he fifth Construction Inflation Alert released by the Associated General Contractors of America (AGC), Washington, D.C., cautions owners, budget setters, and contractors to anticipate larger materials and labor cost increases in 2008 than those experienced in the past 12 months.

“Non-residential construction has had a banner year so far in 2007, and we've seen spending on nearly every segment increase compared to 2006, despite the plunge in home building,” says AGC Chief Economist Ken Simonson. “The materials cost surges that plagued the industry in 2004-2006 have slowed dramatically, and labor remains available in most markets.”

According to Simonson, however, the worsening slide in home building and the turmoil in the credit markets are threatening some types of non-residential construction. “At the same time, some materials costs are beginning to turn up again, and labor costs have started to accelerate,” he notes.

A recent press release from the AGC states the cumulative increase in the producer price index (PPI) for construction inputs (click here to see chart) since December 2003 (28% since August 2007) remains more than double the 13% increase in the most common measure of overall inflation, the consumer price index (CPI) for all urban consumers. Conversely, labor costs have risen at similar rates for construction and for the private sector as a whole.

The cumulative difference matters because the estimates for many projects now being bid were prepared in 2003-2005 under the assumption that construction costs would rise at the same rate as the CPI. That variance explains why some projects have been canceled, postponed, or redesigned.

Meanwhile, the nonresidential industry has profited from increased availability of specialty trade workers who have relocated from residential work. “But wages have begun rising more steeply for specialty trade contractors, suggesting that the number of workers suitable to switch is close to exhaustion,” says Simonson. “In the next several months, the rate of wage increases is likely to reach 5% to 5.5%, up from a recent 4.5% gain,” says Simonson.

According to AGC, labor costs will also probably accelerate further if residential building begins to draw back specialty trade contractors in late 2008. “Construction wages could go up 5% to 6% annually for several years beginning in late 2008,” suggests Simonson.