Construction generates over $360 billion in revenue and has a share of 9% in the total Gross Domestic Product (GDP) of the U.S. Only healthcare and retail outperform construction in these numbers.
Bureau of Economic Analysis (BEA) considers the following as indicators as economic conditions.
- Inflation rate - 9.1 highest in 40 years
- Unemployment rate - 3.6% equal to pre-COVID levels
- GDP growth rate – decreased for the last two quarters
Construction spending is a reliable indicator in formulating the U.S. GDP by Bureau of Economic Analysis (BEA).
When construction spending falls, GDP routinely falls with it.
2022 US Construction 4.3% of GDP
The U.S GDP dropped the first quarter of 2022 by 1.6%, then the second quarter in by 0.9%. Two consecutive quarters of economic contraction is commonly used as a definition of a recession. By that definition - we are in a recession. However, based on COVID-19 and $5 trillion dollars pumped in the economy by the government, we have an economic mixed bag and uncharted territory.
Construction Positive Data Points
Despite troubled inflation and reduced GDP growth, construction economist predict growth for the remaining of 2022 and first quarter of 2023. One data point is the Producer Price Index (PPI) that measures the change over time in the prices by domestic producers for products and services. Construction PPI usually drops during a recession – happened in 2000’s, 2008, and COVID-19 recession periods. Construction PIP is up 19.2% for June 2022 according to the U.S. Bureau of Labor Statistics. Another important data point is project backlog. These numbers remain strong, according to AIA Architectural Billing Index (ABI) and Associated Builders and Contractors. Both organizations report about a nine (9) month project backlog that is near record highs.
Project Concerns
Percentage of backlog may be driven by projects taking longer to complete, owners pushing out schedules in the hope of lower construction material prices. Supply chain and the ability to obtain construction material in a timely manner has delayed projects has impacted along with staffing concerns - finding qualified people to fill key positions and skilled labor supporting project efforts. Labor shortages and increasing wage costs have been affecting the construction industry for a number of years and is unlikely to be resolved in the near future. Wages routinely account for over 50% of the overall construction costs. Labor pricing will influence the profitability of a project.
Interest Rates
The Federal Reserve trying to slow inflation at 9.1% is raising interest rates. Rising interest rates will have a negative impact on construction activity including hikes in construction material making projects more expensive. Suppliers may also be forced to raise prices because of the increased cost of financing. This reduces the profit and size of new construction projects leading to slowing economic growth. Higher interest rates reduce the profit as the construction companies may be forced to pay out of their pockets for interest rates on loans. The rise in interest rate will also reduce the demand for homes with mortgage rates increasing.
Cost Estimates
The ongoing concern on the construction material costs is complicating the cost and bidding process on projects. Fixed priced projects are extremely difficult and risky in this environment. Industry data has shown bid are expected to increase to 8.5% this year following a 6% increase in 2021. Rising fuel prices are putting pressure on project cost and budgets. It is significantly more expensive to have construction material delivered to the site, along with the delivery and operations of heavy equipment such as bulldozers, cranes, and backhoes that run on higher priced fuel.
Risk Management
- Due diligence of the project and budgets against current pricing for material and labor. Consider how inflation, and interest rates, could impact the final cost of a project. Be realistic about the increased costs and make the necessary adjustments in the contract agreement, and bidding process. Include contingencies into the contract agreement to address price uncertainties and increased costs.
- Have an upfront open discussion with project owners about potential challenges and consider risk allocation. Addressing in contract agreements construction material availability, delays and impact on the project schedule.
- Construction materials are more expensive, but also difficult to obtain. Alternatives for construction material and products should be discussed with owners as an option based on availability.
- Evaluate material procurement procedures within your organization. Ensure procedures addresses the challenge when faced with price increases and delays in obtaining material and products. Consider stockpiling essential materials and the cost benefit on projects compared to the additional costs of storage and security.
- Evaluate insurance policies, specific project policies. Higher prices for material and labor will increase the final cost of a project. Losses on projects will lead to more expensive repairs and rebuilds on projects with claims. Ensure you have the proper limits are not underinsured based on these challenging market conditions.
Summary
The last two years the construction industry has seen significant growth. Projections for the remaining of 2022 and early 2023 look good with strong backlogs and Construction PIP up 19.2% for June. However, with the Federal Reserve increasing interest rates to slow inflation, that is only going to increase the cost of everything including construction loans, home mortgages and construction material. It appears it is only a matter of time before that has a negative impact on projects moving forward. Under the current conditions and with an anticipation of a slowdown in about nine months, there are certain actions to assist project performance and help manage and mitigate risk.
