Escalation is cost increase due to time and it’s always present. Delay in projects, especially in inflationary times, can greatly impact your total cost. It’s important to understand if your costs are rising due to schedule, not some other factor, so you can take appropriate action.
The 30-year average for annual construction cost escalation is about 5%, but I’ve seen well over 10% and I’ve seen deflation of 10% as we dove into a recession. And at times these rates bore little resemblance to the general inflation rate. How does this happen?
Construction projects are composed of layers of contractors subcontractors and material suppliers. Each has both their basic cost of labor and materials and their business overhead and proft. Overhead and profit for a general contractor can be in the 15% range. Each layer of contractors and subcontractors adds overhead and profit on top of that of each lower layer.
When the ecomomy starts to sag and work becomes scarce, companies at every level reduce profit to retain staff and keep the business running. When things get worse, they may reduce overhead below long-term sustainability, at leasty for a time.
One can see how, even in an environment of stable labor and raw materials cost, the total construction cost can vary substantially. This change can occur quickly.
A few years ago, a contractor told me that, in one week, he got requests for new work equal to his annual gross business. Under those circumstances, there no reason to retain customary profit margins, especially since in previous years, many contractors had been operating at below long-term sustainability. Costs rise and it becomes hard to find contractors who will even bid on projects.
Look at this carefully. How is your team reflecting escalation? How are they approaching market conditions.
Escalation is measured from the date of the estimate to the mid-point of construction, as work is contracted throughout construction, not just at the beginning, the midpoint being the average. If your schedule has 6-months in planning approval, 1-year after that to start of construction and 1 1/2-years of contruction, from the start to mid-point of construction is 27 months. At the deault of 5% that’s over 11% on top of any other contingency. That’s substantial.
Never let your estimator bury escalation in their estimates. You need to see it. All estimates should be at current costs at the time of the estmate. If you are one year closer to the end of the project you can deduct 5% from the escaltion allowance. If your completion date slips a year, your budget will increase by 5%.
How do your estimators guess at escalation? Ask them. When I was active, I periodically touched base with a group of contractors and estimators to ask them what they were seeing in the market and what provisions they were making for the future.
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I don’t know doesn’t mean zero