Accurately predicting how much it will cost to renovate or build top-notch research facilities amid today’s volatile economic conditions requires a comprehensive understanding of the factors that impact the global marketplace. Reviewing trends that have occurred in recent years makes it easier to anticipate construction cost changes that might occur in the future.
Vermeulens Cost Consultants in Toronto and Boston has conducted extensive analyses of pricing trends going back to 2005. The company’s data shows that between 2005 and 2008 construction costs increased 6 to 8 percent per year, which is double the average inflation trend of 3.5 percent per year.
However, their analysis also reveals that costs began to decrease in December 2008 and have continued a downward slide. The outlook for the future, according to Vermeulens, shows overall construction costs continuing to decline for the remainder of this year by 6 to 8 percent from 2008 levels.
Just as quickly as the window of opportunity opened, though, it could slam shut. In fact, Vermeulens’ cost-tracking studies conclude that costs should improve by 3 to 5 percent in 2010 and by 6 to 8 percent in 2011. The unpredictability of economic conditions and other variables makes it important for owners to take advantage of current conditions during what could be a narrow window of opportunity.
Striking While the Iron is Hot
One year ago, Vermeulen identified that a drop in construction costs below the typical trend line occurs when there is a sudden decrease in institutional demand, a structural change away from construction investment, a collapse in mortgage lending, an increase or maintenance of interest rate levels, sudden cuts in government spending, and a weakness in tax revenue growth and persistent deficits. There are only two pieces of the puzzle that are currently missing -- an increase in interest rates and a decrease in government spending.
James Vermeulen, president and principal-in-charge at Vermeulens, suggests taking advantage of stimulus money to finance projects this year, negotiating GMPs post-bid buy-out, and continuing design and pre-construction. In addition, watch the equity markets for a sustained rebound since confidence in the equity markets is the leading indicator that the window of opportunity for construction will begin to close.
“Continue design and pre-construction because the window of opportunity isn’t that big and you could easily go through 10 months of design before you get a project shovel-ready,” says Vermeulen. “If you push yourself into 2010 because you hold up design now, you won’t get the most favorable bidding.”
Predicting the Trends
Vermeulens uses its trademarked Cost Reconciliation Tracker to determine how the trends are evolving in each of the construction trades.
“We do parallel estimating on all of our projects, alongside a construction manager who generates independent estimates at the same time we do,” says Vermeulen. “Then we have a reconciliation meeting to establish the correct levels of pricing for a given project in a certain market. We use a consensus-building approach and reach an agreement on unit-rate pricing levels by the time we finish our reconciliation on each of our projects.”
Vermeulens gathered pricing information for 16 different construction trades and predicted costs for a period continuing through January 2010.
“We came up with an average for January through November 2008, calculated a standard deviation from that average and then developed a range,” says Blair Tennant, project manager at Vermeulens. “This range is typically between 5 and 10 percent, which is generally what we see in terms of bid ranges, so it makes sense. We tried to pick a specific cost that was representative of that trade.”
The cost per cubic yard for backfill has decreased by approximately 14 percent during the first quarter of this year. The decrease is expected to remain stable throughout the end of 2009 as earthwork is one of the trades affected first by this market correction.
The price per square foot of concrete slab on deck is down 2 percent and is expected to decline by at least 10 percent by the end of the year. The square footage cost of concrete masonry units work rose 2 percent at the beginning of the year to more than $19 in some cases. However, the cost may drop by as much as 8 percent throughout 2009 to between $14.50 and $17.50.
The cost per ton for structural steel dropped by 5 percent in late 2008 and is expected to continue dropping by double that amount through the end of this year. Other areas that are likely to experience lower prices are roofing membrane, curtain wall, plumbing, fire protection, ductwork, air handling units, controls, electrical feeder, lighting, telecommunications/data, and drywall partitions.
“We’ve seen drywall partitions drop 12 percent and we think this will drop further to 15 percent,” says Tennant. “It’s hard to predict the potential for crossover to the residential sector here, where they have been heavily at work. However, some analysts are predicting a short-term rebound in the residential market, so this is one to be careful of.”
