Builders Face Myriad Cost Pressures, And Issue May Worsen

By Andrew McIntyre
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Law360 (May 24, 2021, 7:05 PM EDT) -- The cost of construction materials has soared over the past year as demand has surged and supply has tightened, and experts say the pricing situation could worsen as more projects start to come on line later this year.

Owners, general contractors and subcontractors are all trying to make sense of how to limit their liability in the wake of surging prices for lumber and other materials, and the price escalation has brought increased focus on existing contract language as well as intense negotiation as new contracts are inked.

"It's really about leverage at the end of the day. Who has the leverage and who's willing to make certain tough decisions," said Adam Richards, a partner at Berger Singerman LLP. "There is a tremendous amount of demand, and supply isn't meeting the demand. … It's abundantly clear there's a shortage of very important materials."

Here, Law360 looks at the rise in construction costs, what it means for contracts and what the future may hold for developers.

Rising Prices Are Causing Project Disputes

Lumber prices have soared as mills struggle to get back to capacity. The supply chain remains sluggish, and demand for new multifamily projects is surging. All of that has combined to create a nightmare for developers who are trying to price their projects, experts say.

"We have a contractor that is working on [a] multifamily project. … The rough carpentry subcontractor did the work to provide the rough framing for all of these buildings … in October of 2020 and contacted the contractor in March, even a little earlier, and claimed now the materials were $3 million more costly on about a $7.5 million subcontract," said Joshua Levy, a partner at Husch Blackwell LLP.

"There's a current collaborative effort by the owner, the contractor, and the sub[contractor] to try to mitigate the impact of this price increase and preserve everyone's rights, but ultimately somebody's going to have to pick up" the $3 million difference, Levy added.

Lumber prices 12 months ago stood at $370 per thousand board feet and reached a peak of nearly $1,700 early this month. Prices have fallen somewhat to current levels of $1,390 per thousand board feet, up nearly 300% from a year ago.

While lumber is one concern, steel and aluminum prices also remain high, and there are even price concerns for materials such as cement and rebar, said Carol Sigmond, a partner at Greenspoon Marder LLP.

Tariffs on imports of lumber as well as steel and aluminum are also continuing to put pressure on prices, experts say.

At the same time, as prices rise, questions abound about the supply chain.

Many materials come from China, and there's a lingering question whether some production will shift to other areas of the world, such as Africa or Latin America. There is also a question of whether the U.S. might do more domestic manufacturing, Sigmond said.

"Contractors are beginning to adjust to the new supply chain. More and more contractors are beginning to understand how the new supply chain works," Sigmond said, adding that the rollout of the 5G network also means builders have much more information at their fingertips at project sites. "There is industry adjustment going on."

Contracts and Timelines Are Under Intense Scrutiny

The spike in material prices is causing two main changes in the way contracts are drawn up, with parties shortening schedules and companies seeking to gain contract protection from surging costs, experts say.

The normal process, said Brian Gaudet, a partner at Kilpatrick Townsend & Stockton LLP, would be putting together a project idea and then sending it out for bids, and waiting some time for bids.

That's changing.

"One thing that's going on now is time is not your friend," Gaudet said. "Typically, contractors have longer [periods] to get bids from subcontractors to get their bids locked in. You'd better hurry up because it's getting more expensive while we're sitting here."

Levy said that before the price spike, bids were often good for 90 days, but now, because of the fear of major price movement, the process is being accelerated.

While scheduling is one thing, pricing risk in the actual contracts is another.

Richards of Berger Singerman said that while lawyers a year ago were scrambling to make sense of force majeure, now there's a rush to make sense of the construction contract model, with particular emphasis on payment method. Companies are increasingly looking to put price escalation clauses in contracts, clauses that allow for the contract terms to change as the prices of materials rise.

"There is a focus to review and revisit those contracts and even consider an amendment to those contracts to try to adequately deal with the possibility of significant cost increases," Richards said.

Measuring cost change, however, is challenging, Gaudet said, since there are many ways to measure and various moving pieces, including whether certain elements of an equation have already baked in an expectation for costs to rise.

Gaudet offered an example. An item costs $10, but a party is charged $13 because the price is expected to increase. The price, however, rises to $14. The question is whether there had been a $1 or $4 cost increase. It depends on which starting point is used.

"There is a cost-benefits trade-off on how deep in the weeds you want to get in validating and verifying this information," Gaudet said.

And all this has meant parties are doing close reads of their contracts like never before.

"Most of the paths to resolving the dispute are in your contract if you'll only read it and use it," said Levy of Husch Blackwell. "People are reading and using the material purchase options more, now that they have seen the actual losses."

Parties May Face Additional Price Pressure

The return of mills and plants as the COVID-19 vaccines become widely available should help ease the price pressure on materials, but experts say there could also be a concomitant surge in demand for new construction as many sidelined projects ramp up.

"The mills and the plants getting back to full speed, that may not be good enough," Gaudet said, suggesting supply at full strength may not be able to keep pace with demand.

Many projects have been on hold for months amid market uncertainty and challenges in building during the pandemic.

As the vaccines roll out, developers are increasingly looking to start those projects, which will put more upward pressure on prices. Homebuyers will likely have to pick up much of the slack when it comes to residential properties, experts say.

"Demand is there. Demand is what's driving the problem that we're having," Richards said. "It's not slowing down. … It's a perfect storm of tremendous demand and not enough supply."

"Everything is going to become more expensive, and somebody has to pay for those increased costs. Everybody is … going to try to pass those costs down to the homebuyer," Richards added.

And if the anticipation of a flood of new projects coming on line weren't enough, the start of the hurricane season is June 1.

When storms blow through big cities, the aftermath typically results in increased demand for lumber and roofing materials, Gaudet said.

"If a hurricane hits or several hurricanes hit … major metropolitan areas, there's just all of a sudden more [price] pressure," Gaudet said.

--Editing by Orlando Lorenzo and Jill Coffey.

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