Construction prices fall as demand dwindles
A 2009 Construction Outlook by McGraw-Hill estimates that the level of construction starts will fall by 7 percent to $515 billion this year, which follows a 12-percent decline in construction activity in 2008.
Companies that still have the resources to expand are being rewarded with a rollback on construction costs.
Eighteen months ago, a global building boom was driving up prices on raw materials and labor. In fact, many construction materials have been posting double-digit price increases since 2004. But after peaking in July and August, prices for items such as diesel fuel, asphalt and steel have declined sharply.
"There has been a dramatic turnaround in many construction costs in the last six months," says Kenneth Simonson, chief economist for the Associated General Contractors of America in Arlington, Virginia.
Prices have dropped along with slumping demand. A 2009 Construction Outlook by McGraw-Hill estimates that the level of construction starts will fall by 7 percent to $515 billion this year, which follows on the heels of a 12-percent decline in construction activity in 2008.
The drop in construction business has been a big blow to contractors, who are now forced to cut costs as competition to land new business and stay afloat intensifies. For example, some projects that had received three or four bids in the past are now receiving 15 to 20 bids, Simonson notes. Not only does a competitive bid situation push prices lower, some contractors are willing to bid construction projects at little or no profit just to keep their workers employed, he adds.
Some brands are taking advantage of the slumping construction market to reduce their building and start-up costs. "Many people see this as an opportunity as long as they have the resources to move forward with projects," says Beverly Raphael, president & CEO at RCC Associates, a contractor based in Deerfield Beach, Florida. RCC has served as the contractor for a variety of retail, restaurant and commercial interiors with clients ranging from Cheesecake Factory to Ann Taylor clothing stores.
Houston-based Christian Brothers Automotive has seen its building costs drop by about 10 percent in recent months, largely due to more competitive bidding among contractors. The company currently has 54 locations and is planning to open between 15 and 17 new stores this year. "What we're finding is that there are a whole lot more contractors bidding these days, and they are willing to take less profit, says Mark Carr, CEO and president of Christian Brothers Automotive Corp. The company typically receives about five bids on every new job compared to two or three per bid six months ago.
Cashing in on discounts
Pricing varies widely depending on the specific material. Some products such as gypsum, cement and concrete have continued to see prices climb recently because manufacturers have cut back on production. But other prices are dropping.
Diesel fuel, for example, which can add to the cost of running equipment for contractors as well as added surcharges on delivery of building materials, is half the price it was a year ago. The average diesel fuel price peaked at $4.76 per gallon in July 2008, and has since dropped to $2.19 per gallon as of mid-February. Copper, which is often used in wiring and fixtures, peaked at about $4 per pound last summer and is now trading at about $1.50 per pound, according to the Bureau of Labor Statistics.
Clearly, the drop in demand has produced some pricing breaks for firms that are continuing to build. However, the exact amount of savings being realized varies widely depending on the size of the job, the specific location and the timing.
In South Florida, for example, construction costs have dropped 20 to 30 percent across the board, notes Raphael. The price drop is due largely to the sharp decline in demand as commercial and residential developers alike have pulled back on new building. The same number of general and subcontractors are chasing a limited number of projects. "Competition is fierce, and has resulted in low prices," Raphael says.
Other firms have experienced a more moderate shift in construction pricing. "Those prices are coming down, but not in the same droves as they went up," says Collin Gruthoff, president of Appleton, Wisconsin-based FC Dadson, a national designer and manufacturer of retail environments and displays. Gruthoff has seen materials costs dip between 2 to 4 percent in the last few months. Materials such as sheetrock, cabinets and fixtures represent about 25 to 35 percent of the expense of a store's build-out. So a 2- to 5-percent reduction translates to a minimal 1 to 2 percent of the overall job cost, he adds.
Short-term price breaks
The downside of the construction slump is that while franchisees may enjoy low prices today due to the competitive bidding situation, a number of general contractors and subcontractors won't survive the downturn. When the economy recovers and construction activity begins to accelerate, prices will likely leap higher because there will be fewer construction firms to handle the demand.
In addition, franchisees need to be careful in not being dazzled by a low bid. The store that is being built or renovated will realize a cost benefit. But, if that contractor is not in business a year from now, the warranty on the work could be an issue, Gruthoff says. As a result, it is very important to choose a contractor that will still be in business six months or a year from now, rather than just focusing on the lowest bid, he adds.
The cost of many building materials has already dropped to multi-year lows. So it is unlikely that there will be more major discounts ahead. In fact, franchisees may want to move quickly to take advantage of the lower construction costs before pricing begins to move back up. "A year from now, if the economy and foreign economies get going again then prices could start jumping higher," Simonson says.