--- title: How to Reduce Inflation Risk in Construction description: For certain industries, such as the construction sector, inflation risk is a very real problem, as it leads to a bevy of uncertainties, which can impact the entire process, from planning to bidding to completion. Let's dive into how to mitigate that risk. image: https://www.realized1031.com/hubfs/construction-490965008.jpg --- [![Realized 1031 Exchange Marketplace](https://www.realized1031.com/hs-fs/hubfs/Images/Brand/Logo/Realized/Realized-Logo-Black.png?width=240&height=80&name=Realized-Logo-Black.png "Realized 1031 Logo") ](https://www.realized1031.com/) - [Wealth Management Gap](https://www.realized1031.com/the-wealth-management-gap) - [Our Process](https://www.realized1031.com/how-realized-works) - [Financial Advisors](https://www.realized1031.com/advisor) - [Resources](https://www.realized1031.com/resources) - [The Company](https://www.realized1031.com/about-us) - [Articles](https://www.realized1031.com/blog) [Register](https://www.realized1031.com/marketplace) [Log In](https://www.realized1031.com/login) - Better Business Bureau Rating: **A+** - [FINRA BrokerCheck](https://brokercheck.finra.org/firm/summary/22333) - [Call](tel:1-877-797-1031) **(877) 797-1031** # How to Reduce Inflation Risk in Construction Posted Jul 25, 2022 ![construction-490965008](https://www.realized1031.com/hs-fs/hubfs/construction-490965008.jpg?width=750&height=392&name=construction-490965008.jpg) Anyone reading today’s headlines (or trying to heat their homes, fill their cars, or buy food) knows that prices are going up. By the [end of June 2022, the U.S. inflation rate](https://ycharts.com/indicators/us_inflation_rate) stood at 9.06%, close to double the 4.99% reported at the same time the year before.  In addition to kicking up prices on goods and services for consumers, more money chasing fewer goods and services (the “official” inflation definition) [leads to inflation risk](https://www.wallstreetmojo.com/inflation-risk/#:~:text=Inflation%20Risk%20commonly%20refers%20to,Inflation%20Risk%20is%20Bond%20Markets.), defined as the [potential for higher prices to erode](https://www.realized1031.com/blog/what-is-inflation-risk) current (and future) purchasing power.  For certain industries, such as the construction sector, inflation risk is a very real problem, as it leads to a bevy of uncertainties, which can impact the entire process, from planning to bidding to completion. This problem also extends to investment property owners who are interested in renovating and upgrading their holdings.  ### The Increase in Building Costs In its May 2022 analysis[, the Associated Builders and Contractors](https://www.abc.org/News-Media/News-Releases/entryid/19475/construction-input-prices-are-up-21-from-a-year-ago-says-abc) (ABC) reported that construction input prices increased 2.3% from April, 2022. Meanwhile, construction input prices rose by 21.4% year over year, encompassing 10 of 11 subcategories. The largest price increases occurred in natural gas (a 39.7% increase) and unprocessed energy materials (a 16.3% hike).  According to ABC Chief Economist Anirban Basu, the Russia-Ukraine war’s disruption of energy markets means higher prices, and those prices are impacting manufacturing and distribution. This means “there is little prospect for inflation to meaningfully subside during the weeks ahead,” Basu commented.  A recent [MarshMcLennan podcast](https://www.marshmclennan.com/insights/publications/2022/may/mitigating-the-impact-of-Inflation-on-construction-projects.html) indicated other factors leading to construction inflationary risk, including an increase in demand for infrastructure and a reduction in labor and scarce essential materials. The result is lower profit margins and uncertainty when it comes to accurate bids. Adding to this issue is that before the current period, [inflation rates tended to be neglected](https://www.sciencedirect.com/science/article/pii/S2090447920300939#:~:text=The%20inflation%20rate%20rise%20lowers,result%20in%20project%20cost%20overrun.) when it came to most construction project economics and budgeting.  The likely result of the above could lead to slowdowns when it comes to getting construction projects off the ground, not to mention the fact that such projects will be more expensive to complete.  ### Can Inflation Risk Be Reduced? Inflation and cost increases are likely going to be around for a while. As such, ground-up construction, build-outs, and renovations require inflation risk reduction strategies, such as the following:  **Buy early**. Even if a project isn’t planned immediately, buying materials sooner rather than later and storing them until they’re needed can help reduce price increase risk.   **Consider different materials**. [Alternative wood products](https://facilityexecutive.com/2021/08/six-ways-to-mitigate-construction-material-costs/), zip-board, or ready-mix concrete could be less costly, but just as viable for a building or renovation project. Prefabricated wall panels and frames can also help reduce labor costs while limiting waste.  **Focus on contracts with indexed price points and caps**. In other words, when working with a contractor or supplier, it’s a good idea to stay away from open-ended allowance agreements when it comes to material costs and tie them to indexes, such as the [Turner Building Cost Index](https://www.turnerconstruction.com/cost-index).  To conclude, prices are increasing everywhere, and the construction industry is not immune. However, careful planning, consideration, and flexibility can help reduce construction inflation risks in ground-up, build-out, or renovation projects.  This material is for general information and educational purposes only. Information is based on data gathered from what we believe are reliable sources. It is not guaranteed as to accuracy, does not purport to be complete and is not intended to be used as a primary basis for investment decisions. It should also not be construed as advice, meeting the particular investment needs of any investor. Realized does not provide tax or legal advice. This material is not a substitute for seeking the advice of a qualified professional for your individual situation. 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In addition to kicking up prices on goods and services for consumers, more money chasing fewer goods and services (the “official” inflation definition) leads to inflation risk, defined as the potential for higher prices to erode current (and future) purchasing power. For certain industries, such as the construction sector, inflation risk is a very real problem, as it leads to a bevy of uncertainties, which can impact the entire process, from planning to bidding to completion. This problem also extends to investment property owners who are interested in renovating and upgrading their holdings. The Increase in Building Costs In its May 2022 analysis, the Associated Builders and Contractors (ABC) reported that construction input prices increased 2.3% from April, 2022. Meanwhile, construction input prices rose by 21.4% year over year, encompassing 10 of 11 subcategories. The largest price increases occurred in natural gas (a 39.7% increase) and unprocessed energy materials (a 16.3% hike). According to ABC Chief Economist Anirban Basu, the Russia-Ukraine war’s disruption of energy markets means higher prices, and those prices are impacting manufacturing and distribution. This means “there is little prospect for inflation to meaningfully subside during the weeks ahead,” Basu commented. A recent MarshMcLennan podcast indicated other factors leading to construction inflationary risk, including an increase in demand for infrastructure and a reduction in labor and scarce essential materials. The result is lower profit margins and uncertainty when it comes to accurate bids. Adding to this issue is that before the current period, inflation rates tended to be neglected when it came to most construction project economics and budgeting. The likely result of the above could lead to slowdowns when it comes to getting construction projects off the ground, not to mention the fact that such projects will be more expensive to complete. Can Inflation Risk Be Reduced? Inflation and cost increases are likely going to be around for a while. As such, ground-up construction, build-outs, and renovations require inflation risk reduction strategies, such as the following: Buy early. Even if a project isn’t planned immediately, buying materials sooner rather than later and storing them until they’re needed can help reduce price increase risk. Consider different materials. Alternative wood products, zip-board, or ready-mix concrete could be less costly, but just as viable for a building or renovation project. Prefabricated wall panels and frames can also help reduce labor costs while limiting waste. Focus on contracts with indexed price points and caps. In other words, when working with a contractor or supplier, it’s a good idea to stay away from open-ended allowance agreements when it comes to material costs and tie them to indexes, such as the Turner Building Cost Index. To conclude, prices are increasing everywhere, and the construction industry is not immune. However, careful planning, consideration, and flexibility can help reduce construction inflation risks in ground-up, build-out, or renovation projects. This material is for general information and educational purposes only. Information is based on data gathered from what we believe are reliable sources. It is not guaranteed as to accuracy, does not purport to be complete and is not intended to be used as a primary basis for investment decisions. It should also not be construed as advice, meeting the particular investment needs of any investor. Realized does not provide tax or legal advice. 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