Businesses look for ways to deal with construction inflation

Rampant inflation in the construction industry has contractors, suppliers, owners, and accountants charting construction materials and labor costs that are seeing graph lines seemingly as steep as a Mt. Everest slope.

COVID-19-related supply chain disruptions, labor shortages for skilled construction workers, and rising materials prices, are some of the reasons the construction industry is growing increasingly wary about financial conditions and how to keep up with potentially ballooning project costs.

The National Association of Homebuilders reports that steel mill products are up 55%, saying, “Steel mill products price volatility is greater than it has been at any time since the Great Recession.”

Softwood lumber hit a record high for the third straight month. A NAHB official cited lumber as up more than 200% year over year, and milled copper and brass have increased 44%. Trucks are needed to move materials, and as of early May, diesel fuel had increased about 75 cents a gallon.

The Associated General Contractors of America issued a first quarter Construction Inflation Alert that opened with: “The construction industry is currently experiencing an unprecedented mix of steeply rising materials prices, snarled supply chains, and staffing difficulties, combined with slumping demand that is keeping many contractors from passing on their added costs.”

Individual contractors and owners are for the most part looking at the issue from different perspectives: A contractor’s anxiety about making a profit when costs are increasing almost daily vs. owners sweating out keeping a project within a reasonable budget.

There will undoubtedly be attempts by either side to renegotiate contracts that have already been let and which don’t contain careful language concerning how the contractor and owner will deal with the effects of rapidly rising materials and labor costs.

Going forward, escalation clauses in construction contracts, and price “hedging," will be increasingly go-to methods of dealing with costs that are on one level today but on a different level in a week or a month. Escalation clauses typically fall into two general categories: cost increases due to delays caused by unanticipated events or actions, or increases occurring from rising costs. Price hedging – in the simplest possible description – is locking in a price for commodities now so that later there’s no price sticker-shock.

An event example is the recent bridge problem leading to the Mississippi River water traffic shutdown. On May 14, the river reopened. The Coast Guard reported that backed up and waiting to move were 39 northbound vessels carrying 981 barges, and 29 southbound vessels with 477 barges. Construction materials undoubtedly were on some of those vessels. Scheduling delays will follow.

Event escalation clauses typically reimburse contractors for delays not of their making, such as: a relied upon subcontractor or vendor goes out of business or is hit with their own unanticipated event; a hurricane, earthquake, or other national disaster; a conflict in another country; a pandemic, or something else. Price-escalation clauses are invoked typically when the price of a project, or a component of a project, exceeds a certain threshold. A hedge purchase of commodities can protect against price increases, but results in a loss if prices fall.  

These methods mean that someone is trying to not be hurt by a price increase, either through inflation, or by an unanticipated event. When someone is benefiting, it’s possible someone else is losing. For the best chance of avoiding disputes, these agreements are best worked out on a legal basis between parties.

On any project, contractors and owners alike should consult with experienced construction accounting, finance, and legal professionals. It’s how you might keep your financial picture looking up even as costs are going up. 

This article first appeared in KnoxNews.    

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