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    November 10, 2022

    The State of CRE Construction Pricing and How Technology Can Help

    Rising construction costs are plaguing the commercial real estate industry. Since the start of the pandemic, prices for materials have increased more than 35%, making it one of the most pressing concerns for developers—but for more than a year, developers have been battling a secondary issue: price volatility. We covered the topic last summer when pricing issues first began to emerge, but more than a year later, rapid price fluctuations have become a common pain point for the industry, exacerbated by supply chain disruption, the Russian-Ukrainian war, and manufacturing closures due to COVID outbreaks.

    Price volatility adds a new layer of difficulty to the topic of rising materials costs. “The construction industry thrives on predictability, but we continue to grapple this year with numerous challenges and volatility, making estimating and managing costs more difficult.” said Nicolas McNamara, director of cost consultancy for CBRE, in a report analyzing construction costs. Developers have the onerous job of navigating changing prices, generating reliable budgets and working with stakeholders to strategically buy materials to avoid higher costs. Once you understand the nuances of price variation, however, there are sustainable solutions to mitigate the impact of this unpleasant industry trend. 

    Materials With Pricing Instability

    Construction materials are typically grouped together and discussed as a single unit, but there is much variation in pricing for each material. And some materials are experiencing more variance than others. In 2022, pricing for plastic construction products, steel mill products, and concrete products have been moderately volatile, while gypsum products, #2 diesel fuel, and copper and brass mill shapes have been highly volatile, according to a construction industry report from JLL. Along with the volatility, these materials have also had double-digit or triple-digit price increases throughout the year. 

    Steel mill products are a standout example. The material’s change in volatility has ranged from 42% to 105%, and currently, prices are up only 27% year-over-year. For highly volatile products, price variations are even more pronounced. #2 diesel fuel ended the first half of the year up a staggering 111%, and the price is continuing to increase. The change in volatility has ranged from 83.4% to 111% this year. The materials in these two categories are also among the highest priced construction goods. JLL research expects prices to continue to increase through the end of the year, led by energy costs, which the firm predicts will grow 50%.

    Supply chain delays and decreased domestic productivity are behind the soaring costs and price fluctuations. Shipping delays, factory closures, and labor shortages have created challenges in producing or transporting goods, ultimately driving costs up and maintaining inconsistent supply levels that contribute to volatility. 

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    Stabilizing Costs 

    Organizing construction materials into pricing categories reveals core items that are not exposed to price volatility. Flat glass, lumber, plywood, aluminum mill shapes, and insulation materials have stabilized prices, allowing developers to make reliable decisions about these materials or even increase the use of these products when possible. Flat glass, for example, has a range in change in volatility between 1% and 9% this year, while aluminum mill shapes price variation ranges from 15.7% to 29.2% on the scale.

    Pricing stability is a win, but it doesn’t necessarily mean low costs. The price for aluminum mill shapes has increased by 20.3% this year, and the cost of insulation materials has increased by 16%. However, price increases in the low volatility category are not ubiquitous. The cost of lumber and plywood is down more than 26%, and flat glass costs are only up 8.2%. The JLL report forecasts that the cost of lumber, plywood, paper, and wood will decrease through the year's second half. Price decreases in this category are related to reduced single-family home starts, which heavily rely on wood materials for construction. 

    Strategies to Mitigate Volatility

    While little can be done to change the cost of materials, there are a handful of ways to mitigate the impact of rising and unstable prices. Cost strategies begin by partnering with development stakeholders early, and in the case of materials, that generally means maintaining a close and transparent relationship with the project’s general contractor. The developer and contractor can work together to analyze and understand pricing trends and purchase materials in advance, whenever possible, to lock in pricing. In a midyear survey from the National Multifamily Housing Council, as many as 72% of developers said that they changed purchasing schedules to respond to pricing issues. Nearly half of developers also made design changes or used alternative suppliers.

    Technology can help manage purchasing schedules and analyze cost structures. Construction management software like Northspyre is a quintessential example of how developers include technology in their mitigation plans. Through automated data analysis, Northspyre can anticipate budget overages and identify savings opportunities, and it analyzes and organizes project proposals and contractor invoices to delineate information to stakeholders. This technology can generate significant savings for developers—sometimes enough to offset price increases. Northspyre saves developers as much as 66% on budgeting overages, for instance, and another 6% in overall cost savings by driving better budgeting decisions. 

    New contractual agreements are also emerging to address price variations. Unexpected material cost increases could impact the contractor’s original bid, and there is a gray area about who should cover those expenses. To protect against volatility, contractors include escalation clauses or revised force majeure clauses to pass a portion of costs to the owner. 

    Optimism Ahead 

    CBRE expects construction costs will continue to escalate through the end of the year—but there is some good news around the corner. Researchers forecast price growth will moderate in 2023 and 2024, stabilizing at a growth rate between 3% and 4%. Despite high materials costs and pricing volatility, overall, construction industry sentiment is positive. The Engineering News Record’s Construction Confidence Index, The Dodge Momentum Index, and the AIA’s Architecture Billings Index, all of which measure industry sentiment for new construction, are up compared to 2019. 

    The positive sentiment is evident in construction pipelines, which continue to grow despite rising prices. Developers are still navigating the difficult challenges born during the pandemic, but through strategic planning, data collection, technology, and strong partnerships, higher costs have yet to derail development. 

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