Implications for Construction Costs

How should construction costs be measured?

Industry professionals use a variety of construction cost indices to track cost escalation over time, and estimates vary based on what the index is attempting to measure.

Major indices can be grouped into two broad types: those based on bid costs (also referred to as “whole building” or “selling price” indices) and those based on input costs (sometimes referred to as “measures of inflation”).

Both types of indices are useful, depending on the questions and context. The main differentiator between the two types is whether they incorporate some measure of contractor profit margins. For both types, the level of detail and weighting of index components, as well as the number of geographies represented, varies considerably.

Figure 40: Comparison of construction cost indices

Source: CBRE Strategic Investment Consulting, April 2022.

Input costs lagged bid costs over the prior cycle but not dramatically

Input-based indices do not fully capture construction costs and tend to underestimate escalation rates relative to bid cost indices, which provide the most comprehensive view of how builders experience final costs.

During periods of price stability, bid cost and input indices produce similar escalation estimates. However, bid costs usually increase faster than input costs during periods of heightened construction activity as contractors boost margins (note the wider spreads between averages 2015 and 2019).

Historically, most indices of either type have shown construction costs rising roughly 2%-4% per year, and the differences between major bid cost indices and input cost indices has been less than one percentage point over the past 10 years.

Figure 41: Average annual construction cost escalation, major indices by type

Sources: BLS, Engineering News Record, Turner Construction, Rider Levett Bucknall, Mortensons, CBRE Cost Consultancy, CBRE Strategic Investment Consulting, April 2022.

Bid cost indices struggled to capture the realities of 2021

The spread in escalation rates reported by major indices was wider in 2021 than ever before, owing to significant measurement challenges.

During periods of high inflation or volatility, bid cost indices may lag input-based indices, as contractors react gradually to new market conditions or struggle to make accurate estimates in the face of market uncertainty. Despite all the indications that conditions are not the same as in recent years, some major bid cost indices, like Turner and Rider Levett Bucknall (RLB), reported 2021 escalation as essentially on par or just modestly above the five-year pre-pandemic average.

Meanwhile, all major input indices show a dramatic departure in 2021 from the pre-pandemic average. Unless contractors are willing to absorb the entirety of these input price hikes, bid cost indices should rise in 2022 as contractors recoup costs and protect themselves against future cost growth.

Figure 42: Comparison of construction escalation, major industry benchmarks

Sources: BLS, Engineering News Record, Turner Construction, Rider Levett Bucknall, Mortensons, CBRE Cost Consultancy, CBRE Strategic Investment Consulting, April 2022.

CBRE index aims to balance bid and input costs

We set out to create a new index that incorporates construction demand but was also more responsive to input prices. The goal is to capture both the full picture of construction costs and the impact of rapid price changes.

In 2021, the CBRE Construction Cost Index increased by 11.5%. This increase was in the middle of the range indicated by the major indices in 2021 (see range in Figure 42). The two prior years also show how the index balances swings in costs. In 2019, the index reflected a tempered view of the strong construction demand shown by the major bid cost indices, given the modest labor and material price gains as shown by the input cost indices. Conversely, when input costs began spiking and demand slowed in 2020, the index balanced both trends, landing in the middle of bid and input cost indices.

Figure 43: Average annual construction cost escalation, CBRE vs. major indices

Source: BLS, Engineering News-Record, Turner Construction, Rider Levett Bucknall, Mortensons, CBRE Cost Consultancy, CBRE Econometric Advisors, CBRE Strategic Investment Consulting, April 2022.

CBRE Construction Cost Index points to elevated cost growth in 2022

Given the significant growth in labor and materials costs that has already occurred year-to-date and the expected pace of construction activity through the end of the year, construction costs are projected to increase by 14.1% in 2022 in our baseline view.

Thereafter, improvement in supply disruptions and moderating inflation are expected to rein in input costs, leading to significant decreases in the escalation rate each quarter of 2023 and stabilization in 2024.

However, demand is the key factor in projecting true construction costs, and a continued rise in interest rates has the potential to temper expectations for stronger construction activity once inflation cools. The looming threat of slowing or negative economic growth may cause some projects to pause and could make the debt market a major obstacle. In the event that financing does slow construction activity, our decreased demand scenario projects year-over-year cost growth to be an average of 150 basis points lower than in the baseline scenario. This difference would primarily be felt in late 2023 and 2024, as most projects already in the pipeline are expected to move forward.

However, we do not expect the index to fall at any point in this forecast period in either scenario, though prices for some specific materials could decline. By year-end 2024, the baseline scenario is projected to be nearly 40% higher than Q4 2019, while the decreased demand is expected to be 33% higher.

Figure 44: Historical CBRE Construction Cost Index performance

Source: CBRE Econometric Advisors, CBRE Strategic Investment Consulting, April 2022.

Figure 45: Average annual construction cost escalation, CBRE vs. major indices

Source: BLS, Engineering News Record, Turner Construction, Rider Levett Bucknall, Mortensons, CBRE Cost Consultancy, CBRE Econometric Advisors, CBRE Strategic Investment Consulting, April 2022.