Casework is down by 10 percent, but should not dip any lower in the coming months. It is difficult to predict trends for the future cost of equipment because each facility has specific requirements and variables.
Elevators present an interesting scenario with the cost remaining stable for the typical 3,000- to 3,500-pound models, but Tennant says larger specialty elevators and single-source vendors can increase elevator costs by 50 to 100 percent.
General requirements and conditions are edging down by an average of 7 percent and could remain there throughout the end of the year. Included in this category are supervision, temporary facilities, and temporary work. Excluded from this category are permits, bonds for contractors and subcontractors, sub guard insurance, contractors’ insurance, general liability insurance, and builders’ risk insurance.
“Construction managers are able to buy some of the general conditions and requirements at a lower rate and the projects are staffed leaner,” says Vermeulen. “Contractors’ fees were down 8 percent in the first quarter and we think they will go down 13 percent.”
Escalation contingency was at 6 to 8 percent for most of 2008, but the situation changed dramatically in December when it plummeted to zero.
A summary of all of the trades shows that prices will be down by 8 percent for the remainder of this year compared to 2008.
When Will the Window Close?
There are several drivers -- including volume, commodity pricing, labor productivity, and profit margins -- that will determine how long this window of opportunity remains open.
“One area that many people tend to ignore is the value of the U.S. dollar. From 2002 to the start of the credit crisis, the U.S. dollar had been declining,” says Vermeulen. “Then the credit crisis occurred and the currency has risen 16 percent relative to the global currencies taken as a group. At the same time the U.S. dollar was declining, the stock market was increasing. We need to pay attention to this correlation between the U.S. dollar value and the New York Stock Exchange when deciding how and when the window will close.”
Commodities are impacted by the value of the dollar as all commodities are priced in U.S. dollars. As the U.S. dollar devalues, it takes more U.S. dollars to buy the same amount of a commodity. Therefore, as confidence increases in the economy, equities will rise and the U.S. dollar will fall -- resulting in higher commodity prices.
Construction volume, another driver, peaked in 2006 when residential building started to decline. Residential construction volume is down 58 percent since the peak. However, the non-residential sector continued to grow until the third quarter of 2008. Since then, it has only dropped 7 percent. Vermeulen anticipates that the $140-billion stimulus package will cushion the non-residential volume drop as the stimulus represents 10 percent of the non-residential volume over the next two years
“We’ve gone from 1.8 million construction workers down to around 1.4 million, representing a 20-percent reduction in the labor force. This has a very dramatic impact on productivity, since the 80 percent currently employed are substantially more productive --which drives the overall labor cost of the trades down,” says Vermeulen. “Labor productivity will begin to decrease in 2010 as construction volumes increase. Similarly, profit margins in 2009 are down, but as volumes pick up, they will edge up in 2010.”
Various contingency levels for design, construction, escalation, bidding, and the owners’ project contingency are recommended in light of the cost drivers and their impact on construction.
The design contingency, for instance, means having enough money to complete the design through to the contract document. There are different contingency levels for each phase of the design process with preliminary design being at 10 to 15 percent and schematic design at 6 to 9 percent. The design contingencies are not driven by market conditions, but rather by the performance of the design team and how quickly the process is completed.
Construction contingency is typically at 3 to 5 percent and Vermeulen anticipates seeing the same numbers in 2010. Escalation contingency was between 6 and 8 percent in 2008, dropped to zero this year, but should increase to 3 to 5 percent in 2010.
The recommended bidding contingency last year was zero.
“If you have a project you can bid and buy out in 2009, you could have up to 5 percent in bid buy-out savings,” says Vermeulen. “You could establish the 2009 pricing levels, but then buy out better than that.”
If you do have a savings, Vermeuelen recommends putting it into the owner’s contingency and keeping it there because the chances that trade or sub trades that have bid at cost might go bankrupt are dramatically higher now.
“You can buy your add-alternates later once your project is running smoothly.”
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