The Effect of Inflation, Supply Chain Disruption, and Labor Shortages on Real Estate Development by Justin Wong

The Effect of Inflation, Supply Chain Disruption, and Labor Shortages on Real Estate Development

by Justin Wong

A. Increases in Building Material Costs

Since the start of the COVID-19 pandemic in March 2020, real estate developers and home builders have faced numerous obstacles which were non-existent prior to the pandemic. From substantial increased in building materials cost, supply chain disruptions, and labor shortages, builders have been forced to reevaluate their construction process and overall sustainability. Industry leading resources for builders including the National Association of Home Builders and the Associated General Contractors of America, Inc. have conducted research related to aforementioned factors affecting home constructions.

The National Association of Home Builders (NAHB) collected information regarding increases in building materials. Since the start of the pandemic in March 2020, building materials have risen 35.6% (19.2% since April 2021). Lumber prices have increased 60.4% since September 2021, gypsum prices have increased 23.5% since January 2021, and concrete prices have increased 9% since April 2021. Additionally, steel product costs experienced a 128% cost increase in 2021 and decreased by only 12.4% in early 2022. Further, from January 2021 to September 2021, building materials including building paper/products, asphalt, fertilizer, plastic water pipes, plastic materials, wood window and door frames, copper pipes and tubes, and thermoplastic resins rose 20% to 30% of Materials such as aluminum base scrap, fabricated structural metals, and other engineered structural wood members saw price increases exceeding 20% from April 2021 to September 2021.

The increases compiled by the National Association of Home Builders (NAHB) are reinforced by research conducted by the Associated General Contractors of America (AGC). The AGC reported a 20% increase in the producer price index since January 2021.

The AGC commonly produces tables displaying the percentage change in Producer Price Indexes (PPIs) and Employment Cost Indexes (ECIs) which they release and update monthly. Their latest release, regarding the PPI and ECI of April 2022, illustrated the percentage changes on a year-to-year basis starting January 2017. According to the PPI table, as of January 2020, prices for cement increased more than 7.5%, concrete has increased to date by more than 15- 25%, plastic construction increased more than 45%, flat glass increased more than 10%, gypsum products increased more than 20%, steel mill products more than 125%, aluminum mill shape increased more than 45%, construction machinery/equipment increased more than 10%, asphalt increased more than 90%, and sand/gravel/crushed stone increased more than 10%.

The cost increases in a plethora of materials, including materials crucial to the home construction process including lumber, steel, concrete, and gypsum demonstrates how builders and developers have had to handle and adapt to an unpredictable financial landscape. As material costs continue to increase, the profit and revenue that builders and developers are able to obtain will experience decreases. If builders and developers, in turn, decide to increase their labor costs, the amount of consumers may decrease due to their unwillingness or inability to afford higher costs and thus, result in a financial loss for builders and developers. As a result, builders and developers have been faced with the difficulty of setting a price range which will allow them to maintain financial profitability and not scare off prospective clients.

B. Delays in Home Building and Labor Shortage.

Like the NAHB, the AGC cited delays in home building constituting a recurring issue for homebuilding firms. According to a survey conducted by AGC in July/August 2021 consisting of over 2,100 construction firms, 88% of firms are experiencing project delays due to supply chain disruptions, material shortages, or lack of approvals/inspectors. More than half of the firms explained projects have been canceled, postponed, or scaled back due to increasing material
costs and fluctuating market conditions.

The overwhelming construction delays being experienced by builders and developers constitutes a present and future detriment. Due to the delays, home builders are forced to prolong projects which will diminish their ability to begin and recover revenue from new projects unless they agree with current clients, who will likely be unwilling, to increase project costs. Further, as delays persist, builders and developers will endure significant opportunity costs as their yearly
project total will decrease due to prolonged project times.

Another factor contributing to project delays is the ongoing labor shortage in construction. In January 2022, construction employment decreased by 9,000 workers, causing construction unemployment to be at 7.1%. Due to a decrease in labor availability, construction firms are raising pay (5.8% from February 2021 to January 2022) to remain competitive. Construction compensation, wages, and salaries increased by more than 6% since January 2020. Additionally, minimum wage has gone up $1 per hour yearly since 2020, resulting in higher labor costs.

The presence of a labor shortage as well as higher labor costs will lead to lower profit margins for builders and developers. If builders and developers decide to increase their costs, then as with building material increases, builders and developers will risk losing clients unwilling to meet increased costs. Additionally, with the supply chain and labor issue, construction firms face difficulties in managing a project and are forced to start project planning much earlier than usual.

C. Impact of Inflation

In addition to the shortage of materials, the labor shortage, and supply chain disruptions, inflation is the central issue that home builders and property owners will continue to face. As of June 2022, the inflation rate reached 8.6%, 7.1% greater than the inflation rate seen in 2020 (1.4%). The substantial inflation rate has contributed to the rising housing and material costs. Furthermore, the current inflation rate is expected to initially persist in 2022 because of a strong demand and restrained market supplies. There are estimates that the continued lack of supplies will lead to persistent high inflation rates. As of June 10th, the inflation report issued reflects a 40 year high of inflation at 8.6%.

The ongoing and continual rise in inflation adds on to the financial dilemma builders and developers already face. Inflationary trends will result in higher building material costs which will further the struggle of financial sustainability. Additionally, for builders and/or developers who plan projects out either months or a year in advance, it will be difficult to surmise what material prices will be at the time of those projects with inflation increases. As a result, builders and developers may be hesitant to take on future planned projects or refrain from determining a firm price in order to combat the inflationary trend.

D. Conclusion

Since the onset of the 2020 pandemic, builders and developers have dealt with a multitude of unpredictable and stressful factors related to construction projects. Financial and time aspects of a construction project have been at the forefront of issues with material costs experiencing extreme increases and project delays constituting a recurring theme. As there is no certain time for when the construction world will be back to ‘normal,’ builders and developers must account for an unstable future.