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6 minute read

What’s behind soaring material costs and how can contractors cope?

By: Sovereign Insurance | Featuring: Tanvir Rakhra

Being in the construction business has never been easy. Over the decades, contractors have had to navigate economic downturns, labour woes, safety issues, technological disruptions, and even everyday variables like the weather. 

In today’s environment, there’s both good news and bad news for commercial contractors and their clients. Post-pandemic, public construction spending has rebounded, and Canada is in the midst of a 12-year, $180 billion infrastructure plan.1 

According to the latest figures from Statistics Canada, investment in the non-residential construction sector increased for the ninth straight month, advancing 1.4% in April. Investment in industrial construction increased 1.7% to $931 million, with Ontario accounting for most of the net growth. Meanwhile, commercial investment increased 1.5% to $2.9 billion, with nine provinces reporting growth.2

“It depends on which province you’re in, but overall, spending is up significantly,” says Tanvir Rakhra, Surety Manager, Contract Surety, Eastern Operations at Sovereign Insurance. “However, many contractors continue to face challenges when it comes to ongoing supply chain issues and material cost escalations.” 

In fact, non-residential construction building costs rose 12.8% year-over-year in the first quarter of 2022, also surpassing the previous high (+11.4%) of the last quarter, according to Statistics Canada. Construction cost increases were the largest in Toronto (+17.3%), Ottawa (+17.2%) and Edmonton (+13.9%).3 

What’s behind the rising costs? As every business is well familiar with, global production and supply chains have yet to recover from worldwide disruptions caused by the pandemic. But there are many other reasons material costs are escalating. 

“There were weather-related events such as the Texas ice storm, China has limited production on certain goods due to new emissions controls, there’s a natural gas shortage in Europe, and we’re facing skilled labour shortages, which makes it difficult to get projects completed in an appropriate amount of time,” Tanvir says. “In addition, inflation is on the rise, rising oil prices means it is more expensive to ship goods, and there’s high demand for materials.” 

During the pandemic, wage subsidies helped mitigate some of these challenges, but these subsidies have since wound down. “Now, contractors that were locked into contracts pre-pandemic for projects that are not yet complete are dealing with the burden of these cost escalations,” says Tanvir. “The margins they thought they were going to attain are dwindling, and they have additional overhead costs because of the labour shortage. They’re having to increase salaries to keep key personnel.” 

These complex issues aren’t going to be resolved anytime soon, so contractors need to take steps to mitigate the effects of cost escalations. 

“There are many strategies contractors can use, but by far the best one is to buffer their bids to account for fluctuating costs and build in a higher gross margin,” says Tanvir. 

When possible, contractors should push for a cost-escalation clause, which is a provision in a contract that allows for increases in agreed-upon fees, wages, or other payments to account for fluctuations in the costs of raw materials or labour. 

“Longer-term projects should have cost-escalation clauses built into contracts, but we’re finding some contractors have been unsuccessful in getting these, especially on public projects,” says Tanvir. “A lot of owners push back on cost-escalation clauses because they want certainty at the time of bid.” 

Another strategy, particularly for larger firms that have access to capital, is to buy material in bulk at the beginning of a project to ensure some cost certainty. “Those who are unable to do that can leverage the relationships they have built over the years—with their suppliers and sub-trades—and work with them to ensure cost certainty ahead of a large project,” Tanvir says. 

In the longer-term, contractors will have to find ways to attract and retain employees beyond wage increases, particularly as a large number of workers are retiring over the next 10 years. Tanvir notes that the Canadian government has various initiatives that aim to get more women and young people involved in the trades and is trying to attract immigrants to build up the labour pool. 

It’s also critical to have the right insurance coverages and surety in place. Given today’s challenges, Tanvir says the surety team at Sovereign is actively reaching out to their brokers and contractors to provide guidance and get their feedback. 

“When it comes to surety, there are more questions we have to ask, especially for larger projects that take the course of many years,” he says. “We have to figure out how the contractor is mitigating the risk of soaring material costs when the project is priced so far in advance.”

While the difficulties are many, Tanvir says it’s important to keep in mind it’s not all doom and gloom. “Contractors are quite resilient and adaptable, and always have been,” he says. “They will rise to the challenge.” 

 

Sources 
1 Infrastructure Canada, “Investing in Canada: $180 billion infrastructure plan over 12 years  
2 Statistics Canada, “Investment in building construction", April 2022," June 13, 2022
3 Statistics Canada, “Building construction price indexes, first quarter 2022,” May 5, 2022

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