Below is a good article on the current state of the construction industry. As you know, things are really in flux. Although things seem to be going ok, there are significant headwinds to every project, which ranges from supply chain worries, soaring costs for materials and labor, etc. The industry seems to be a bit risky. Most of our bond clients are for construction - surety bonds (whether it be construction bonds, bid bonds, or performance bonds). For our clients, this can be some good information and help you plan for the upcoming year or two
Soaring material prices, supply chain delays spook owners and developers
The rising cost of many materials and increased sourcing headaches have project owners rethinking their return to normalcy and threaten to derail construction's expected resurgence.
Published April 12, 2021
The road to recovery may be longer than you think.
As the second quarter of 2021 kicks off, contractor confidence is high, with plenty of optimism that the coming resurgence of re-started projects will lift construction firms from the abyss of COVID-19 to go even beyond their pre-pandemic heights. Just look at the Associated Builders and Contractors' Confidence Index, which is now positive for sales, profit and staffing level expectations for the next six months.
The only problem is, to build things, contractors need willing owners to finance them. They may become more scarce in the coming months, as continued kinks in the global supply chain drive material prices higher, extend delivery times and make already anxious developers more skittish.
Courtesy of XL Construction
“People are starting to become a lot more buoyant and confident around things,” said Chris Bailey, senior vice president of integrated solutions at San Francisco Bay Area-based general contractor XL Construction, who recently authored a report to clients about supply chain hurdles. “But there needs to be some degree of caution as to how we re-engage with all of this, because we can't just do what we did in 2019. Product is not coming online as quickly as projects are.”
Cold feet, again
That juxtaposition is causing owners who want to get back to work to reconsider if now is the best time to do so. At Fort Worth, Texas-based Century Mechanical Contractors, secretary and treasurer Diane Mills said the recent explosion in materials costs is inducing sticker shock in her clients, especially those who priced their projects before the pandemic, but then hit the pause button at its outset.
As those owners re-enter the market, they’ve had to adjust their expectations or re-consider their projects all over again, she said.
“Owners are coming back and saying they want to build, but they set their budgets two years ago,” Mills said. “What might have cost $100,000 if they started last June is now probably closer to $160,000. So they’re even having to pull back again and rethink what they’re doing, because it’s out of budget.”
Finance professionals are also witnessing a second round of cold feet among developers trying to resuscitate deals in the current environment.
Courtesy of Clopton Capital
“I had a developer come back to the table with a deal he mothballed last year, but now it was going to cost him 20% more,” said Jake Clopton, founder of Chicago-based commercial mortgage broker Clopton Capital. “He said he couldn’t do it, that it didn’t make sense to build right now. I mean, in the end, it’s really all just a math problem.”
Clopton said he’s had several developers with land carrying costs approach him to kickstart projects, but with old GC bids. When they’ve re-priced them, and evaluated the current state of the lending market, where bank loans can be non-existent for some project sectors and private money loans can have 10% interest rates, their deals are no longer penciling out.
“They’re just uneconomical at these levels,” Clopton said.
There’s even evidence that a recent increase in construction spending above pre-pandemic levels isn’t due to more projects coming online, as much as it is the need to absorb higher costs. Construction spending climbed 5.3% from February 2020 to a seasonally adjusted annual rate of $1.52 trillion, the Census Bureau reported April 1.
But prices for goods used in construction jumped 3.5% from February to March and 12.9% since March 2020, representing the highest monthly and yearly increases in the 35-year history of tracking that data, according to the Associated General Contractors of America.
“These material cost increases—steep as they are—tell only part of the story,” said Ken Simonson, AGC's chief economist, in a statement on Friday. “They are based on prices the government collected a month ago, and they fail to capture the notices contractors are receiving daily about longer lead times, shipments held to a fraction of previous orders, and other challenges.”
That said, projects are waiting in the wings.
“Here comes the tsunami of economic and employment growth across America,” said Anirban Basu, chief economist for Associated Builders and Contractors, in a statement last week about the March jobs report, which included 110,000 new construction jobs, with 73,100 of them in the beleaguered nonresidential segment. “With more stimulus on the way, the United States may end up growing faster than China this year, which would be the first time that occurred in decades.”
Contractors have been adding workers as they’ve been building up their backlog of new work, much of which they cannibalized in 2020 simply to stay in business. Indeed, overall backlog rose to 8.1 months in February, just 0.7 months shy of its pre-pandemic heights.
"Here comes the tsunami of economic and employment growth across America."
Chief Economist, Associated Builders and Contractors
But the new question is how many of those projects will get derailed again, before they can be re-started, due to skyrocketing material prices. The global supply chain has been stretched thin after nearly a year of dormancy, and hasn’t been able to achieve anywhere near its pre-pandemic, just-in-time efficiency.
