Nonresidential building contractors are now experiencing the worst of the recession. Their reserves have been depleted by the long slowdown.

Available work keeps shrinking as project completions exceed project starts even though starts have rebounded significantly from their lowest level last summer. Wage rate gains have slowed, but the inflexibility of union contracts has delayed the recession impact on wages for many contractors.

Construction materials prices are now rising again.

Cost rises are difficult to pass through to building owners in a weak market so they reduce contractors’ margins. The plight of nonresidential building contractors will worsen at least into the summer.

There is no hard data to measure how much margins have contracted. Experimental total building cost indexes from the Bureau of Labor Statistics show that costs for nonresidential buildings, based on a standard warehouse, school and office building, have increased marginally in the last three months but have declined about 4% over the last year. The decline includes a 6.8% rise in the materials cost index for nonresidential buildings and a 4.5% increase in wage rates for nonresidential general contractors. This implies a 30-40% drop in project charges for construction management, administrative expenses and profits. Most of this cut would have to come from profits. The margin cut is not this large because the decline in project costs is partly due to productivity gains in the use of labor and, to a lesser extent, materials. Still, the profit reduction is huge.

This is the outlook for contractors’ margins for the rest of 2010. Construction volume will slip 3-4% lower into the summer but will be rising by yearend. Higher volume will permit bids with higher margins. The turnabout will be earlier for private construction. The value of commercial construction starts has picked up slightly in the last three months with a more substantial gain expected to develop progressively during the year. However, institutional starts have slipped in the last three months as the full impact of the recession finally reached state and local government budgets. Federal stimulus funds for buildings will only partially offset collapsing state and local government budgets.

The labor cost outlook is also favorable. New contracts will trim wage gains to less than 3% year. But the material cost outlook is not favorable. The price index for nonresidential building construction increased 2.3% in January from December and 3.8% in the last three months. This overstates the expected trend because it includes a rise in oil prices to the top of the expected 2010 price range. But metal prices are also rising sharply and will rise further based on the large January rises in both ferrous and non-ferrous scrap prices. Metal prices can rise in a weak construction market because they are largely set by international demand levels in construction and manufacturing. Note that US manufacturing production rose 1% in January, a 12% annual rate. Expect as much as a 6% rise in materials prices during 2010. The current steady to slightly lower price trend for lumber, plastic, concrete and glass products will reverse to a slight rising trend in a stronger economy later this year.

Source: Reed Construction Data