communities, but it does create a ripple effect on supply and prices.

The Great Recession put many construction firms out of business. The market is only just now beginning to replenish what it lost in the lean years of 2007, 2008 and 2009. There are simply too few contractors, consultants and suppliers to meet the current demand, so labor costs have risen as a natural economic consequence.

Materials, too, are in short supply. In addition to the local spike in demand for concrete, steel and lumber following the recent fires, the overseas supply chain has been affected by market and climatic phenomena. We’ve received a variety of notifications from suppliers alerting us to shortages and delays due to typhoons in Japan, excessive rainfall in Northern California and other unprecedented weather events.

We know from basic economics that diminished supply leads to rising prices. According to the Terner Center for Housing Innovation at UC Berkeley, construction materials saw a 4.4 percent price increase in 2017 and construction worker wages rose 2.6 percent that same year.

California school districts that are feeling the price pinch can take solace in knowing that they are not alone. Districts throughout the state are busy re-evaluating their budgets and capital improvement project scopes in the midst of these rising costs. At VPCS, we strive to find solutions that accommodate current pricing realities while still meeting our clients’ goals. We revisit plans to find value engineering opportunities; we phase projects to maximize state matching funds; we apply appropriate cost escalation strategies to projects that are currently in design in order to anticipate cost impacts.

This price wave was unavoidable. VPCS works side-by-side with our clients not just to ride the wave but to help keep everybody productively and financially afloat.

By Kelli Van Pelt Jurgenson

May 23, 2018