There’s a well-known Chinese proverb: “The best time to plant a tree was 20 years ago. The second-best time is now.” We are frequently asked if now is a good time to build, so let’s look at the data.
Fannie Mae put out their annual Home Price Expectations Survey, telling half the story; as housing pricing goes up, so do expenses. Today, those expenses are largely driven by wage inflation, material & transportation inflation. If fact, the growth in housing prices and inflation forecasts are closely connected, especially when it comes to housing development.
Here's a comparison between the two trends and how they impact housing margins:
Optimistic scenario: 32.9% home price growth
Panel-wide consensus: 20.8% home price growth
Pessimistic scenario: 8.7% home price growth
Inflation Forecasts (2024–2028):
Federal Reserve targets inflation around 2% annually, but current forecasts suggest inflation may range between 3–5% annually, depending on economic conditions. However, specific inflationary pressures on labor and materials in construction tend to outpace general inflation due to supply chain constraints, labor shortages, and global demand for materials.
The construction industry is facing significant labor shortages, especially in skilled trades, which pushes up wages. Labor cost increases often exceed general inflation. A labor shortage leads to higher pay for available workers, potentially outstripping even the optimistic rise in home prices (32.9%).
Labor shortages can slow down projects, increasing overhead costs and eating into margins for developers.
Rising Material Costs:
The prices of key construction materials—like lumber, steel, concrete, and drywall—are directly impacted by inflation, supply chain issues, and geopolitical tensions. Even if general inflation averages 3–5% annually, material costs for housing development may rise more sharply due to global demand and supply disruptions.
For example, during recent years, material costs in the U.S. have risen by 7-15% annually in some cases, due to factors such as tariffs, transportation issues, and scarcity of raw materials. This outpaces both home price growth and inflation.
Margin Squeeze from Rising Costs:
While home prices might increase by 20–32%, inflationary pressures on labor and materials could grow by 3–10% annually, depending on market conditions. The gap between the rising costs and home prices can reduce profit margins if the cost of construction increases faster than home values.
In the pessimistic home price growth scenario (8.7%), if labor and materials inflation remains elevated, developers could face a situation where costs rise faster than prices, leading to slimmer or negative margins.
Cost Escalation Clauses, Early Procurement & Controls:
Developers may need to adopt strategies like cost escalation clauses in contracts or early procurement of materials to lock in prices and protect margins. However, these strategies may not fully offset the inflationary impacts on long-term projects.
Controls for how clients make selections are paramount, ensuring that all changes are tracked and those initiated by clients have accurate statements of work, and are approved.
Value Engineering with BIM and VDC:
Technologies like BIM (Building Information Modeling) and VDC (Virtual Design and Construction) become critical tools in protecting margins. By optimizing material usage, reducing errors, and improving project efficiency, BIM can help developers manage rising costs. Early detection of inefficiencies or clashes in the design phase can lead to savings that mitigate the impact of inflation on materials and labor costs.