The Expert Podcast

So in the construction industry, why are building costs still going up? We have inflation which should be reducing demand, reducing homes being purchased which should lower prices under supply and demand. We have inflation which should also be counting back purchasing from consumers which should reduce demand. This should reduce prices. Even lumber costs have gone down slightly in the last month or so. So what gives? Why are building costs still high and in actuality still going up? Well there's a few factors that go into this.

First of all, demand is still going up even though interest rates have risen and inflation is starting to pinch the consumer. Demand for building materials at the retail level - you know, big box stores, Lowe's, Home Depot - at the wholesale level, the lumber yards that service contractors, demand is up in both categories. Why is that? Well, a house is not a discretionary purchase. If your grocery bill goes up, maybe you can cut back on buying so much high-end meat. If your gasoline price goes up from three dollars a gallon to five, well maybe you'll drive a little less and cut back on fuel. You can't cut back on having a house. You need to have a house whether you rent it, own it, live in it part time, whatever the case is - you still need to have a house.

Now do you maybe end up with a slightly smaller house? Possibly. That might have an effect on the volume of lumber used, but in any house most of the materials are still about the same. You still need the same number of appliances, you still need the same number of core fixtures like breaker boxes, plumbing. But the square footage on houses, even in the face of all this, is not dramatically decreasing. It's hovering at about the same rate it did. So demand is still there. The same number of people need homes - in fact, more people need homes now than did before. So the demand for the number of houses are the same.

What else is affecting it? Well, what's happening is a lot of materials or the raw source components for materials come from overseas - they're imported products. And the US dollar is losing in conversion rate. So the exchange rate of a dollar versus other currencies that buy either finished goods, appliances as an example, or the raw materials that go into finished goods goes up when dollars buy less materials overseas. That's going to affect the price locally.

Another factor that goes into building cost is fuel. Everything that is put into a home has to be delivered by truck, and that truck may bring it from the port to the manufacturing plant, from the plant to the distribution. Another truck brings it to the local lumber yard and finally it goes to the job site. Every one of those moves of the product uses fuel, usually diesel fuel - six bucks a gallon many parts of the country. DEF fluid that goes into trucks is in short supply. In fact, some of the major producers are being told by the rail lines to cut back on their volume of DEF shipments. This is affecting shipping costs.

In addition, various fuels are used at the manufacturing site to build, machine, mill items. Natural gas powers a lot of these plants or powers the electricity, electricity that goes into these plants. So that's another factor on the upward side of it.

There's still supply chain problems. So shipping containers that you know, 20 or 40 foot containers that you see on overseas vessels, they're in short supply. There's not enough of them to bring all the goods from other countries. So when it's in short supply, the lease rate or the rental rate goes up. So if you're a shipper, you have to pay more for use of that container, not counting the higher cost of the shipping itself, whether it's by rail, by truck, by ship - it's called intermodal.

That same shipping container starts out maybe packaged up in Asia and all the materials stay in that container from the time it comes over on the boat. It's offloaded out of port, there's usually a ferry type truck that brings it from the port to a local dispatch yard, and then maybe it goes on a train and that train may take it halfway across the country to an intermodal depot. And then that same container never gets unpacked, gets taken from the train, put on a truck, and the truck brings it to maybe a more local or regional distribution plant. And then at that point it may be unpacked and put into LTL - less than truckload - and that will bring it to the local big box store or maybe it's even a smaller retail store or the shipping or the lumber yard. All of those moves require fuel, and that fuel cost being higher puts upward pressure on the price of whatever is in that container.

