Construction Cost Indices: Their Creation and Use

Tom Wiggins
Those who regularly work with construction cost estimates will at some time use a cost index.

To use cost indices, most people look up a couple of values in the tables, perform some rudimentary math and the resultant factor can be used for the desired adjustment. The adjustment desired is typically cost change over time at a location or cost differences between locations, often including some time adjustment.

However, construction cost indices are an extremely powerful tool whose use is broader than these typical applications. For example, the U.S. Government produces indices, such as price indices for houses for a few building types, including houses. The government uses them to prepare price deflators for Gross Domestic Product (GDP). They recognized many years ago inherent problems unique to construction indices.

An important aspect of using a cost index is to ensure you are asking the right questions about its source.

An important aspect of using a cost index is to ensure you are asking the right questions about its source. Do you understand what the index really measures? Do you know how the information was compiled? A basic understanding about the methodology used to create an index can aid in the interpretation of the results it provides.

A few basic index distinctions will help provide some clarity. The first question to ask about an index is: 'What does it really measure?'. Most construction indices are built using the cost of the inputs – a representative selection of labor, material and equipment. Notice the distinction, cost of the inputs, not price of the output.

It is essential to remember that a cost index measures the price movement for some objects over time and/or location using a series of values. A basic understanding of the theoretical construct aids in interpreting the results from applying the index. Different index creation methodologies may yield very different search results.

Most U.S. cost indices use cost inputs. It's difficult to prepare an output index for the construction industry. This is unfortunate since market forces are not well measured by input indices. Output indices measure changes in prices of what is produced by entities engaged in construction activity. An output index includes the items built into the price paid by purchasers of the output element – materials, labor, plant and equipment, overheads, profits, margins. An example is the home seller index which measures the selling price of a house.

It is essential to remember that a cost index measures the price movement for some objects over time and/or location using a series of values. 

Market conditions may be the factor that skews input-based index comparison results the most. This is why some organizations seek to introduce some aspects of output measures, creating a pseudo-output index.

A comparison of four construction indices begins to demonstrate the point. The Turner Cost Index is presumably an output index. The PPI Nonresidential Construction Index by the Bureau of Labor Statistics attempts to measure subcontractor pricing for items, introducing aspects of an output index. RS Means and ENR produce traditional input indices. While other factors contribute to the variations shown, it illustrates very clearly how measures of the market (reflecting output prices) influence an index. Input cost indices do not show the extremes of economic cycles like output indices.

Index Comparison

Most users of cost indices are focused on smaller issues than adjusting the value of construction GDP. Anyone with a database of historical construction costs relies on construction cost indices to prepare cost estimate benchmarks. When establishing a benchmark, using previous project costs to establish a budget, adequately ascertaining cost change for time and location is essential.

However they are used, indices provide a simple way to relate the cost of an item at a specific time to a corresponding cost at a different time, or a different location and time. The focus is modifying historical costs. Unfortunately the use of an index as an accurate predictor of future costs is not yet a reality.

When comparing different locations, local codes and climate can skew cost comparisons. Adjustments for these considerations are never straightforward. Thoughtful consideration may assist if the results after applying an index do not seem quite right. Differences in seismic and wind loading design requirements can impact cost comparisons between locations. For example, any index comparison of costs between Los Angeles and Minneapolis should include consideration of a seismic cost adjustment. But, countering the higher Los Angeles cost due to seismic requirements would be some higher costs in Minneapolis due to the climate. Similarly, a coastal Florida building will have unique costs for wind loading. Then, there is Charleston, South Carolina with both seismic and wind design requirements to consider.

If you want to avoid misusing a cost index, understand what it measures.

The type of construction modeled in the index should be considered. Many indices are intended to reflect general building construction. Some may be tailored to a specific building type, i.e. manufacturing, or type of construction, i.e. steel frame.

Indices are differentiated by how they are compiled. Most construction indices are Laspeyres Type. They hold constant the types and quantities of each item required, suitably weighted according to contribution toward total cost.

If you want to avoid misusing a cost index, understand what it measures. Remember that cost indices are as much an art as they are science. Use the index values with some thought and consider judicial adjustments for what they are not measuring.

Written by