“During this shutdown, a lot of shipping was taken out of commission because there was nothing to transport,” said Bailey. “People weren’t willing to put money into maintaining shipping and transportation equipment when there was no revenue at the other end of it, so things have fallen into a state of disrepair. What we're seeing now is that even when product is ready to leave, the transportation market is trying to catch up.”
The fact that the mammoth Ever Given container ship blocked the Suez Canal, one of the world's business cargo routes, for six days in March can't help. "That will just provide more delay on top of everything that was already delayed," Bailey said.
Longer lead times
No matter the reason behind the delays, contractors say longer delivery times are having a severe impact on construction schedules.
Courtesy of Pepper Construction
“If you had a project that was ready to buy structural steel and precast wall panels for a new distribution facility, if you got in line today, it would be nine or 10 months before you got that material,” said Scott Higgins, senior vice president at Chicago-based Pepper Construction Company. “The impact is going to be very simple: higher prices and longer schedules.”
Back in Fort Worth, Mills said opportunity for jobs is there, but material suppliers can’t keep up with orders.
“We could do the work,” Mills said. “We just can’t get the equipment in many cases.”
She pointed to a recent quote for air handling units for schools, which usually require a lead time of six to 12 weeks. Her suppliers recently told her they would take four to six months instead.
“The impact is going to be very simple: higher prices and longer schedules.”
Senior Vice President, Pepper Construction
“Well, if you have a summer project that you need to start June 1 and you’re bidding it today, you’re probably not going to get your equipment in time to get it done,” she said.
At the same time, she says pressure in her local bid environment has heated up.
“There’s a lot of work being bid here,” Mills said. “But there are also a lot of people needing work to fill their backlog again, so it’s very competitive. Even though the pricing is higher, the margins are lower.”
High prices headed higher
Construction material prices have risen so sharply in 2021 that the Associated General Contractors of America last week issued a rare Construction Inflation Alert, a move the group hasn’t taken since 2008, citing a 12.8% jump of input costs for projects since the pandemic began.
While that double-digit rise is notable in itself, some foundational materials for contractors have spiked even more, with lumber and plywood gaining 62%, and steel mill products recording a 20% jump since April 2020, according to AGC's analysis. Diesel fuel, the lifeblood of the heavy equipment needed to build major projects, has surged 114%.
Material costs have surged, but not bid prices.
Courtesy of Associated General Contractors of America
But while those costs have been leaping upwards, contractors looking to rebuild their depleted backlogs haven’t been able to lift their bid prices by anywhere near the same amount, eking out just a 0.5% gain over the same period, according to AGC.
“Contractors should become even more vigilant about changes in materials costs and expected delivery dates and should communicate the information promptly to current and prospective clients,” read the alert from AGC, which is hosting a webinar on rising costs and strategies for dealing with them this week.
A recovery coming off the tracks?
With higher prices, longer lead times and skittish developers, the real question then becomes whether these issues, which have emerged as contractors desperately try to put the impacts of the pandemic behind them, can actually derail the coming recovery.
“I think to a degree, yes,” said Mills.
Clopton feels confident that supply chain issues will eventually work themselves out, especially given the enormous amount of pent-up demand from previously sidelined projects coming back online, coupled with the $1.9 trillion in funding from the American Rescue Plan, and a proposed $2 trillion infrastructure funding package.
“You've got an enormous amount of liquidity in the system that's looking to do projects and get the economy moving,” Clopton said. “And while demand [for materials] is way outpacing the increase in supply, I think everybody expects that to be transitory.”
Indeed, Basu, the ABC's chief economist, voiced a similar view Friday after the most recent price jumps emerged.
"While we will likely see further materials price increases going forward, the pace of increase may not be as rapid," Basu said in a statement. "As the COVID-19 pandemic fades, suppliers will be better positioned to respond to demand. That will help moderate price increases at some point, though in the very near-term, contractors should anticipate additional cost escalations.”
The last fly in the ointment that gives construction market observers pause is how long the current impacts of the pandemic took to actually materialize on jobsites.
While an absence of toilet paper and PPE were hallmarks early in the pandemic, the more recent economic pains bearing down on materials and the supply chain now weren’t felt until six to nine months after the pandemic began. With a quarter of 2021 already in the rearview mirror, it could take just as long for them to unwind themselves.
At least, that’s Bailey’s point of view at XL Construction.
“These disruptions to global trade are driving up the cost of shipping goods and adding a new dimension to economic recovery,” Bailey wrote in his report to clients. “The chaos has forced buyers to pay record prices to secure space in whatever containers are available to move. This is predicted to remain an issue until early 2022.”
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