When a recession hits what occurs to the cost of construction?
This is a question that may have crossed the minds of builders developers investors and homeowners alike.
In periods of economic downturn it is only natural to expect changes.
But does a recession mean that building costs automatically come down?
Or does it imply that they skyrocket because materials become more challenging to source?
The answer might not be as straightforward as one might expect.
Table of Contents
Building Costs During A Recession
During a recession such as the Great Recession building costs can moderate. In the present case costs show a 3.3% increase year over year as reported in September 2022.
However if a recession lasts for a significant period of time construction costs including labor and material costs have the potential to decrease.
Historically labor and material each account for about 1/3 of the total construction project price. Additionally factors such as equipment and overhead costs which include rent and administrative expenses contribute to the pricing.
A crucial component however remains the profit markup that contractors may compromise on during a recession to secure work.
Impact On Construction Costs
The impact of a recession on construction costs is quite significant. For example during the U.S. Great Recession contractors went as far as bidding jobs below actual costs and even made salary cuts.
The adverse conditions led to an increase in the unemployment rate in the construction industry.
Supply and demand dynamics also affect construction costs during a recession. Large material supplies accommodate reduced demand potentially bringing down prices.
Tight money policies by banks however may limit purchasing power and prevent price decreases. Although government stimulus efforts can also mitigate recession impact supply and demand mainly determine pricing.
The 2022 recession shows labor and material shortages rendering price reductions less likely. These occurrences coupled with rising inflation and mortgage rates impact residential contractors like home builders in the Midwest markets and the National Association of Homebuilders.
Labor And Material Expenses
During a recession both labor and material costs can have a significant impact on building costs. Historically labor costs make up around 1/3 of the total construction price per the summary.
Material costs also account for another 1/3 of the price.
Impact of Recession on Labor Costs
During the Great Recession in 2008 the construction industry registered high unemployment levels. This situation led to contractors bidding jobs below actual costs.
They were even making salary cuts in order to secure work.
Material Costs during Recession
Supply chain disruptions such as those that have occurred during the COVID-19 pandemic can cause an increase in construction material costs. However if there is a large supply and reduced demand these prices can decrease during a recession.
Supply Chain Improvement
The supply chain is showing signs of improvement with 64% of building materials dealers reporting this progress. This could potentially lead to stabilization or a decrease in material costs.
Equipment Costs
While labor and material costs typically make up a large proportion of the total construction project price equipment costs can also be a significant component. The need for specialized machinery might increase these costs vastly.
Overhead Costs and Profit Markups
Further components of building costs during a recession include overhead costs like rent and administrative staff. Profit markups can also vary.
Some contractors may sacrifice their profit just to secure work during a recession further affecting building costs.
Cost of Money
Another crucial factor influencing building cost is the cost of money. The price might not considerably decrease due to tight money from banks which can limit purchasing capacity.
This necessitates government intervention to stimulate demand.
| Cost component | Influencing factors |
|---|---|
| Labor costs | Unemployment rates salary cuts |
| Material costs | Supply demand supply chain disruptions |
| Equipment costs | Specialized machinery requirements |
| Overhead costs | Rent administrative staff costs |
| Profit markups | Competition contractors’ pricing decisions |
| Cost of money | Interest rates bank lending practices |
Overhead Expenses
As many professionals in the construction industry and A/E design firms know the costs associated with construction projects are not limited to labor and materials. Overhead costs play a significant role in the overall project price.
During a recession these costs can have a considerable impact on the construction cost increases.
Overhead expenses typically include fixed costs like rent administrative staff salaries and investment in collaboration tools work management platforms and construction management programs.
Other aspects of overhead expenses include the cost of money loaned by banks resources for avoiding employee burnout cost of communication channels among team members and various tools to improve productivity such as using task delegation techniques maintaining no-meeting days and normal workload management etc.
Recession Influence on Overhead Expenses
A recession can have a profound effect on such costs. With the tightening of money from lenders variable rates may trend upward thereby increasing the cost of money.
In tough economic times contractors may also need to implement salary cuts or even layoffs leading to high unemployment rates which was witnessed during the Great Recession of 2008.
Profit Margins In A Recession
The profit markup on a construction project is a significant component of the overall construction project price. This percentage can be affected and unstable during a recession.
During a recession contractors often face increased competition and the demand for construction projects may decrease. To secure work in such a challenging economic climate some contractors may even bid on projects below actual costs.
Recession Impact on Profits
An example of this effect could be seen during the Great Recession where contractors had to bid jobs below actual costs further resorting to making salary cuts to offset the decrease in profit margins.
Moreover a prolonged recession can lead to a dip in residential housing demand provoking a decrease in the resale values of existing homes and new construction homes. This would further impact the constructors’ profit margins pushing them to make tougher financial and lifestyle decisions to maintain their businesses.
Such correction in the housing market can however maintain the general financial stability in the U.S. economy and safeguard potential homeowners and their investment decisions from experiencing a housing crash due to irrational buying frenzy during peak market conditions. !
