Labor Shortages, High Material Prices Made 2005 a Real Budget-Buster

By Roger K. Lewis
Saturday, December 24, 2005

"If bids for constructing buildings you design aren't over budget," one of my architecture professors once told the class, "you aren't trying hard enough."

This year, though, architects did not have to try hard at all for projects to exceed their clients' budgets. Construction costs have risen at a rate almost without precedent, whether the project was a bungalow or a baseball stadium.

Bottom-line cost increases for projects in the design and construction pipeline, cited anecdotally within the building industry, are running a whopping 25 percent. A project realistically budgeted at $40 million at the end of 2004 today could cost $50 million.

And a cost increase of this magnitude, normally expected to occur over several years, instead has come over several months.

What accounts for 2005's construction cost spike, especially given the national economy's very moderate rate of inflation?

Explanations start with the law of supply and demand. On the demand side, construction continues apace, and the need for labor and materials remains high. But on the supply side, the availability of labor and materials has not kept up with demand. Thus costs have risen just as economic theory predicts.

But material prices also have been exacerbated by other factors, in particular this year's devastating hurricanes that curtailed U.S. petroleum supplies. Energy costs shot up, adding to the costs of manufacturing and transporting construction materials.

Yet even without dramatic cost increases, creating and conforming to construction estimates is a challenge. Consider the complexities of each stage of construction finance, from budgeting to bidding to actual building.

The first stage involves establishing a very preliminary budget when a project is contemplated but not yet designed, and often without detailed site surveys. Owners and their consultants essentially make an educated but inevitably optimistic guess about cost based on the scope of the project and known costs of comparable projects. Initial budgets typically factor in modest amounts for anticipated inflation and unknown contingencies.

The second stage occurs during design, as more is known about the site, the structure and construction market conditions. Professional cost estimators and general contractors analyze evolving design drawings, site data and pricing trends. They refine and update previous estimates. Only rarely do construction budget numbers decrease during this stage.

The "rubber hits the road" during the third stage, when construction bids are obtained. Only then can the owner and design consultants know with certainty if cost estimates were accurate.

Not surprisingly, contract bids usually exceed previous cost estimates, no matter how thorough the estimates. Labor and material pricing conditions are always volatile, sometimes changing measurably over a few months, typically the amount of time elapsing between the last cost estimate and the receipt of bids.

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