The VBI Vertical Construction Cost Index
Plotted data set of significantly similar projects across markets and over time.
We have discussed in other articles the challenges associated with obtaining consistent construction pricing. Developers often ask themselves, am I getting a good price? My per door cost was so much less on Phase I, can the general contractor’s number be believed given that Phase II has gone up so much? Given the opaque nature of the industry, many companies have attempted to develop their own platforms for estimating costs. The challenge is the lack of data consistency, transparency and reliability. Certain commodities like lumber or steel can be tracked more easily as stand alone materials, but understanding exactly of what percentage of a given project those commodities consist is nearly impossible. Collecting a consistent and accurate breakdown of just labor and material from the general contractor or subcontractors can feel like “pulling teeth.” Even if you could get clear and transparent data from all the carpenters bidding your project, and even assuming they accurately each break out labor and materials, you likely still will never truly know what amount of materials is further broken down into different commodities like lumber vs. structural hardware (which is primarily steel). Therefore, accurately tying ones project costs to granular categories is likely a Sisyphean effort. While some platforms may provide some insight to general contractors, in our experience the quality of the data from firms such as RS Means or The Blue Book often leave much to be desired compared with actual bids and seldom lined up with internal numbers. That said, in concert with our clients who build consistent product repeatedly in markets offered us an opportunity to develop the VBI Vertical Construction Cost Index. This utilizes two indices from the St. Louis Federal Reserve, the Producer Price Index by Commodity: Special Indexes: Construction Materials and the Average Hourly Earnings of All Employees, Construction.
The challenge is that the two foundational indices move independently and, while generally correlated, the Covid years saw incredible run ups in material costs while labor cost increases were significantly less. Combining these indices, in concert with an understanding of the relative ratio of labor vs. materials by test fitting the index to the data set, which we know to consist of highly consistent product has resulted in a consistent index which provides a high level of confidence.
The VBI Vertical Construction Cost Index
Is this a replacement for a rigorous bid process and detailed scrutiny, absolutely not. However, we offer the VBI Vertical Index as a tool against which you may compare your own costs. We believe that this index provides a good starting point for evaluating a project’s vertical costs, especially if you have a very similar prior project with which to compare it.
How to Use the Index
Let’s assume you are currently obtaining numbers for Phase II of a multifamily development with largely the same specifications and finish package. The total of vertical costs (excluding site-work, landscaping, etc.) per unit for Phase I was $285,000. The GMP Contract for Phase I was executed in January of 2021 when this index was at 201.063. It is now June of 2023, and you have just received the final bid sheet from your general contractor and are about to go to GMP on Phase II for $368,000 per unit, a 29% increase! The index sits at 263.053. Is this a fair price? To calculate, simply divide the later index by the earlier index and multiply that by the earlier per unit cost. This yields an expected vertical construction cost for Phase II of $372,869.
Therefore, in this example, the number appears to be in line with expectations. This is certainly not designed to be an end all be all in evaluating construction pricing, but at a high level and as an additional check on one’s own risk analysis. If a developer were to receive a number far below what the index might indicate, that should raise questions that the proposed GMP price is too good to be true.
Is this a new general contractor?
Is the developer setting themselves up for massive change order fights because the general contractor or its subcontractors have missed major items in their bids?
If its the same general contractor as the earlier project, perhaps they lost their shirt on that one and hope to make up for it?
If the number is significantly higher than the index would suggest, this should raise a different set of questions.
Does this new general contractor too risk averse and including far greater internal contingency to protect themselves?
Could it be that, assuming the developer builds many similar projects in that market with a current general contractor in good standing, but is forced to work with a new general contractor because their usual go to was too busy, the price is considerably higher because the go to general contractor has developed efficiencies in building that developer’s product over and over?
In any case, we provide this as a general tool for the benefit of our readers in the hopes that they may find it useful. We would also appreciate feedback when testing this index using your own internal numbers. How accurate do you find it? Could it be improved?
Regional Adjustment
Additionally, our data has shown a consistent delta between major US markets. Unfortunately, our data set is insufficient to cover all markets. That said, we have found consistent differences between several major US markets, which is understandable given regional differences, favorable or unfavorable business climates and tax structures, access to distribution infrastructure, available of labor and market demand. While we anticipate these relative differences to move over time, we offer this data as another tool to evaluate your construction costs. We believe this may have value, especially to developers who have a consistent product that they wish to introduce into a new and unfamiliar market, with invariably new general contractors in whom the developer may have yet to establish a relationship of trust.
Similar to the calculation above to evaluate pricing in the same market over a period of time, we offer these ratios for a similar analysis. In the cast of this scenario, we recommend first completing the time calculation above to approximate your per unit costs in current dollars based on your prior project cost. Once one has established a current per unit number for their home market, then one follows a similar relative calculation to obtain a target per unit cost in the new market. As an example, let’s use the more current $372,869 per unit cost from the scenario above for this developer’s home market. Let us also assume the developer’s home market is Georgia but they have elected their next project will be in Texas. While these markets are generally comparable, we have found Texas to be slightly less expensive. Therefore, utilizing the equation below, one would expect that the per unit cost for this developer’s product in Texas would be slightly less at $346,236.
Again, we do not advocate any company use these tools alone to make financial or investment decisions. However, we hope that you find these tools useful as another way to evaluate the construction pricing you receive given the incredibly opaque nature of the industry and the lack of good alternative data sources to ensure you are getting the right price for your projects.
