More Sticker Shock

• By Michael Fickes
• 05/01/07

More Sticker Shock

“Most communities don’t know that construction costs are rising, but they do go into sticker shock when we show them a budget for a new school,” says Nancy Myers, a principal with N.R. Myers Group LLC, an educational facilities consulting firm in Indianapolis.“I’ve never seen a school project cancelled because of rising costs, but I have seen projects cancelled because people thought construction costs too much to begin with.”

Ralph W. Rohwer, a vice president and project director in the Seattle offices of Atlanta-based Heery International, has seen several school projects cancelled as prices have risen from high to higher.“No one has ever budgeted for double-digit inflation,” he says.

What has happened in the construction industry? Why have prices moved up so dramatically in recent years? What happened during 2006 that slowed down the price increases? Will that trend continue?

A Look At Construction Cost Data

School districts that haven’t built a school in a while may not realize just how stunning the run up in construction costs has been.

According to data from the Bureau of Labor Statistics compiled by Ken Simonson, chief economist with the Washington, D.C.-based Associated General Contractors of America, the producer price index (PPI) for construction materials and components barely changed between 2001 and 2002. In 2003, it popped up a bit and rose three percent on the year.

In 2004, the index recorded a double-digit inflation rate of 10.1 percent. It fell back to 6.1 percent in 2005 and 4.3 percent in 2006, but Simonson believes another round of price increases is on the way.

Through 2003, inflation barely affected the general economy or construction, notes Simonson. Starting in 2004, however, one commodity after another shot up in price and continued to rise at an elevated rate — through the middle of 2006. Then in July and August of 2006, diesel fuel prices fell sharply. Construction plastics started coming back down. Steel leveled off.

But prices have likely fallen all they can, continues Simonson. “For the rest of this year, I’m concerned that construction materials prices will rise more rapidly. In the last three months (the first quarter of 2007), diesel fuel prices have risen 8.5 percent.

“Over the last three months, highway and street construction costs rose 3.5 percent. Other heavy construction costs have gone up 1.6 percent. Non-residential building costs rose 1.5 percent. Multi-unit residential costs have moved up 1.8 percent. Single residential costs are up 1.2 percent. That’s just for three months. On an annual basis that’s 5 percent on the low side for single unit residential to more than 14 percent for the highway and street construction category.”

What’s Causing the Run Up in Costs?

Ask a contractor what is behind the high costs and you might get a shoulder shrug for an answer. According to Simonson, contractors tend to look for local explanations for price variations. “They don’t realize that even though they build just in the U.S., use U.S. labor, and buy from local suppliers, political and economic forces around the world can make a difference in the cost of supplies,” he says.

In this case, the source of price hikes lies overseas in the economies of huge countries undergoing rapid modernization. During the first quarter of 2007, for instance, China’s economy grew by 11.1 percent. Economic growth in India has been averaging 8 to 10 percent annually. Both of these economies have been boosting production of infrastructure, industrial capacity, housing, cars, and other consumer goods. These products increase demand for steel, copper, and other materials. “Overseas demand for these products also increases the demand for ocean shipping,” adds Simonson. “That may not mean anything to someone buying high-value products like plasma televisions, but for companies importing cement, it can raise prices dramatically.”

Indeed, Simonson’s data show that ready-mixed concrete prices rose 8.7 percent in 2004, 11.3 percent in 2005, and 9.8 percent in 2006. For the first three months of 2007, ready-mixed prices surged 2.8 percent, an annualized rate approaching 11 percent.

Worse yet, economic activity in China and India is just indicative of the problem, not the entire explanation. Even if economic growth in China and India slowed down, countries across Southeast Asia have undertaken massive modernization programs that are adding to the stresses affecting material costs.

Add to that the effects of political turmoil and labor unrest in producing countries, and it becomes clear that rising costs are likely to be part of the construction picture for a long time. For example, the world’s largest copper mine — Chile’s Escondida Mine — suffered a strike last year that shut down production for 25 days, says Simonson. Labor unrest in Mexico cut off growth in Mexican copper output. Political turmoil in the Congo took copper mines there completely out of the picture.

“Transportation tightness and surging demand for materials mean that industries dependent on materials and on deliveries will experience higher inflation than a service business or something where there is a great deal of value added to materials that may be small or lightweight,” concludes Simonson. “That makes construction particularly vulnerable to price increases.”

How One District Has Coped With Rising Costs

What can a school district do to cope with rising costs without going to the extreme of shutting down a building program?

“Sometimes we decline to execute projects that come in with prices too high,” says Paul Gerner, associate superintendent for facilities with the Las Vegas-based Clark County School District. “But we haven’t been put in the position — in which others have found themselves — of canceling a project.”

Clark County’s school construction bond revenues come from three sources: property taxes, vehicle transfer taxes, and a share of the local hotel room tax. So rising property values, rising vehicle prices, and rising hotel room prices — all of which go up at the same time that construction prices rise — generate more bond revenues for Clark County school construction.

“Our financial people have also successfully brought down the interest we have to pay on bonds with techniques that, for example, have increased our bond rating,” Gerner says.

District officials have also formed a Debt Management Commission responsible for ensuring that the district doesn’t over extend itself.

In addition to revenue enhancements and financial management, Gerner says that the district’s facilities group conducts continuing outreach programs with general contractors, sub-contractors, and architects. Outreach aims to interest more companies in bidding on Clark County School District work. More bidders mean more competition and lower prices. “We ask each company what we can do to make them more interested in working on our projects,” Gerner says. “We also ask them what we can change in our specifications to get us more bang for the buck.”

As a result, the district always has at least three bidders for each project. And enough cash to pay the most qualified low bidder.

For now.