So what else goes into all that activity? Well, it's labor. There are people that need to drive the trucks, run the cranes, run the forklifts and the distribution plants, maybe pack and unpack the containers, maybe you know split it up into pallet size shipments. Sometimes there's assembly of these items or a manufacturer from raw materials. Every single one of those activities requires a human. That cost has gone up because incomes have gone up, labor rates have gone up, hourly rates paid have gone up, especially in the moves that have some type of specialized skill. Truck driving as an example, manufacturing - if there's skilled workers with certain training that need to go into these jobs, they're in high demand and their rates have gone up. Even though the manufacturers and the shippers have gone to different parts of the country with lower labor rates, it's still going to put upward pressure on whatever item is going through that supply line.

There's still some remaining effects of COVID where some plants may shut down for a week if they have too many infections. That's not as common. There's a couple other event-related costs that go in - maybe there's a storm that shuts down a port for a week, or hurricane, or some other natural disaster. Those aren't as common, but a few of those happened last year and those, you know, put a monkey wrench into the supply lines. No matter how you look at it, it puts upward pressure on all the goods that you're putting into a house, and that's going to affect the final output price of the house.

Many times a builder doesn't even know what their cost is going to be until they put the last coat of paint on the house and have all the material costs allocated and accounted for. So if you're expecting inflation or higher interest rates to put a damper on building costs, that's not happening. It's actually going up even more. There is a slight easing on the lumber, but that's only one component in a house.

That doesn't even count the fact that building a house or an addition or a remodel or a commercial property has a great deal of labor directly applied to that build, not even counting labor that goes into creating the materials that you put together at the house. That builder has to have certain number of hands of labor on site to construct the house, do the framing, do the concrete pour, all the other things that go into a house. Maybe they're done by subs, but it doesn't matter - there's still human hands that go into that, and all those labor rates have gone up. In fact, one of the bigger problems, not so much as the rate has gone up, it's you can't even get certain types of skilled trades, and so those delays also put upward pressure on the cost of the house.

So if you could turn around, you know, a builder grade 2,000 square foot house, let's say, in 90 days or 120 days in a typical market - a market that has fast throughputs - you now have a couple of things that make it go longer. You may not be able to line up your subcontractors one after another: electrical, plumbing, framing, sheetrock, like so one leaves the next day, the next one's there. You may have gaps in between, a week or two in between each trade. Those week or two add up, maybe add another month or two to the project timeline.

In addition, there are municipal budgets that are under pressure, meaning the permitting, zoning, all of the offices that the government runs to sign off on your project - they're having labor issues as well and they're having to downgrade their hours. So instead of getting a permit signed off in 10 days, it may be two weeks. If you had all that time up, you may be looking at three months additional throughput. So instead of a 90 or 120 day project, you have a 180 day project or maybe a nine month project.

And those extra five or six months add carrying costs and also add other hidden expenses - damage and missing items, maybe weather related if you're in a part of the country that you can't really build as fast in the winter because it's snow or snowy, or maybe in the summer it's too hot. That may add other parts of your timeline. You know, every month can add one percent to the cost of a job. Every extra month of delay. So three month, four month delay can add four percent. You know, on a $300,000 house, you're talking $12,000 extra expense.

So these are hidden factors that put upward pressure on the final delivery price of any project, whether it's a new build, whether it's a remodel, addition, commercial project, even municipal projects - build bridges, roads - all have the same thing going into them. So this is why prices are not going down, and that inflation of builds is a spiraling effect. It puts inflationary pressure on other industries that are related to insurance industry. If you know your cost to rebuild a home is going to be 20% higher than it was two years ago, well if you're an insurance company, you may have to factor that into premiums for property insurance. So if you have to pay to repair property and you know it's going to be more money, you have to charge higher insurance rates.

Leasing rates for property - if you're a commercial property owner that rents to tenants and you know that your build cost is higher, you may have to jack up your commercial rates or residential rates. So these increases in prices affect all the way through, front to back, different parts of the economy, and these are the reasons why inflation interest rates normally would have an effect of putting a blanket on supply and demand and cutting the demand. We're still in a demand side market, and we'll talk in other videos about how that's affecting real estate sales. Put your comments below, let us know what you think, and we'll see on the next video.