British Columbia’s Construction Sector

Introduction

The purpose of this topic box is to discuss:

• recent performance of the construction industry;
• recent estimates of cost inflation in the construction sector; and,
• private sector forecasts of construction cost inflation going forward.

British Columbia's construction industry accounts for approximately 6 per cent of the province's real GDP. This sector has seen tremendous growth over the last few years, with gains in both residential as well as non residential construction.

Investment in residential structures has grown considerably over the last several years, and the recent strength in the non-residential construction sector has led to some concern surrounding a shortage of skilled workers in the industry. It has also raised concern regarding cost pressures, not only with respect to upward pressure on wages, but also in terms of higher building material costs.

Recent Industry Performance

Last year the non-residential construction sector posted strong growth. Real investment in non-residential building construction was up 18.8 per cent in 2005, following a 3.4 per cent increase in 2004. Investment in industrial buildings (e.g. manufacturing and processing plants) was up 33.4 per cent in 2005, and investment in institutional buildings (e.g. schools and hospitals) increased 34.6 per cent. Meanwhile, investment in commercial buildings (e.g. stores, warehouses, office buildings) grew 9.9 per cent last year.

The value of non-residential building permits in British Columbia rose an enormous 54.7 per cent in 2005, while residential building permits were up 18.5 per cent. Building permits provide an early indication of planned building activity.

Cost Pressures

With such strong growth in the non residential construction sector, the issue of labour shortages and rising material costs in British Columbia has been at the forefront, and was the main medium term concern of the Economic Forecast Council¹. The two main components of construction sector costs are wages for labour, and costs for building materials.

According to Statistics Canada's Survey of Employment, Payroll and Hours, average hourly earnings² in the non residential construction sector increased 4.1 per cent over the January to November period of 2005, relative to the same period of 2004. This follows the 2.5 per cent and 3.1 per cent annual increases in non residential construction wages observed in 2003 and 2004, respectively. Meanwhile, residential construction wages rose 4.6 per cent in the first eleven months of 2005, reversing the 2.9 per cent decline seen in 2004. It is important to note that while total building construction wages (residential and non residential) have risen by 5.1 per cent in the first eleven months of 2005, different trades within the construction sector face different wage pressures as the demand for particular forms of skilled labour are greater than others. For example, average hourly earnings in the heavy and civil engineering construction sector rose only 2.2 per cent in the January to November period of 2005, as opposed to the 5.1 per cent increase in total building construction wages (See Table 1).

1	The Economic Forecast Council is a group of independent private sector economists who met on December 5, 2005 to provide advice to the Minister of Finance on the provincial economic outlook.
2	Wages in the construction sector are for the whole province due to a lack of regional data.

However, wages are not the only driver of construction costs, as overall building material costs have also risen. For example, input prices for diesel fuel used to operate machinery has risen considerably over the last two years and was up approximately 33 per cent in 2005 following a 17.7 per cent increase in 2004 and a 9.7 per cent increase in 2003. Other building materials such as plastic pipes and pipe fittings saw a 14.3 per cent price increase in 2005, while other materials such as concrete products and metal plumbing fixtures have seen more modest price increases of 3.1 per cent and 2.6 per cent, respectively. Meanwhile, the price of steel product manufacturing came off a 20.5 per cent high in 2004 to post a smaller 4.8 per cent increase in 2005. Analysts believe that steel prices may come down due to increased supply of steel in the market, as China has become a net exporter of the material.

In Vancouver, Statistics Canada's overall construction price index for non-residential buildings increased 7.5 per cent during the first nine months of 2005 relative to the same period in 2004. This price index has risen considerably over the last two years, and rose 8.6 per cent in 2004 following a 1.3 per cent increase in 2003. Given that the Vancouver non-residential construction price index is rising much faster than wages in the British Columbia non-residential construction sector (up 4.1 per cent over the January to November period of 2005), it is likely that higher construction costs have been driven primarily by higher materials costs. The Credit Union Central of BC recently said that, "indications are the cost of materials, especially steel and concrete, has risen faster than the cost of labour over the past year or two, although this may reverse in the next two years" (Economic Analysis of BC, Volume 25, Number 8, December 2005). That wage costs may outpace material costs in the next few years suggests that it may take some time before the issue of skilled labour shortages in British Columbia is resolved.

While cost overruns can be expected in such an environment, the severity of the overrun partly depends on what assumptions for inflation have been made. If cost estimates were developed several years ago, when inflation was lower, and if it was assumed that inflation would continue at those same low rates instead of today's rates, then this would lead to a cost overrun. Due to the cumulative effect of inflation, the longer the time between the original estimate and actual construction, the larger the overrun would be. For example, cumulative inflation in the construction sector from 2000 to 2005 was approximately 22 per cent (sum of the figures in Chart 2 above). If cost estimates were developed in 2000, when construction inflation was about 2.0 per cent and it was assumed to remain at that rate in the future, then by 2005 cumulative inflation of about 12 per cent would be built into project budgets. This leaves a gap of 10 per cent, which would represent the cost overruns.

Private Sector Forecasts

Meanwhile, various analysts are predicting a wide range for construction costs going forward. The Credit Union Central of BC expects price inflation on building construction in the Vancouver region to be between 5 per cent and 6 per cent over the next two years. On the other hand, the BTY Group (a consultant firm specializing in cost management and project management) expects cost escalation in the lower mainland to be around 11 per cent in 2006 and a further 10 per cent in 2007 (Market Intelligence, 4th Quarter, December 2005).

One of the reasons for BTY's higher forecast may lie in their higher inflation estimates for 2005. In their December 2005 report the BTY Group stated that in the lower mainland construction cost escalation was 10-11 per cent in 2005. The report stated that the cost escalation was being driven by, "increased construction volumes, a limited contractor and labour pool and rising materials costs". Figures from Statistics Canada, however, indicate that non residential building construction costs in Vancouver were a more modest 7.5 per cent during in the first nine months of 2005 compared to the same period of 2004.

The Economic Forecast Council mentioned that demographic trends are expected to exacerbate labour shortages over the medium term, and that British Columbia needs to promote its strength as a desirable place to live in order to successfully compete in the labour market for skilled workers. This is why various measures to address skills shortages have been introduced. This is discussed further in the topic box on page 58.