Opinion | COVID-19 impact on construction costs and escalation
Opinion | COVID-19 impact on construction costs and escalation
For those of you that have attended our Cost & Project Management presentations over the past several months – there was a constant theme around crystal balls and the moving market; especially in terms of hard construction costs. At the time COVID-19 was a distant problem, developing mostly with concerns around the supply chain. I guess we discovered our black sheep!
There is no doubt now that COVID-19 will have a great impact on construction costs.
The primary focus of this opinion piece is residential and commercial; however, it needs to be noted the entire construction industry is interconnected. There tend to be consequences and impacts in all asset types which influence each other; after all concrete is always concrete it does not overly differentiate by asset (no semantical arguments please). Also, with the stimulus funds that will flow into construction they will more often or not be directed towards institutional and civil (transit) projects; with the private sector left to fend for itself (thankfully).
Practical strategies for managing construction cost escalation
Three pragmatic strategies
So, the question is what will be the impact on construction costs? Some believe costs will go up, some believe costs will come down and both are likely correct. The question is more around time and how long the pandemic impact lasts and ultimately; will we end up in an official global recession. The question around the recession is how hard it hits Canada, often in a recession all bets are off and construction prices will plummet, projects will be cancelled, distressed deals will appear, purchasers can’t buy, and financing will dry up etc. But, that’s a little doom and gloom and we are not there yet.
The short term
Let’s take an optimistic view and say this scenario lasts just a few weeks longer. Costs will go up, claims will be submitted, and schedules will go long.
Think about temporary hoists with only two workers at a time on a 40-storey tower trying to get to their floor. That’s an hour per person lost every day (minimum).
Or, the line up in the morning as site’s screen workers come in – add in physical distancing and productivity will plummet.
The supply chain is now somewhat broken with it being difficult to impossible to get materials from Quebec with the shutdown, local fabrication is partially closed with backlog upon restart, China is going to have long lead-ins and the United States is somewhat in flux etc. We will have a future opinion piece on the supply chain around trade in the coming weeks, so stay tuned!
Sites were already struggling with obtaining skilled labour for certain trades, and it’s only going to get worse before it gets better. That assumes the sites don’t close, as the main priority has to be safety of workers and their families. Someone has to pay for this, as trades, owners, general contractors, and suppliers all will be hurting. Costs are going to increase on projects, likely more than the sudden drop-in interest rates will help. Where construction financing is in place, put that savings straight into contingency, because it’s likely largely gone.
As we run through the next billing cycle, who isn’t going to try and get as much cash as possible? The risk is if the sites stop and the project is over certified; is there enough cost available to complete? If the cash is gone by the time the remobilization happens in the future; is there an increased risk of defaults? Ultimately costs go up in the short term.
Can I register the condo? Can I occupy the units? If the answer to either of those is ‘no’, then costs likely go up. If the industry stops for a short period, then costs carry on and go up. Margins; however, tend to do the opposite. Who had the foresight to put a contingency for global pandemics?
The next question is, are you tendering right now? We know the trade / supplier offices are likely largely up and running remotely, and I assume there are people to bid. If you are responding to a tender how do you approach the bid especially in the new world of risk we are in? If classification as an essential service continues, but productivity is 40-50% (say) does that get factored into the bid? If the materials come from countries impacted significantly, what premium do I put on them, and how do you take risk on schedule or cost?
Is COVID-19 here for the season, or back next year? Tender high, or tender low as you need the work (perhaps) then face cash flow issues in the future. Or, do you simply not bid, because it’s not worth it? Unless you were to go safe (a.k.a. high, with lots of caveats) and someone else goes in low, that’s less competition in a years’ time (Darwinism approach)!
At this point, as an owner perhaps you could qualify some trades, or consider delaying? After all, what’s the hurry? But, that’s a whole different topic.
Lastly, once the sites come back to full productivity (a relative term with labour shortages); then owners will want to make up time, so again costs increase and labour constrains. Projects were already well behind schedule in a lot of cases, so the situation continues to exacerbate.
One way to look at tendering in the current market is it’s like playing Russian Roulette – we are genuinely into the unknown.
In terms of tender quotes or budgets, the documents we have received recently from the industry are full of caveats around COVID-19. An example from one submission from a Construction Manager “we are uncertain on how the current world affairs are going to impact pricing as a whole, until a more stable economy and construction market is apparent”.
The medium term
What will happen in the next few months, that’s a little bit unknown as its going to be influenced by the volume of work in the market. The issues noted above in the short term will become exacerbated. If there are a lot of project cancellations, these would invariably mitigate cost increases and potentially invert. Less demand = less work, which often should lead to a competitive environment. This brings back fond memories of 2015 to early 2017 when tendering had the word competitive in front of it.
In the medium term it’s more likely that the previous historic levels of escalation may be mitigated for some trades, but this will be entirely influenced by volume of individual trades. I’m not sure we will see a massive inversion in costs today, but it’s entirely possible as each week goes by that costs will invariably start to soften.
Now those are general statements, and there are always opportunities to get a great price. Taking advantage of it being the right time, right place, right relationship or finding an estimator with suspect math skills. That exists in any market! Even in the previous craziness of double-digit escalation we saw some amazing deals (including formwork!)
The long term
Now, consider this pandemic hanging around a lot longer, then we will likely be in the middle of a full on recession with the restrictions still in place. At that point do we even care about escalation? Well yes, to a relative degree, people need homes and jobs, commerce and business are an essential requirement. There is the prosperity part that goes nicely with health.
Construction is also a massive employer in Canada with well over one million people contributing in a positive way to society in general. However, longer term thoughts would drift back to memories of 2009 or the recession before that if you’re old (er). Costs come down in recessions, liquidity dries up, companies go into receivership, work vanishes in the private sector, and shifts over to public investment. Then usually the market eventually comes back and escalation goes at a fair pace again. Akin to the Monty Python dead parrot sketch, the market is dead, no it’s not it’s just sleeping.
It is all about timing (and relationships). Tendering is a lot about timing, costs are often very much about timing; like most things in life you want to be in the right place at the right time for good things to happen (a bit of luck never hurt either).
When people panicked, we ran out of toilet paper and hand sanitizer. This is the time for calm, pragmatic and careful consideration in the approach to development / construction planning and budgeting. Panic will do you no good ultimately. You need to have a plan, alternate plan and a back-up plan, considering the various potential outcomes and the risks so you can act accordingly when the time comes. No matter what happens, it is likely there will be some degree of negative outcome. However, if you can proactively manage to mitigate the impact, perhaps you can create an opportunity out of the situation.
In the end it will all ultimately work out, and everyone will be changed by the experience. Hopefully construction and many other aspects of life can learn from the current challenging situation and maybe spur the industry into adopting new tools. Something positive can be gained from the learning.
Improving site safety, finding ways to maximize use of technology to our advantage (remote working, reducing risk on site, improving productivity, analytics & data). And, please can escalation slow down? Being called doctor doom at every market presentation is not as much fun as it seems!
Lastly, when the claims come, they will be high. When the change orders are submitted, they will be high; but don’t panic!