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One of the topics that regularly arises during our conversations with school districts is how current economic realities have affected construction projects in 2023 – and are likely to impact projects in 2024 and beyond.

One of the primary “pain points” for construction projects has been the impact of inflation, and the variety of ways it has influenced a district’s approach to them.

Even though the term inflation has been part of the public conversation perhaps more than any other time in the last 40 years, the term itself can still be a mystery and cause confusion. What is inflation, and why is it such a concern for construction projects right now? In this article, we will offer a brief overview of what school districts might consider when approaching a construction project in a high-inflation environment.

Defining Inflation

Inflation is a loss of purchasing power over time, meaning the dollar will not go as far tomorrow as it did today. It is typically expressed as the annual change in prices for a collection of goods and services.

In the United States, there are two primary measurements of inflation. The first is the Consumer Price Index (CPI), which measures the cost of things consumers buy directly, excluding fuel and food. The second is the Personal Consumption Expenditures (PCE) index, which measures things people consume, but also considers things those consumers do not pay for directly, such as health care.

Under typical circumstances, higher inflation can be the result of an economy in which people are spending at a higher rate than usual due to a surplus of cash or credit. If consumers are in a buying mood, businesses may raise prices because they lack adequate supply. Or, companies may choose to charge more because they realize they can do so without losing customers.

Why is inflation such a hot topic right now?

Fortunately, the apparent cooling of inflation’s upward trend has entered the conversation. U.S. inflation, as measured by the consumer price index (CPI), has fallen from its peak of 9.1% year-over-year in June 2022 to 3.7% as of September 2023. Note that although inflation has trended lower, prices remain elevated compared to Federal Reserve (Fed) targets as rising energy prices and higher shelter costs continue to put upward pressure on prices.[1] In short, the rate of inflation and elevated prices for goods and services are likely to remain a concern and top of mind for many.

How inflation may impact a district’s construction projects

Inflation drives up nearly every element of a construction project, and in an environment where prices can rise quickly and without much warning, projecting costs and sticking to a construction budget can be difficult to say the least. Some of the most common challenges can include:

• An increase in construction material prices: Materials like steel, soft wood, plastic, copper, gypsum and others.
• Increase in cost of “secondary” construction materials: The cost of construction elements including fuel, machinery, transportation and technology have risen due to inflation.
• Increase in labor costs: A shortage of skilled personnel in the construction industry increases project costs since skilled workers seek more pay due to inflation. All these elements make it challenging for managers to develop plans, project construction budgets and even engage in existing work.

So – what can a school district do?

It is impossible to predict with certainty when and if inflation will rise or fall, or when prices for materials will finally stabilize – though some have argued that the Fed’s increase in interest rates may slow the domestic economy and lead to a stabilization of prices. Regardless, there are steps that a district should consider, including certain strategies to stay on schedule with current construction projects and map out a route for future ones. Here are just a few:

Assemble project teams: Gather a team of experts that includes architects, contractors, and financial and investment advisors to bring together knowledge of disparate elements of the construction and financial sectors. This collective expertise puts you in the best, most informed position possible to determine the viability and timing of capital projects, as well as cost-saving options when it comes to the projects themselves.

Design intelligently: Work with your architect to make design choices that optimize available materials. Consider alternative building materials to avoid difficult-to-get materials which tend to be more expensive and can prolong the construction timeline.

Flexibility: When designing the bid package, include alternatives that allow your district to control the final cost of the project. If bids come in over expectations, the project can be pared back without rebidding. If bids come in below expectations, it allows more “nice-to-haves” to be incorporated into the project.

Pay attention to cash flows: An investment advisor can work with a school district to provide a clear picture of expected future cash flows. In some cases, the investment advisor may also provide “laddering” options, which enable the district to invest in a way that seeks to achieve greater stability of cash flows. This in turn will help better balance the timing of expenditures with the investment of additional available funds for longer periods of time. Put simply, make the higher short-term interest rates work for you!

It’s not all bad news

Inflation may not be entirely detrimental to a district’s finances. Prices for goods bought may go up, but the ability of districts to buy in bulk can help mitigate some price increases.

In addition, investment rates available to school districts have moved higher quickly in 2023 as the Fed worked to curb inflation by raising the target overnight rate, a benchmark rate from which other short-term treasury yields and bank deposit rates are derived. Since March 2022, the Fed has raised its target overnight rate to a range of 5.25-5.50%,[2] which is at or near its highest level in over 20 years.

It's tempting to make drastic changes or take unnecessary risks to try to follow a potentially outdated construction plan and hedge against the economic climate, or even shelve a project altogether. But adjusting construction planning and financing, based on the best information on hand, should serve a school district well as the U.S. waits for inflationary conditions to sufficiently moderate.

About PFM Asset Management

PFM Asset Management LLC ("PFMAM") is an investment adviser registered with the U.S. Securities and Exchange Commission and a subsidiary of U.S. Bancorp Asset Management, Inc. ("USBAM"). USBAM is a subsidiary of U.S. Bank National Association ("U.S. Bank"). U.S. Bank is a separate entity and subsidiary of U.S. Bancorp. U.S. Bank is not responsible for and does not guarantee the products, services or performance of PFMAM.