How Will Inflation Impact the Construction Industry?

Construction Economics Analyst Ed Zarenski Has Your Answers

Ed Zarenski spent 42 years in construction, 30 of which he spent as a building project cost estimator and construction economics analyst. Today Bloomberg News, the Washington Post, The Financial Times, CNBC, Los Angeles Times, Marketwatch, Newsweek, strategy+business, Yahoo! Finance, ConstructechTV, Ontario Construction News and more seek Ed Zarenski’s crystal ball for deciphering what’s really happening in the construction industry, beyond the headlines. Ed also taught Advanced Construction Cost Estimating and Construction Economics for five years at the Worcester Polytechnic Institute, and writes an industry blog, Construction Analytics on EdZarenski.com, where he gets more in depth about construction industry economics. I highly recommend you bookmark his page.

As you can imagine, Ed closely monitors his blog readership analytics, and he shared this interesting observation: his audience has shifted from 200 to 300 reads a day on his construction forecasts in Q1 to a growing 300 to 400 visits a day for his inflation forecast.

If you’re an architect, specifier, building owner, real estate developer, or building materials distributor wondering how to prepare and plan for what’s ahead in residential and non-residential construction, Ed Zarenski has some business intelligence for you in our late April conversation:

W. R. Meadows: Did you see any construction slowdown prior to the pandemic? How did the pandemic impact the building industry?

Ed: Nothing of the sort was happening before the pandemic. In the first quarter of 2020, we were in record territory in all types of building. It was the last quarter of 2019 and the first quarter of 2020 before any of the impacts showed up, which in construction, the impact really hit in April. January, February and March of 2020 were normal months. We will get some new data around May 3^rd*, comparing March data for this year to last year, so we’ll have a really good indicator comparing what was ‘normal’ before the bottom dropped out.

Construction was not slowing down. The pandemic really threw a twist into everything. Not only did we lose all of those construction starts and we lost labor force, but the biggest impact is all of those lost starts from last year. Now, there were jobs delayed–almost all jobs delayed are back online now. It may extend their duration a few months this year, so that’s not such a bad thing.

Money got taken out last year for a few months and the jobs started back up, so money gets added to it for a few months in 2021 until the project finishes. It’s the projects that dropped out completely–the new starts last year—that is what’s going to have the biggest impact on everything going forward.

W. R. Meadows: How do you balance lean inventory with being prepared for scarcity and building materials supply chain disruptions?

Ed: You definitely have to be ordering your materials for each project well in advance of when you’re going to need those materials. Steel is easy to talk about. You probably have all of the design document-level drawings that you need to do steel take off on a building six months before you need it. You should not be waiting to put the steel contract out to bid. You should put it out to bid and you should have the steel ordered well in advance. It won’t prevent you from having to pay whatever the steel price is going to be, but it will ensure that you have your product on the job site when you need it. That’s going to be as important to the materials situation this year as the cost of materials. Not only is the cost of materials up, but the delivery of materials and the demand for materials is showing that shortages are delaying deliveries and extending the time on all projects. So, in the early design development of a project in the pre-construction phase, first, one of the things that should be considered right now is, ‘All of these projects that I built in 16 months over the last few years–can I still build them in 16 months or will it take 18 months now?’ And the second thing to consider is, ‘What is my early buy-out schedule? How far in advance can I buy these things out so that they will be delivered on time?’

And that’s the lean process: get it delivered when you need it. Not before. But the key to getting that delivery is, ‘How far in advance do I have to order it now to get my foot in the door before the guy down the street, who has a bigger order than I do, when I don’t want to be behind him waiting two or three months for my product?’

The lean approach offers more than just knowing I’m going to have my materials in advance. There’s a lot of planning that helps in advancing the project schedule and the entire project to the benefit of the owner. I think lean is still a good process, but there’s just a couple of things in the process that make things difficult for all contractors now, whether you’re lean or not.

W. R. Meadows: What kind of inflation can we expect and prepare for?

Ed: Inflation is much higher for residential than it is for non-residential. I’m predicting that residential inflation will be between 7% to 8%, and I’m predicting for non-residential buildings, it will be between 3.5% and 4%.

And there’s much more going on in non-residential building than there is in residential. In residential building, everyone knows that lumber is skyrocketed and residential construction is booming – it’s at an all-time high. There is so much working going on, that in itself drives inflation. A contractor that normally builds three or four homes a year is all of the sudden building a fourth home a year because he knows that with the market out there, he can sell that home before it’s even done being built. And he can sell it for whatever he’s asking for it, and people are going to bid 10% over asking price, so that’s driving the inflation rate in residential.

In non-residential, you have a couple of competing things going on. First off, the Producer Price Index for material inputs for non-residential is up 12% over March of last year. But if you look at the rate that owners are paying for buildings and paying for sub-contractors, that’s only up 2% or 3%. What that means is, all of that cost in the Producer Price Index is not being passed on to the owner. The cost is there, so somebody is paying for that material. So how is that cost not being paid on down to the owner? The wholesale, the retail, the builder?  The subcontractor? Everybody is taking a little bit off of their margins, so margins are decreasing. Even though there is more work to bid on right now because all of that stuff that got delayed last year, there are now contracts that are being bid now, plus the normal workload of contracts are being bid. So, if the number of projects to bid on is up, you would think that would lead to higher inflation. The Producer Price Index is up. You would think that would lead to higher inflation. But the amount of that cost being passed on to the owner is down, so inflation is being held in check. That is why I’m only predicting only 3.5% to 4% inflation for non-residential buildings this year.

*Editor’s Note: On May 3^rd, Ed Zarenski posted his much-anticipated Construction Spending 2021 Update blog, which you can see here.

We extend a special thank you to Ed Zarenski on sharing his time and expertise with us and our W. R. MEADOWS blog readers; we look forward to gaining his insights again as building industry issues unfold.

About Ed Zarenski:

Ed spent most of his life as a competitive runner, racing everything from the mile to the marathon. He is still an avid biker, hiker and skier, and looks forward to every morning and his sunrise dog walks. He worked as a United Way ambassador and campaign chairman for more than 20 years, and conducts food-collection events to support his local food bank. He has two college-graduate children just starting their careers. He’s practiced amateur astronomy since the 6^th grade and spent 10 years studying, developing comprehensive testing techniques, and publishing articles about hundreds of pieces of astronomy equipment. He loves teaching kids about astronomy, and in semi-retirement, now he has time to do all of the above.

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