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.

Despite firm bids and signed contracts, a project still can turn into a budget-busting nightmare during construction. There are many reasons for cost overruns: extra work related to unforeseen site and subsoil conditions; incomplete design documents; delays or damage caused by weather; material shortages or labor strikes; contract performance failures by contractors and subcontractors.

During the first three stages, diligent owners and designers continually compare probable costs with probable financial resources, since a project won't get built or finished unless resources match costs. And costs are determined not only by market conditions, but also by project size, complexity and quality.

Therefore, the budgeting and design process requires that owners and the design team continually reconsider and refine the scope of the project as well as monitor costs and financing.

In the face of 2005's extraordinary construction cost escalation, project owners have limited options. A few may be able to absorb increased costs by committing additional funds. But when money is limited or nonexistent, project sponsors and architects have no choice but to scrutinize and modify designs that seemed affordable a year earlier.

Such modifications, often referred to as "value engineering," tend to be less about creating long-term value and more about cutting short-term capital costs. These cuts can include reducing project size, eliminating or deferring construction of targeted project elements, simplifying construction details or using cheaper materials and systems. Many cuts make sense, but some can compromise a building functionally, technically and aesthetically.

Regrettably, by focusing only on initial capital costs, value engineering in particular and the budgeting process in general ignore life-cycle benefits and costs. This philosophy -- pay less now but pay much more for decades to come -- pervades the building industry and is unlikely to change.

In 2006, developers, public agencies, private institutions and even homeowners who want to remodel will be tested. All will be challenged to achieve the difficult balance among aspirations and budgets, rising construction costs, available funding and long-term value.

Roger K. Lewis is a practicing architect and a professor of architecture at the University of Maryland.

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