By Maarten van Haaps ,
Head of Construction, Marsh Specialty, Pacific
16/06/2022 · 4-minute read
Rates of inflation are increasing rapidly in many developed economies. And construction companies are feeling the effects — not only are essential materials and skilled labour significantly more expensive, but supply chain pressures and shortages are making it harder to secure needed construction materials.
Timber, steel, and many other materials critical for construction projects have experienced skyrocketing increases in pricing. Whilst the root of the problem can be traced back to supply chain disruptions in materials and labour due to the COVID-19 pandemic, new challenges — including geopolitical risks — continue to crank up the pressure on pricing at a time when there is an increase in demand due to government-led infrastructure activity.
At the same time, the available construction workforce is shrinking as an ageing cohort of skilled workers either retire or face restrictions related to travel and workers move into other professions given competitive salaries elsewhere.
As in other regions around the world, dramatic price hikes are having a significant effect on contractors and developers in Australia. The latest Producer Price Index published by the Australian Bureau of Statistics indicated the cost of house construction rose 15.4% in the 12 months ending March 2022, mainly as a result of price increases for timber and metal products. Over that period, the cost of reinforcing steel increased 43.5%, structural timber 39.2% while plastic pipes and fittings increased 26.5%.
Contractors or developers, depending on need or contract, may have no option but to absorb the increased costs, eating into already slim margins and affecting their liquidity.
Lack of clarity about future costs and supply is complicating the bidding process and affecting contractors’ competitiveness. All this will lead to above inflationary increases in bid costs for Australia with global engineering consultancy Arcadis forecasting building tender increases of 4-5% in Sydney and Brisbane and up to 5-7% in Perth. Similarly, infrastructure tender prices are forecast to increase by 6% in NSW and Victoria over 2022 and 5% in Queensland.
Rising fuel prices are putting even more pressure on contractors’ budgets. Not only has it become significantly more expensive to get materials to a construction site, but many pieces of essential heavy equipment — such as bulldozers, cranes, and backhoes — run on fuel.
Labour shortages and increasing wage costs have been affecting the construction industry for a number of years. Given the broader economic pressures that exist, this challenge is unlikely to be resolved in the near future. Since wages can account for over 50% of the overall construction costs, the impact of labour pricing has an acute influence on the profitability of a project.
Since most contractors operate on slim margins, increased costs are impacting the bidding process. The steep recent price increases make it extremely difficult to estimate future costs, which may be several times the original estimates by the time work commences and more still by the time the job is completed. And delays in getting materials on site due to supply chain challenges often mean that the timeline for a project’s completion is often unclear.
In most countries, the risk of inflation and delay through non-force majeure events are borne by contractors. In these situations, incorrectly pricing costs into a bid or having enough allowance for bottlenecks in supply can have catastrophic effects on budgets, particularly for contractors that operate via fixed price contracts. This has led to an increasing number of construction companies getting into financial difficulties and even going out of business.
Some contractors and developers are facing increased challenges to secure funding for projects amidst questions about the bankability of projects. In a high inflationary environment, funders will generally be more cautious when offering funding to projects that are high in value, complex, or have long build times.
As inflation continues to affect economies and industries, contractors and developers should consider actions that can reduce the impact on their operations. Some actions include:
 Rising costs hit home in the construction sector (afr.com) - accessed 14 June 2022
 Construction costs ease but significant challenges in the near term - Australian Property Journal - accessed 14 June 2022
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