Opinion piece | COVID-19 impact on construction costs and escalation (part deux)
Opinion piece | COVID-19 impact on construction costs and escalation (part deux)
At the end of March I wrote an opinion piece on how the pandemic would impact construction costs and escalation on the short, medium and long term. This was a very popular post, and since we are now in late September – we thought it was time to do a follow-up piece, in the same format.
In March we were in lockdown and no one knew what was going to happen next. That now feels like an eternity ago and things are still looking a little unpredictable. Three things that are certain: 1) my commute shrunk, 2) my waistline did not shrink, and 3) my work-from-home setup got very fancy! Two positives out of three ain’t bad!
Practical strategies for managing construction cost escalation
Three pragmatic strategies
- Ontario opened up their businesses, services and public spaces (at what seemed like a glacial pace), and now may have to start closing things down again with COVID-19 cases on the rise.
- A number of companies, we suspect, could become insolvent.
- Canada’s unemployment peaked at a staggering 13.7% in May of this year, and has been dropping rapidly in a v-shaped recovery.
- The federal government launched CERB (Canada’s Emergency Response Benefit) to give financial support to Canadians who had to stop working for reasons related to COVID-19, and this gave them $2,000 for a 4-week period. They have also started to roll-out further economic stimulus, albeit very slowly.
- House prices went up a lot, and we saw some crazy July numbers in both resale and new homes in the GTA. Rental rates have dropped in the GTA (Toronto in Particular), but I see this as only a relatively short-term reprieve.
Who knew that if you increased the supply of something compared to the demand, that the price would come down? I wonder how housing could become more affordable? Wait a minute; I might be onto something here. I would say build more and make the process easier, but that sort of radical thinking does not seem to be catching on these days.
So, what changed in the market? Let’s dig in.
of development executives said project cost escalation is a significant challenge facing development firms, followed by environmental regulations (70%), government policies and processes (65%), and trade/ labour shortages (65%)
Source: Altus Group Global Property Development Trends Report (2020)
The short term (almost history!)
As noted earlier my waistline expanded, so to counteract this I purchased a treadmill. My short-term benefit was losing 5 lbs just getting it into my basement and assembled. I digress.
In some very quick bullet points:
- April saw ±313,000 construction workers lose their jobs (Statistics Canada’s Labour Force Survey), which represents ±21% of the construction workers across Canada, and ±93,000 in Ontario alone. These numbers were so high I had to double-check them, but thankfully around two-thirds of these have since been rehired, as of August. Unfortunately for Alberta, they are likely to continue struggling well into 2021.
- April new condo sales in the GTA were below 500, which is significant as the 10-year average for April is 2,099, and last year it was over 3,000. March was amazing and best one we have seen in the last 10 years. Fast forward to July and the market came back with force, Alterra leading the way with some great sales for their 28 Eastern project in Toronto.
- Initial loss of productivity on open sites in Ontario, we estimate was 40-50% with a drop-off in manpower of over 25% in some cases. That has recovered quickly back to around the 90-100% range. Most sites were not exactly running at full productivity pre-COVID.
- A BILD Survey shows over 80% of all projects were delayed by 3-6 months.
- Completions of condos carried on at a remarkable pace, but below last year’s level as of July. This causes us issues as more condominiums are starting than completing, which has been a trend for a number of years.
- Claims did start to flow, mainly on commercial projects, with third party construction managers.
- Tender prices / quotes stayed relatively stable at pre-COVID highs, but that lasted around three months. Escalation reared its nasty head and it seems we are going to have problems again.
- There were also supply chain issues. For example, the Financial Post did an article on shipping via sea, and closer to home we have seen elevators backlogged. These issues may have alleviated over time, but there are still challenges and we suspect this could become a larger issue as we move through the fall and as the second wave potentially takes hold.
- Costs for General Conditions did go up, and we are seeing anywhere from $10,000 to over $100,000 more per month from pre-COVID. This seems to vary more by construction manager than by actual stage of construction, which is one of those oddities. Low rise is not quite as bad with an increase of $100,000 – $150,000 per project.
