Prices for steel and timber have risen drastically over the past year. They peaked in May, when the monthly average for timber had tripled from the 2020 level and rebars cost over 60 per cent more. Although prices have now fallen back a little, these raw materials remain far more expensive than a year ago. The June price for timber was roughly 170 per cent above the 2020 level. The corresponding increase for rebars was about 50 per cent.

Where steel is concerned, the big price rise reflects steel-mill shutdowns last year because production activity declined as a result of Covid-19. Restarting cold furnaces is a lengthy and costly process for the mills, so they lagged behind when consumption picked up.

Several factors have contributed to the sharp increase in timber prices. First, the pandemic sparked a refurbishment boom, both nationally and internationally. Second, the bark beetle epidemic in Canada has destroyed many trees at a time when production was already lower than usual because of Covid-19. That led to sharp price rises. Since raw materials have also become to a great extent financial assets, the influence of financial players on the price level is increasing proportionately with the volatility.

The sharp increase in raw material prices has coincided with substantial growth in freight costs. Low capacity on ocean transport from China, stringent restrictions in many ports and a shortage of containers have contributed to this.

As a rough rule of thumb, materials typically account for half the cost of a new building. So a price rise of 50 per cent, for example, would thereby boost construction costs by 25 per cent.

Although we have seen a marked rise in Norwegian construction costs, the increase has been much smaller than the trend for raw material costs would suggest. According to Statistics Norway’s construction cost index for residential newbuilding, the increase was 5.8 per cent from May 2020 to May 2021. However, the index for materials prices, viewed in isolation, rose by 9.5 per cent. The labour cost index climbed by 2.1 per cent over the same period.

Several factors could explain why the full effect of rising raw material prices is not being seen in construction costs. First, it takes time for price increases to propagate along the value chain. In reality, many products and semi-manufactures have been produced a considerable time ago. As stocks are used up and need to be replaced, the rise in raw material prices is likely to become evident. Second, it is conceivable that suppliers are reluctant to pass the whole price increase on to customers in one go – at least if they think the position is temporary.

Which brings us to an important point – namely, that great uncertainty prevails. Construction projects last long after the contracts have been signed. Property developers and builders thereby find themselves in a very challenging position today. Who is going to bear the risk of raw material costs remaining high or increasing further? Will contractors offer turnkey assignments under such conditions? Will that require large risk premiums, which could in themselves increase construction costs? Many may perhaps prefer to wait and see. If that happens, will we eventually see surplus capacity among building contractors?

It is naturally difficult to forecast how raw material markets will develop. Since we are expecting a normalisation of society and consumer patterns, at the same time as the consumer side is growing in many markets, it is reasonable to expect a gradual normalisation of raw material prices. However, we think it will take time for them to return to their pre-Covid level. And if that is the case, while risk premiums for contractors rise, projects will be significantly more expensive in coming quarters.

Big differences between building types
The impact of increased raw material prices on construction costs may vary between different segments. To illustrate this, we can consider the difference between offices and logistics premises. Steel structures account for about four per cent of the cost of an offshore building, but roughly 20 per cent for a logistics structure.  A rise in steel prices will therefore have very different effects in these two cases.

Higher construction costs also have many wider consequences. On the one hand, they help make it more expensive to put up new buildings, rehabilitate existing premises and customise for new tenants. That could put pressure on the profitability of such projects. On the other, the marginal cost of providing new space rises. That could boost rent levels and increase the value of existing buildings with a high standard. This is particularly relevant in areas with a good supply of building land, because replacement costs largely lay the basis for rent levels.