What do rising construction costs mean for local authorities? Joe Scott-Soane jscottsoane@arlingclose.com

Inflation has dominated the headlines for the better part of a year now as it spiralled quickly into the double digits, but headline inflation is an aggregate measure, and the last year has seen one of the highest periods of construction price inflation on record. This started during the tail end of the covid pandemic when supply chains were still extremely stressed, but demand had begun to increase as economies reopened amid loosening lockdown restrictions.

Falling deliveries of building supplies and rising demand for new work increased the upward pressure on inflation. This culminated in September 2022 when 48% of businesses had reported an increase in the price of goods bought compared to the previous month, an exceptionally high level of inflation in the sector. This has fallen away since but remains elevated at around 38% (or two in five) of businesses reporting higher prices than the previous month in March 2023.

Data from this month shows that brick and concrete deliveries fell 33.5% and 23.9% respectively compared to March 2022 while the price of all work materials for construction rose 8.7% compared to the same period a year earlier. This comes after the increase in construction prices never averaged more than 3% over a year all the way back to 2014.

As the world economy came to a sudden halt during the covid pandemic, there was a significant dip in the construction price index as well as the level of deliveries across various building material groups. As we approached March 2020 and the economy was locked down to stem the spread of covid, the price increase of new work unsurprisingly fell to near 0 levels when compared to the previous year as demand slowed significantly.

This persisted for most of the year but as lockdowns were lifted and became more sporadic, the price of new work in the construction index began to pick up. Since May 2021 the price of new construction work has risen from a 3% increase on a year-on-year basis to a peak of 12.1% in May 2022. The highest reading since the series began. This elevated level of price inflation for new work has persisted well into 2023 with monthly readings showing above a year-on-year 10% increase every month since.

Although higher interest rates and weaker demand in the face of rising costs have somewhat lowered demand for construction projects, this has not been enough to offset the supply push factors of inflation in the sector. Higher energy prices, the war in Ukraine and difficulties in the labour market have been key drivers of rising prices over the same period and have been enough to keep prices up even as the economy stagnates.

When we see the “headline rate” for CPI in the news constantly, it can be a rather nebulous figure that encompasses various prices over the wider economy. But there are some specific parts of the construction index that we can draw out as they relate to local authority projects.

The “new work” part of the construction index can be broken down into more distinct sectors, splitting out the increase in private sector work leaves us with the public sector projects remaining and these can be split into further detail of infrastructure, housing, and non-housing projects.

This is why local authority projects also experienced extremely high levels of inflation over the last year. Infrastructure projects are 14.1% more expensive than March 2022 while housing projects and non-housing projects are 10.4% and 8.1% more expensive respectively. This is a huge increase on projects that can often be expensive to begin with and may lead to inevitable slippage in capital projects should they now be over budget.

The price of construction contracts can be agreed quite far in advance of the project delivery date in order to give the construction companies time to source materials and complete planning. The price of these projects is often linked to the increase in the price of the construction index as a way of these contracts keeping up with inflation in the sector. As a result, local authority projects that were agreed several years ago, may now appear comparatively too expensive despite being affordable when originally set out.

This level of construction price inflation will certainly come as a surprise for those who set out what were once well thought out and planned capital projects in 2020 only to find the price having increased by as much as 12% since. This can certainly throw a wrench in the works and will certainly call for Councils to reassess capital projects, not just as a whole but on a case-by-case basis. Affordability will have to be considered and may require some tough calls on deciding when to deliver projects to keep costs within, or at least close to, budgets.

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