So what is going on with the market and how can contractors survive the rising construction costs? The trick is to first understand how and why materials costs in construction are increasing so that you can start to manage budgets effectively.
Why are the prices of materials skyrocketing?
Since the pandemic, the prices of construction materials have increased dramatically.
- Cement prices have risen as much as 30% since last year with bagged cement increasing by 15% in June.
- Steel has increased by 38% overall with fabricated steel increasing by 5.9% in May.
- Timber, particularly imported plywood, has increased by 29.8% in May compared to May last year, with sawn or planed wood increasing by 3% in May.
What's more, is that this trend is also expected to continue into the summer!
So what is the cause of the rising material costs in the construction industry?
1. A shortage of raw materials
Like most other industries, many sawmills and steelworks shut down early in the pandemic. Either that or at least they drastically reduced their output (e.g. cement manufacturers didn't fire up all kilns). At the same time, however, there was a boom in building and home improvement as quarantined homeowners began DIY projects, especially during the first lockdown. Then came record-low mortgage rates which just fuelled home building even more.
The slowdown in the production of materials coupled with increasing demand is continuing even today. Manufacturers and suppliers are struggling to build up stock levels so this has led to a global shortage of raw materials and soaring prices.
2. A rise in labour rates and unemployment
As well as supply chain woes, the pandemic also caused a spike in the unemployment rate. This only worsened when Brexit kicked in as hundreds of thousands of Eastern European workers had to return to their respective countries.
The construction industry was hit particularly hard by this as is seen in the Office for National Statistics report. Employment in this industry fell from 2.3m in 2017 to 2.1m at the end of 2020, 42% of which is due to EU workers leaving the country. There are now 35,000 construction vacancies, the highest since records began 20 years ago.
As demand continues to increase, some trades are becoming overwhelmed with work. As a result, labour rates have skyrocketed too.
3. Brexit-related complications
In addition to workers, Brexit has also caused chaos when it comes to the importing of materials. Roughly 60% of imported materials used in UK construction projects are sourced from the EU, so as you can imagine, the uncertainty around Brexit and its impact on importation has caused a massive amount of disruption.
Yes, the UK-EU trade deal has finally been agreed and it has been confirmed that no additional tariffs on imports or quotas would be added. However, the damage has already been done.
We all saw the queues and queues of lorry drivers stuck at the UK ports at the turn of the year, and that was because of the uncertainty surrounding Brexit. Before the deal was agreed, there was increased congestion which led to massive delays and this has caused an ongoing lengthening of supply lines from Europe.
4. A shortage of lorry drivers
With lorry drivers being on the road for so much longer now, building sites are struggling to receive deliveries which delays projects even more. The availability of hauliers is a factor that has become an issue over the past few months. It is now a critical nationwide problem and it's only fuelling construction project delays and the rising material costs.
Contractors are feeling the pinch…
Contractors have been hit particularly hard by the rising construction costs. Why? Because they bear the risk of price increases in materials between the time of contracting and the time of purchase.
Under normal circumstances, contractors submit a fixed-price bid for a job based on materials at that time and they factor in the typical rise of materials into that cost, which is between 3.5-5.5% per year. That way, when the foundation for a house has been laid and it is ready to work on (could be 6 months+ later), they can order the materials and still make a profit on the job.
What has been happening over the past few months, however, is that the price quoted for a job in the previous year isn't sustainable for the job when it is ready to work on. This is because, in a period of 6 months after the fixed bid has been agreed, the cost of materials have increased more than 12% on average! Since materials often represent half or more of the cost for a job, this alone could wipe out the profit margin from a project.
Add to this the delay in getting materials, and this could result in many contractors paying a lot more for labour unnecessarily and actually losing money on projects. If this keeps happening over time, this could put many contractors out of business.
3 ways contractors can survive rising construction costs
Putting projects on hold or cancelling them all together isn't an option if you want your business to survive over the next year. The question remains then, how can you complete these jobs if raw materials are only getting more and more expensive?
Save money by improving your material management
If you find smarter ways to manage the materials you do use, you can start to tighten your belt on waste and inefficiencies. Some of the ways you can save money by cutting down on this expense include:
- Embracing prefabrication - to operate more efficiently and reduce waste. This method also reduces the cost of labour for your company which can further offset the rising material costs.
- Use lean construction - this involves a lot of planning but leads to increased productivity and reduced material wastage. This strategy has the capacity to reduce waste by up to 64%.
- Leverage technology - software such as Building Information Modeling (BIM) and Construction Field Management (CFM) can improve planning accuracy, budget estimates, and project management to streamline the whole process and save money.
2. Fix prices as soon as possible with clauses
The whole industry is aware of the rising material costs so, since you legally bear the risk of this fluctuation, you should consider adding clauses into your contract.
To mitigate the risk of unexpected price increases, add price escalation clauses to your construction contract. For example, include details of materials and prices subject to potential escalation in the contract. Then, all parties should agree upon the circumstances in which the right to a price adjustment will exist (i.e. above a certain threshold, e.g. 5%). Make sure to detail all of this in the contract before signing and agreeing on the initial price for the project.
3. Know your numbers!
If you don't know your numbers and you continue to agree on prices that aren't sustainable when the actual job comes around, your business will start taking a hit and you'll begin burning cash. To prevent this, go through your books or sit down with your accountant so that they can help you forecast.
- How much cash do I have now and how much am I burning?
- How long can I sustain this?
- What is my sales price compared to my competitors?
- Do I need to increase this?
If you go back to the basics and aim for better cash flow management and forecasting, you can plan to get through the next 6-12 months as the current situation stands. You just need to know your numbers so you can forecast your pipeline and start pricing jobs correctly.
Start managing your budget effectively
The pandemic is the main reason for the rising construction costs with Brexit being the unyielding sidekick to the chaos. Together they have both caused soaring prices by interrupting simple economics: supply has drastically decreased while demand has boomed.
To ease the pressure on construction businesses (and to prevent them from going bust in the next 6-12 months), contractors need to know their numbers at all times and manage the resources that they do have as effectively as possible. If they do this, they can plan ahead on projects and reduce the risk of being caught out by shortages or further price rises.
Survive the rising materials cost with PS Accountants!
We specialise in helping contractors and construction businesses. From compliance and maintaining a consistent cash flow to running the business more efficiently, we can help you in a range of areas to help you thrive in business.
Please don't hesitate to get in touch!