Construction Tender prices continued to increase through 2019 - with increases noted of 10-12 percent from early 2018 to late 2019. The ongoing tender price increase raises the estimated outturn cost of projects in planning. Projects on site are not immune with continued cost increases on account of greater than allowed for contracted inflation provision (4 percent) being experienced on projects such as the National Children’s Hospital.
The quantum of increase in tender prices experienced emphasises the importance of providing for future tender inflation in feasibility studies and development cost planning – calculation of an appropriate allowance needs to be a key part of financial risk planning for a project. This allowance should be based on four things:
1. The estimate of project costs (including contingencies) at current market prices;
2. The pre-construction and construction period for the project;
3. The procurement and expenditure profile over the design and construction life of the project;
4. Anticipated market conditions.
Amounts provided for tender inflation should be identified separately in a budget and should be incorporated into the individual cost components and adjusted as necessary at various project review stages. This paper (download full paper here) looks at the current trends in material and labour costs and, based on an assessment of the level of competition, demand and supply in the market, lays out a prediction for future tender inflation in 2020 & 2021.
Construction Market & Ireland Economy Outlook
The Irish economy looks set to register strong growth again in with GDP likely to increase by almost 6 percent in 2019. The economy is expected to grow by a slower rate in 2020 of 3.3 percent according to current forecasts.
The output of the Irish construction industry peaked in 2007 at over €38 billion, representing almost 24 percent of GNP. In 2019 it was estimated that the output of the industry was valued at €26.8 billion (equivalent to c. 9,75 percent of GNP) – this level is still below the sustainable European level of 10 – 12 percent of GNP. Right sizing construction output would imply a construction output range of €28.4 - €34.0 billion in 2020.
Based on ESRI data regarding rate of fixed capital formation Keogh Consulting estimate that construction output is estimated to grow to €29.0 billion in 2020 (+€2.2 billion, +8 percent) at constant prices.
Output per construction worker has stayed broadly within the range €180 - €200 K output per employee with minimal productivity gains since the construction market peak in 2007. This would imply an extra 10,000 – 14,000 workers being required to meet the expected €2.2 billion growth in output in 2020.
Labour costs are rising with the 2018 & 2019 sectoral employment order feeding labour cost inflation – the October 2019 SEO will increase costs on the back of the +2.7 percent wage increase and an increase in the working week from 37 to 39 hours. We estimate that this will give rise to a base 5.2 – 7.7 percent increase in labour costs.
Tender prices to increase through 2020
Our view is that there will be further increase in tender prices in 2020 as contractors look to selectively tender and cover the costs of rising labour and materials prices. The increase in tender prices emphasises the importance of providing for future construction inflation in feasibility studies and development cost planning. On this basis estimates regarding tender inflation over the period to 2020 have been forecast using the following assumptions:
1. Forecast GNP growth in Ireland of +3.3 percent in 2020 moderating from +6.0 percent in 2019. +€2.2 billion in construction output.
2. The general rate of CPI inflation forecast at 1.0 percent in 2020 (0.5 percent 2019) and 1.2 percent in 2021. Thereafter it is assumed that CPI inflation is in line with the 2.0 percent ECB target;
3. Inflation in building and construction materials rises by +3.0 percent in 2020 and 2021, unwinding some of the material price reduction experienced at the end of 2018;
4. Average labour costs rise by +6.0 percent in 2020 and then by +4.0 percent in 2021 and 2022;
5. It is assumed that the weighted building and construction cost inflation rate is made up of 60 percent materials and 40 percent labour costs. 30 percent M&E in building ;
6. Competitive tendering of projects.
The forecast of cost and tender price indices has been calculated using the following calculations:
1. Cost Index Forecast = 60% x Equipment and Materials Inflation + 40% x Labour Cost Inflation
2. Tender Index Forecast = Cost Index Forecast x Expected Change in Tender Margin
3. Average M&E cost at 30% of Total Building Cost
After peaking in 2018 at a rate of 7.2 percent our forecast is for tender inflation to increase by 6.5 percent in 2020 based on the key assumptions noted.
The Keogh Consulting iOS App can assist you in the benchmarking of the costs of your project and estimation of an initial inflation allowance based on your programme. It can be downloaded from the Apple App Store here http://bit.ly/KeoghCosts.
A hard copy of the Keogh Consulting Construction Cost Database can be downloaded here.keoconsult_cost_database_q1_2020.pdf
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