What Really Drives Construction Cost?

Any developer, construction professional, or individual involved in a construction project will be concerned about what drives or effects construction costs. Barbados and the wider Caribbean is currently experiencing a far more competitive market driven by the current global recession and shortage of work, and much is often debated about construction cost drivers, or how […]

By Robert Hoyle

February 14, 2012

Beachlands Barbados Beachlands Barbados

Any developer, construction professional, or individual involved in a construction project will be concerned about what drives or effects construction costs. Barbados and the wider Caribbean is currently experiencing a far more competitive market driven by the current global recession and shortage of work, and much is often debated about construction cost drivers, or how changes in the market effect construction costs or tender prices.

A tender for any building contract is made of four constituent parts; the cost of labour, materials, plant and equipment and market forces, although the proportions will vary dependant on the nature of the particular project or market. An increase in cost however, in any of these elements, will not automatically effect tenders and will certainly not to the same degree. A ‘normal’ construction project might have a split of labour 30%, materials 65% and plant 5% of the overall costs. The most significant element of material prices will undoubtedly have an effect on construction costs, but this is not necessarily what one would expect.

For example, the Arawak Cement Plant have recently announced an increase in the price of cement by 9.50%. If your project is already on site this will in normal circumstances have no effect on you, but would only reduce the contractor’s profit. If the price with your builder has not been agreed though, then any increase may be passed on to you but this has to be put into perspective.

In order to do this we have analyzed various schemes to establish the overall effect of a 10% increase in the raw material price of cement, steel and blockwork on various types of building. The results are tabulated below:-

10% increase in raw material cost Average 3 Bed Home 3 storey concrete framed office building 50 unit high end concrete framed apartment building
% increase $ increase % increase $ increase % increase $ increase
Cement 0.13% 380 0.14% 18,000 0.23% 395,000
Steel 0.24% 690 0.20% 25,500 0.25% 586,000
Concrete Block 0.29% 850 0.19% 24,000 0.09% 131,000

Fuel prices are similarly often quoted as the cause for construction cost increases. High oil prices do mean higher building or operational costs, and diesel cost is one of the most highly influential items in the construction industry as it affects all supplies, material and labour costs. Diesel, oil and gas costs can compose nearly 3 percent of construction cost by effecting gas prices, material acquisition and material delivery costs. But again a 10% increase in fuel prices once fully worked through the supply chain would only add 0.30% to construction costs.

Conversely, labour costs (which admittedly have been static recently) have a far greater potential to effect prices. A rise in labour costs by 5% could increase the costs of the construction project by 1.5% and it is important to put this into perspective.

However, the biggest single cost driver is the tender market. In the current economic climate work has become more scarce and therefore more contractors are chasing less work and margins are being eroded. Whilst labour, material and plant prices have risen and are forecast to continue to increase marginally over the next three years, tender prices have fallen since their peak in 2008 and this trend is likely to continue for a number of years. Contractors are effectively absorbing material price rises by reducing profit in order to remain competitive.

It is interesting to note the historic relationship between building costs and tender prices, or more accurately the lack of relationship. Accurate historic data is not readily available for this region but the principle is the same worldwide. Building costs whilst influencing construction costs are not the driving factor. The graph below illustrates the relative trends in building costs versus tender prices over the past 12 years. It is clear that whilst building costs may rise, tender prices may follow, be unaffected or fall during the same period.

UK Building Cost Index vs Tender Price Index

As a potential developer it is always important to protect or mitigate the effects of price change. This is most commonly achieved by fixed price contracts, i.e. a scheme is tendered and contractors submit a firm price bid for the works. Once the contract is let the contractor takes all the risk for price changes in materials, labour and plant.

The alternative is a fluctuating price contract where any changes to prices are calculated on a formulaic basis and the contractor reimbursed accordingly. In theory this should result in lower tenders as the risk is with the employer. In reality though, unless a particular commodity is perceived as being very volatile, any saving would not likely be achieved. In this situation a bespoke formula could be introduced which is applicable once a cap on that commodity is realized, but this is not recommended except in the most unusual of cases.

There are also other important factors to consider however. A client should be less concerned with the tender or contract price than with the final cost of the development. After all the tender price is only the cost part way through the process, and is often not the amount that is eventually paid. Careful consideration should be made to mitigate the effects of this cost escalation.

First and foremost the right procurement route with the most appropriate contract should be sought. This above all else will effect final out turn costs. Secondly, the contract documents should be properly drafted and prepared to protect the client, be as unambiguous as possible and limit the amount of provisional or undefined work. This will create a level playing field between contractor and employer so that each understand what is being contracted, what the risks are and what the rules are for resolving uncertainties. This may sound simple but it is not uncommon for deficiencies in the contract arrangements to lead to ambiguity, disputes, cost escalation and the late delivery of projects.

It is quite apparent that the biggest driver of construction costs is the tender market and supply of work as opposed to material, labour and plant costs. Moreover, aside from the market the tender price will be most influenced by the nature and quality of the documentation and the contractor’s view of the associated risk. As importantly, the final out turn cost will be most heavily influenced by the quality of documents and the administration of the project, rather than the perceived driver of escalation in material costs.

Robert Hoyle is a Chartered Quantity Surveyor and runs the Barbados office of Rider Levett Bucknall, the global property consultant specializing in Project Management and Quantity Surveying. Rider Levett Bucknall publish a Quarterly Caribbean Cost Commentary which is available on their website at www.rlb.com

Robert Hoyle

Robert is principal at Rider Levett Bucknall (Barbados) Ltd. He operates from Barbados and has over twenty years of experience working as a Chartered Quantity Surveyor in the construction industry. Robert has experience in both the public and private sectors and has worked in the UK, Middle East and Caribbean. Robert has extensive experience, including luxury residential, commercial and government works.