Rising Construction Costs and the Residential Sector

We’ve become accustomed to hearing that home prices are down, housing supply is up and residential construction is sharply slowing down as a result.

But there’s another threat looming on the new project horizon — construction costs — and developers are directly in its path, according to Financial Week.

The Associated General Contractors of America warned builders that construction costs would increase in 2008 in its Construction Inflation Alert report, issued earlier this month.

Even with the current residential decline? It’s possible.

Why overall costs are rising:

• Wages. When the residential market fell this year, many workers switched into the commercial sector to make ends meet. But that doesn’t mean the supply of commercial workers is endless.

A residential builder, for example, will likely not be able to switch and become a pipefitter — which an increasing number of industrial projects, such as power plants and refineries, need. According to Ken Simonson, AGC’s chief economist, specialty trade contractor wages have begun sharply rising, which indicates the amount of residential workers with the skills to transfer into commercial building is "close to exhaustion."

The rate of wage increases is likely to hit 5 to 5.5 percent in the next few months, up from a recent 4.5 percent increase.

• Materials. It seems likely that the residential market’s decline would affect sales of building materials as demand for those supplies lessened.

It did, somewhat — but commercial construction’s relatively consistent strength has kept material demand up.

As a result, material costs are up — slightly more than double the general rate of inflation, according to Financial Week. That will hurt 2008-planned projects that designed a budget based on lower material costs.

What It Means for the Industry

Analysts predict the housing decline will lessen and that home sales and construction will eventually increase in 2008.

The past indicates that construction sector activity does greatly affect material prices: Highway and street construction have boomed in recent years, and so did diesel fuel, asphalt, concrete and steel costs, which more than doubled in 2005 and 2006, according to the AGC.

That’s good news for the housing industry, because the AGC predicted that residential construction will put more downward pressure on lumber, plywood and gypsum product prices and affect demand (and therefore, costs) for other materials in the overall construction market.

And the residential sector won’t be affected by some increased costs for materials that are not used in home construction.

Wages are less likely to be an issue as more residential jobs become available. The supply of residential workers should be plentiful if housing construction picks up gradually, which it’s predicted to do.

However, if construction rises suddenly — or if a significant number of residential workers have either transferred to commercial and find it more lucrative or have undergone specialty training to fill commercial voids and don’t want to return to more general residential building tasks —  the residential workforce may actually see a need for more workers. (That’s not highly likely, though.)

All builders will have to deal with higher shipping rates — unless they opt to purchase locally (which is better for the environment.) Hopefully, that will spur some interest in sustainable building and material reuse and recycling.

In fact, residential construction’s biggest threat actually may be from another country — not another sector. Not only are developing areas like China drawing from the U.S. materials supply as they beef up housing and infrastructure, importing materials won’t be easy for the U.S., either. The cost of shipping raw materials has gone way up — reported this week by the Wall Street Journal — which will affect some materials’ entry into the U.S.