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Construction Inflation: How Bad Does This Get and How Long Does it Last?

September 21, 2021

The economy boomed at an impressive rate the first part of this year, with consumers enjoying the opportunity to resume their previous patterns. However, the expansion resulted in a surge of inflation which had not been seen in over two decades. The “real” rate has jumped to over 5.0% and the “core” rate has been over 3.0%. So, how long does this inflation surge last and how bad does it get before calming down?

Material Prices

Most of the commodity hikes have been felt in construction. Throughout the year the Fed has insisted the inflation rate is transitory. They assume the pace will slow and rates will fall back to familiar levels, since much of the inflation has been created by commodity prices. Prices have soared all year. Lumber was at an all-time high in mid-summer. Steel, copper, and aluminum were up dramatically. These hikes corresponded with similar spikes in the price of oil. The good news is that these price hikes were a response to a demand-driven shortage as opposed to a “real” shortage.

A demand-driven shortage means that suppliers and producers are struggling to keep pace with higher demand, but eventually, suppliers and producers catch up. The Fed assumed that once suppliers geared up, prices would start to fall and indeed that was the case with lumber and steel. There is no expectation that prices will tumble back to those abnormally low levels in 2020, but they will likely be back to 2019 levels by the end of the year.

What’s to Come

The Fed has asserted this is transitory, driven by demand shortages, and when the suppliers catch up, the end of the inflation threat will be near. That recovery has been thrown into question by the return of the virus threat. Suppliers that had been anticipating solid and predictable demand are no longer sure what will happen and are slowing down already. This will extend the shortage situation and leave prices high.

What to Do

There are some traditional means by which to address inflation but none of them really seem to address the current situation. One method is to try to boost inventory before prices get higher. Many companies have engaged in stockpiling to avoid higher costs later, but for this to work there must be a recovery that uses that accumulated inventory before it becomes too much of a cost burden. A second tactic has been to wait out the price hikes by reducing activity, but that puts a company at a disadvantage if competitors are ready and willing to grab for market share.

There is still enough construction growth to draw companies in – especially in the residential market. The situation in the commercial sector has been much rougher. Office building was restarting on the assumption that people will start heading back into their offices but that pace has rapidly diminished as the protocols and restrictions have resumed. There continues to be growth in the warehouse and logistics sector but shortages of key components have complicated that recovery as well. The wait for the steel truss needed for warehouse construction can be as long as a year. Public sector construction has been on hold pending the conversation regarding infrastructure spending but even as it starts up there will be acute shortages here as well and shortages yield inflated prices.

Inflation Motivators and Predictions

The Federal Reserve has not suggested they intend to do anything substantial to address inflation (such as hike interest rates). They are talking of a reduction in their support for the economy – a tapering of their activity in the bond market. This will not have much of an impact on inflation at this point.

The other motivators for inflation have been wage hikes and a surplus of money in the system. Thus far the wage hikes have not pushed inflation much. There has been consistent wage inflation in areas where skilled workers are in short supply but generally the workforce has not been in a position to leverage. The money supply issue has been a concern as it was estimated there was close to $5 trillion in excess savings around the world earlier this year. That amount has declined by over half as people spent during the summer but it is still an overhang. The presence of excess cash and cheap access to loans means that people and businesses can ignore inflated prices to some degree.

The best estimates hold that inflation has likely reached its peak due to the return of the virus concerns, and that means that prices will likely stabilize through the remainder of the year. The fall will not be as swift as the rise, as producers are wary about over producing. If they get the impression that next year will improve, they will ramp up and prices will decline.

MarksNelson’s experts know the challenges the construction industry faces and can help your company prepare for the rigors ahead.

Margo has been an integral part of the accounting department at MarksNelson for more than 10 years. Clients appreciate her unique ability to clearly explain complex situations and use data to analyze their current and future state in order to chart a course for... >>> READ MORE

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