Healthcare project materials costs: Which way on the roller coaster
When you planned that healthcare construction project three or four years ago, you assumed that costs in general would rise pretty much in line with consumer price increases, and you built that into your estimates. Over the last couple of years, though, it hasn't been working out that way. Costs, particularly of selected materials, have started to soar, and if there's an end to this inflation, it's nowhere in sight. Recently, the day after the federal Bureau of Labor Statistics released the latest data on these developments, HEALTHCARE DESIGN Editor-in-Chief Richard L. Peck asked Ken Simonson to comment on them and analyze their potential impact specifically on the healthcare sector. Simonson has been tracking materials costs for several years on behalf of the Associated General Contractors of America, and pointed to specific facts and trends that healthcare project planners had better start working into their calculations. A sneak preview: It's not all bad.
Peck: Materials costs seem to have taken off in this field. What's happening?
Simonson: Construction in general is facing much higher cost increases than consumers or most other businesses. They're occurring primarily in three areas: diesel fuel, steel and copper.
Diesel fuel has, of course, several roles in construction: powering off-road equipment, such as earth-movers, construction vehicles, concrete mixers and pumpers and cranes, and in fuel surcharges for various hauling operations. Diesel fuel prices have risen much faster than gasoline—in mid-April the United States Energy Information Administration announced that, for the first time, diesel fuel cost more than $4 a gallon in every region of the country, up 40% from last year. That's compared to an average $3.38 for gasoline. It's highly unusual at this time of year when, normally, the price for “middle distillate” declines as heating oil demand drops.
As for steel, prices are rising as fast as they did in 2004 and are reaching record levels. There are several factors: production is energy-intensive, the dollar is declining, and U.S. scrap yards have become the bargain bin for the world. Unfortunately, overseas producers have plenty of markets worldwide and are maintaining their prices, with the dollar decline only aggravating this. Meanwhile, there are fewer steel producers in the U.S. and they're more disciplined, maintaining their prices at world levels as they rise.
Copper, used heavily in infrastructure and such products as consumer electronics and cars, still comes from relatively few sources and there has been considerable instability in those areas: power shortages in Zambia, civil unrest in the Congo, strikes and earthquakes in Chile. All of this can and does cause huge price spikes and, right now, copper is trading at nearly $4.04 a pound, up about 30% from a year ago.
Peck: One take-home message from all this seems to be that healthcare project planners had better stop using the CPI (Consumer Price Index) as a guide.
Simonson: That's for sure. The PPI (Producer Price Index) is more relevant, and that's rising at a rate of about 6.5%, compared to 4% for the CPI. This is mostly impacting non-residential construction, too, as the decline in the single family home market has caused falling prices for materials such as plywood and gypsum. The latter is a bit of good news for non-residential purchasers such as healthcare projects, since they use so much wallboard.
Peck: But are there any other mitigating factors in the healthcare market—perhaps the persistent demand for new construction and renovation of aging facilities, seismic-proofing and the like? Might these projects be more inclined to absorb the costs?
Simonson: Yes, there still is a major modernization effort going on in the field, and there's certainly no sign of falling demand for their services. I would say this sector is better able to absorb these increases than other business areas, such as retail.
Peck: What is the overall outlook, in your view?
Simonson: I expect these 6 to 8% PPI increases to continue for some years to come. I think hospital construction activity will hold up well, though, at least for the next year. One area of vulnerability may be in the long-term care sector, where customers for private pay alternatives such as assisted living rely on proceeds from home sales to pay for them. Another potential problem area might be medical office buildings, if vacancies continue to develop in more general purpose office buildings. Both of these will be areas worth watching in the short term. HD
Kenneth Simonson is Chief Economist, Associated General Contractors of America. For more information, phone 703.837.5313, e-mail
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