Inflation is an essential concept that can significantly affect the financial stability of any construction project. For UK-based construction businesses, managing inflation is crucial to maintaining profitability and ensuring successful project completion. While inflation might seem like a specialist topic reserved for economists, it is vital for all stakeholders involved in construction to understand its impact on project costs.

In this blog, we will explore inflation in the context of construction, with a particular focus on how it is addressed within the New Rules of Measurement (NRM) published by the Royal Institution of Chartered Surveyors (RICS). By shedding light on this topic, we aim to help businesses better manage their costs and avoid unexpected financial pressures.

1. What is Inflation in Construction?

In simple terms, inflation refers to the general rise in prices of goods and services over time. In construction, this could mean an increase in the costs of materials, labour, and equipment between the time a project is planned and when it is executed.

For example, if steel prices increase by 5% over a year, and your project spans multiple years, you would need to account for the price difference in your budgeting and contracts. Failing to do so can result in significant financial strain.

2. The Impact of Inflation on Construction Projects

Inflation affects the overall cost of construction projects in several ways:

• Materials Costs: Prices for materials such as steel, concrete, timber, and insulation tend to fluctuate over time. A spike in prices can lead to budget overruns if not accounted for.
• Labor Costs: Rising wages due to inflation or skills shortages can increase project costs, particularly if a project spans several years.
• Equipment Costs: The costs of purchasing, leasing, or maintaining construction equipment can also increase with inflation.
• Subcontractor Pricing: Inflation affects the costs subcontractors incur, and they will often pass these increases onto the primary contractor, which in turn can raise the overall project costs.

In long-term projects, inflation can have a cumulative effect, significantly increasing the total cost compared to the original estimate. Therefore, it is vital to account for inflation when budgeting and planning your project, particularly when negotiating contracts and setting contingency funds.

3. How the NRM Approaches Inflation

The New Rules of Measurement (NRM), developed by the RICS, provide a structured approach for preparing cost estimates and cost plans for construction projects in the UK. The NRM offers guidance on how inflation should be factored into these calculations.

NRM1: Order of Cost Estimating and Cost Planning for Capital Building Works

NRM1 provides guidance on preparing cost estimates at the early stages of a project and incorporates provisions for dealing with inflation. It suggests adding an allowance for inflation in two key areas:

• Tender Inflation: This accounts for the potential changes in prices from the time the project is planned until tenders are received.
• Construction Inflation: This accounts for inflation that might occur during the construction phase. NRM1 advises cost planners to include a forecast for future inflation, especially for projects with a long duration.

Cost planners are encouraged to use indices and forecasting techniques to estimate inflation rates. Common sources for such forecasts include the BCIS (Building Cost Information Service) Tender Price Index and other economic forecasts published by RICS.

NRM2: Detailed Measurement for Building Works

NRM2 focuses on detailed measurement and quantification of works to provide greater cost certainty. It includes recommendations on adjusting measurements to reflect inflationary increases, particularly for projects where exact prices cannot be fixed at the time of planning.

NRM3: Order of Cost Estimating and Cost Planning for Building Maintenance Works

While NRM3 is mainly concerned with maintenance and life-cycle costs, it also highlights the importance of factoring in inflation for the ongoing maintenance and operational costs of a building.

4. The Role of BCIS in Predicting Inflation

To estimate the impact of inflation on construction projects, many professionals use the Building Cost Information Service (BCIS), which provides comprehensive data on tender prices, costs, and inflation forecasts. The BCIS Tender Price Index is particularly valuable for estimating tender inflation.

The BCIS considers factors such as:

• Market Conditions: The current supply and demand for materials and labor.
• Government Policy: Economic policies that may affect inflation, such as interest rates or fiscal measures.
• Global Events: Fluctuations in global supply chains or geopolitical events that affect the cost of imported materials.

Using BCIS indices, construction professionals can make informed decisions about inflation allowances and adjust their estimates accordingly.

5. Practical Steps for Managing Inflation in Construction

Understanding inflation is just the first step. Proactively managing it in your projects is critical to safeguarding your financial health. Here are some key practices:

A. Incorporating Inflation in Budgeting

When planning a project, it is essential to include an inflation contingency in your budget. This is a sum of money set aside to cover unforeseen cost increases due to inflation during the construction phase.

Forecast inflation rates using tools like the BCIS and review them periodically. Since inflation is unpredictable, adjusting your contingency as the project progresses ensures you’re always prepared for potential price hikes.

B. Using Fixed-Price Contracts

A fixed-price contract ensures that your contractor delivers the project for a predetermined price, which can be useful for protecting your business against inflation. However, this approach transfers the inflation risk to the contractor, and they may include higher costs to mitigate their risk. Therefore, fixed-price contracts are most suitable for short-term projects or when inflation rates are expected to remain stable.

C. Index-Linked Contracts

Alternatively, an index-linked contract adjusts the contract price in line with an agreed inflation index, such as the BCIS Tender Price Index. This type of contract shares the risk between the client and contractor, making it particularly useful for long-term projects where inflation is more uncertain.

D. Regular Review and Reforecasting

Inflation is dynamic, and rates can change rapidly due to various market and economic conditions. It is essential to review and reforecast your project’s financials periodically, ensuring that any inflationary changes are captured and reflected in your budget.

E. Hedging Material Purchases

Another strategy to mitigate inflation risk is to hedge material purchases, locking in prices for key materials early in the project. This strategy can be particularly effective for projects with high material costs, such as those involving steel or timber.

6. Conclusion: Protecting Your Business from Inflation

Inflation is an inevitable part of the construction industry, and its effects can be particularly pronounced in long-term projects. By understanding how inflation is addressed in the NRM and using tools like the BCIS Tender Price Index, UK-based construction businesses can better manage their costs and avoid financial pitfalls.

Proactively incorporating inflation into your project planning and budgeting, negotiating the right types of contracts, and regularly reviewing financial forecasts are critical steps to protect your business from the adverse effects of inflation. With these measures in place, your projects can remain on track financially, even in the face of rising costs.

For more information on inflation management, RICS provides a wealth of guidance that can assist in navigating these challenges. If you need specific advice for your project, consider consulting with a quantity surveying professional to ensure your budget reflects current inflation trends accurately.