All in all, most of the construction industry has certainly performed well and shown its resilience since March. None more so than the workers on-site, who braved the unknown to keep building for the future generations and the trades, general contractors, construction managers, numerous trade organizations and many others who worked tirelessly to make it as safe as possible.
We are not out of the woods yet, which moves us on to the medium term.
The medium term (remainder of 2020)
We are in the medium term now and it is somewhat odd. We are told we are in a recession, and for some it feels like it, but others are in denial. Also, don’t ask me what’s going on with the stock market, and maybe just put all your money on red at the roulette table, or the horse with the funny name in the world of equestrian sports.
Rather than write War and Peace, here are some simple observations:
- Productivity is still being impacted. In order to meet physical distancing requirements, construction sites had to limit the number of people in elevators and hoists, in addition to other protocols. This is not as fun as the 1889 book Three Men in a Hoist (oh wait, that was a boat). There are, however, mitigation strategies, and this is where your construction managers or general contractors can earn their fees.
- Trade prices are being impacted. The productivity noted above may also come into play with trade bids. We are seeing COVID and non-COVID prices, with lots of exclusions and caveats.
- Commodity prices have reduced. The World Bank says this trend is likely to continue, on the back of a drop-off in demand. Production has continued at the same pace. The main impacts on construction being aluminum, iron ore (went up initially) and copper. Although that is the raw material price and the impact on the end manufactured / engineered product is much lower. Any significant reductions in rates are more likely to be linked to local drops in demand, especially if significant, or if someone goes tariff crazy!
- Lumber prices have been out of control. This is due to the pandemic and the slowing down of production.
- The General Conditions for future projects will remain higher into next year.
- Construction cost escalation will remain an issue. Building permits are up, condos under construction are up, and the market is beyond busy.
- Formwork contractors will only get wealthier. Sorry to say, but they are all losing money (honestly). Don’t mention the poor drywall guys and the down-in-luck mechanical trades. In all seriousness the market is busy, as noted earlier, and supply and demand usually win. When its busy prices go up more than you think is reasonable, and when it’s not busy they never go down quite enough.
- Trade defaults are unfortunately likely coming in the late fall. In addition to this, there will be insolvency in the wider economy, and retail will be badly hit. To quote Sandra Skivsky, chair of the National Trade Contractors Council of Canada (NTCCC), in an article in the Ontario Construction News, “The COVID-19 pandemic is a ticking time bomb for many construction industry trade contractors, with a potential major cash crunch in the fall”. The logic in the article makes a lot of sense and paints a particularly bad, potential situation, depending on what happens with access to financing and general liquidity in the market.
This brings us to long term.
The long term
The long term impacts will become clearer later this fall. The line in the sand was really Labour Day (even if someone on our team suggested it’s Thanksgiving, just so they could include a picture of a turkey in their slide deck. I kid you not.)
We are now emerging from our local summer vacations, and the kids are going back to school (in some form or another). If work slows down (which it shows no sign of), then the defaults may increase, liquidity may dry up and construction prices could start to fall. However, if we do not slow down (looking more likely than not), and carry on at pace, then construction prices will not fall. They will carry on with the trend we saw in July and August and increase and increase rapidly.
Escalation has been high for several years now, within high rise residential in the GTA for example construction costs have increased 38.3% since 2016 with formwork / pre-cast the main culprits, but drywall, mechanical and masonry are also increasing quite significantly in that period.
Amongst all the great findings in the report, the following two are important here:
- Every 1,000 new homes provides $72M in HST, $80M in development charges, $11M in land transfer tax, and $5M in education development charges.
- On the positive side, those 1,000 new homes provide 2,200 jobs, and $600M in economic activity.
Investment in homes, infrastructure and construction is a no brainer as it pays for itself, many times over. I could reference numerous articles, studies and government reports that support this.
What we need is less talking, more getting stuff done! Show that Ontario and Canada really are open for business. The road to recovery is ahead of us, but someone must pave it first.
Our next update is coming around November and it has a 50/50 shot of being positive or negative. Either way in the long term I would bet on real estate in Canada. I emigrated to Canada almost twenty years ago and haven’t regretted a single minute of it.
In the mean time, I suggest reading our Global Property Development Trends Report.