How does Inflation Affect Construction Industry?

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Inflation is a major challenge for the construction industry as it leads to an increase in the prices of building materials, hiring rates of machinery, consultation fees, and other inputs to construction projects. As a result, it may delay project completion, increase construction costs, and reduce profit margin.

Inflation is not the only obstacle that construction projects encounter. However, unlike others, it affects the construction business, clients, and employees. For instance, if a contractor increases prices or extends the construction timeline, the burden shifts towards the client.

Inflation is an average increase in the price of goods and services over time within an economy. Additionally, it devalues the currency used in that economy. For example, if you purchased a hammer for $10 two years ago, today, the same hammer would cost $12. The characteristics of hammer have not changed, but inflation and currency devaluation are the reason for the 20% rise in the price.

How Does Inflation Affect Construction Industry?

Price of Construction Materials

Inflation increases the cost of various construction materials and continues to do so with time, affecting both existing projects and bids. Profit margins of existing works will reduce, and the price of bids will increase.

Any delays or long delivery of construction materials will further increase the extra cost. As a result, the initial and final costs of projects would differ.

The cost of construction materials is about 35% to 60% of the overall construction cost. So, it is important to know the factors that influence the cost of building materials. Figure-1 presents a conceptual model of factors influencing the cost of building materials.  

Cost deviation that occurs could be either positive or negative. If it is positive, it indicates the cost overrun. The cost overrun, which is strongly related to inflation, is a common problem for the construction industry. The major factor that leads to cost overrun distress is the rise in construction material. Sometimes, contractors delay projects to prevent cost overruns.

Prices of Other Construction Inputs

Inflation increases the cost of other construction inputs like fuel, equipment,  and technology. For instance, the price of fuel price in the United States soared from $3.01 in 2021 to around $5 /gallon in 2022. So, higher energy prices mean higher transportation costs of materials and equipment and higher costs for rented machinery.

Manufacturers of construction equipment commonly increase the cost because of an increase in the cost of raw materials and delay in production due to inflation. This reduces the profitability of the entire project. 

In the construction industry, inflation can lead to cash flow management problems, declines in sales volume, longer production timelines, and other issues within the construction operations.  

Affect of Inflation on Construction Parties

The sales team may earn a commission per project. They may benefit from inflation only when the project price is raised and when there is no reduction in the number of clients.

The salary increase rate of skilled laborers is not the same as currency devaluation or increases in the prices of foods, clothes, and other requirements. This encourages workers to push for a higher salary and a better working environment. The shortage of laborers is another problem that the construction industry faces due to inflation.

Supply chain partners are likely to pass the burden of inflation on to the contractor, which strains the long-term relationship between the contractors and the supply chain partners.

Affect of Inflation on Small Firms

The effects of inflation in the construction industry differ from that in other sectors and vary based on the market and materials.

Small firms that work on fixed prices will be hit hard during inflation and may lose their business as they cannot cover the extra cost of materials. This encourages small firms to work at flexible prices and makes them reluctant to take on new work.

Site accessibility is an extra issue for small companies working outside cities. Small firms working outside cities are believed to be the weakest construction party in the hierarchy of the construction process.

Companies with modern construction methods can order materials well in advance before construction begins. However, companies that use traditional construction methods can order materials around two weeks in advance. This is mostly due to a shortage in storage spaces. 

It is estimated that the U.K. will need to build around 340,000 homes. So, any delay or problem in the construction plan will create a housing crisis. That is why contractors need to plan their future bids and construction methods carefully to prevent cost overruns due to inflation and maintain a reasonable profit margin. 

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