This post is part of a series sponsored by IAT Insurance Group.
As construction industry professionals gear up for 2024, they are faced with a landscape marked by potential challenges, much like the preceding year. Recession concerns, persistent inflation, rising interest rates, critical labor shortages and ongoing supply chain disruptions remain at the forefront of construction industry considerations.
There are, however, proactive ways to address these challenges and position your company in the best light going into the new year. Consider the following seven trends and potential solutions.
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Tight labor supply
The construction industry is grappling with a shortage of skilled workers, which is expected to worsen in 2024. In 2023, it was estimated that over 546,000 additional workers would be needed beyond normal hiring to meet rising labor demands.[1]
This shortage is driven by a lack of younger workers entering skilled trades, coupled with an aging workforce. Nearly one in four construction workers is older than 55,[2] and even when those workers are replaced, they are not as experienced.
Solutions
The construction industry will need to increase outreach efforts and focus on dispelling the stigma associated with blue-collar work to address the lack of skilled workers. Here are some ways to do so:
- Recruit from local trade schools
- Build rapport with local high schools, many of which are now starting technical programs
- Get involved with local trade associations and help educate individuals about construction careers
- Provide on-the-job training
- Retain experienced workers with incentives like stay bonuses, excellent employee benefits, a positive work culture, and opportunities for leadership and promotions
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Increased subcontractor default
Subcontractors have had to shoulder substantial additional costs in the past year, totaling over $97 billion,[3] creating cash flow problems and making subcontractor default a significant concern across the construction industry. This issue is closely linked to labor shortages and exacerbated by rising interest rates and the possibility of an impending recession.
The result: a rise in claims where subcontractors fail to pay their obligations and default on their project commitments.
Solutions
To mitigate subcontractor defaults, prequalify your subcontractors, and consider mandating that subcontractors obtain surety bonds, or as an alternative, consider subcontractor default insurance. Ask for references from other contractors who’ve used their services; check experience level; and don’t be afraid to discuss their financial wherewithal. Ask subcontractors about their surety relationship. If they have a surety program, request a letter of bondability from their surety company. Also, if the general contractor has a surety relationship, they should ask their surety agent and company for input on the subcontractors they plan to use. Finally, make sure you have favorable terms in your subcontracts, such as “paid-when-paid” clauses.
Expanding your pool of subcontractors to avoid overreliance on a select few will also reduce risk.
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Interest rates remain unpredictable
Higher interest rates are contributing to overall cost inflation in the construction industry. Increased financing costs have led to higher construction material and labor costs, which can further impact project budgets. Approximately 82.5% of construction materials saw substantial price hikes, averaging around 19% since 2020.[4]
Solutions
Minimizing interest rate exposure, debt avoidance, prudent financial/cash flow management and seeking favorable contract terms will be key to combatting higher interest rates. Whenever possible, make cash payments for equipment and materials, and consider negotiating with suppliers for better terms.
You might also look to negotiate the retainage terms in contracts. For instance, reduce the standard 10% retainage rate to 5% when the project reaches a certain completion milestone to increase cash flow. Also, contractors can request upfront payment for materials from project owners to keep cash within the project, reducing the need for bank financing.
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Inflation lingers
The construction industry is grappling with escalating costs across various aspects, including materials, labor, insurance, as well as other general administrative expenses. These rising costs are exacerbated by ongoing challenges related to material price volatility and unpredictability. As mentioned above, construction materials costs continue to rise. In 2022, the average inflation rate was 8%.[5] Although that has since waned, there is still economic uncertainty throughout a number of construction markets.
Solutions
As profit margins continue to be pressured, collaborating with your insurance brokers and agents to review your coverage and ensure you’re getting the best value for your insurance expenses can help. Leverage your good track record, such as a lack of workers’ compensation, general liability, equipment and property claims to negotiate the most competitive rates.
In addition, gain a thorough understanding of your expenditure categories, particularly general administrative costs. Assess the impact of recurring expenses on your business, and in times of increased costs, be sure you are regularly monitoring your financial reports to identify areas where you can more effectively manage or cut costs.
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Pandemic hangover will continue
The construction industry will continue to deal with repercussions stemming from the COVID-19 pandemic. Delays in project initiation and funding uncertainties are causing project timelines to be extended, making it difficult for contractors to predict and manage their backlogs effectively. Material sourcing is also a challenge due to disruptions in the supply chain and project funding issues, which have affected both private and public projects, as funding may not be secured, or projects may be abandoned after initiation.
In 2022, nearly 40% of surveyed contractors reported project postponements, with some rescheduled, but over 35% mentioned that these postponed projects were either not yet rescheduled or had been canceled entirely. In 2023, 13% of firms indicated that projects scheduled for the first half of the year had already been postponed.[6]
Solutions
To address the challenges of the COVID-19 hangover in the construction industry, thoroughly document project delays and how they are managed to protect against potential liabilities like liquidated damages. Ensure that delays caused by factors beyond your control, such as late material deliveries, are well-documented to avoid unjust penalties.
In the private and commercial sectors, confirm project financing before committing to contracts with owners or developers. Request evidence of financing to ensure that the necessary funds are available, reducing the risk of project delays due to financial constraints.
Collaborate closely with suppliers to understand lead times for materials. Identify materials that may become scarce, and explore acceptable alternatives with project owners. Lock in necessary materials early in the project to avoid potential shortages and delays, even if it means incurring slightly higher initial costs.
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More private equity firm buyouts
An increasing number of private equity firms are acquiring construction companies. Private equity firms engaging in transactions within the construction industry increased from 16% in 2016 to 41.5% in 2021.[7]
While this injection of capital can be beneficial, the long-term impact remains uncertain due to the continuity of these firms, especially when the original owner’s expertise is replaced. It’s unclear whether these new portfolio companies will thrive, face financial difficulties, engage in mergers and acquisitions, or follow other paths, making it an evolving industry issue with unknown outcomes. In addition, many — if not most — portfolio companies are limited life entities for private equity firms. As a result, the financial management of a construction company can come into conflict with creditor approaches, surety companies and banks, for example.
Solutions
To mitigate the impact of private equity firms acquiring construction companies, retain key employees through contracts lasting for a specified duration. This strategy helps ensure that the expertise and knowledge crucial for the firm’s continuity remain within the company, maintaining stability and expertise during the transition. In addition, make sure there is a business alignment between newly created portfolio company and their key trading partners, such as sureties and brokers.
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Repurposing large construction projects
As a result of Infrastructure Investment and Jobs Act investments and other construction needs, there are a wide array of construction projects in the pipeline. Also, there is a notable shift from old construction types like retail and office buildings to new construction trends such as warehouses, multifamily units and mixed-use developments. Many new construction projects involve repurposing old spaces, such as converting retail stores into warehouses.
While the higher interest rate environment will potentially affect this trend, the industry is still anticipated to thrive, reflecting year-over-year gains in some sectors.
In 2022, new construction projects in the United States were valued at nearly $1.8 trillion.[8] Although this figure is expected to decrease by 2025, construction spending has been consistently rising in recent years, encompassing both residential and non-residential building construction. Notably, the U.S. Infrastructure Bill allocates federal funds for diverse infrastructure initiatives and is anticipated to stimulate increased demand for construction services, equipment and materials.
Solutions
To adapt to evolving construction trends, consider starting small. When venturing into new types of construction projects to meet changing demands, begin with smaller projects to test the waters and gain experience. Additionally, collaborate with qualified subcontractors for tasks outside your expertise to ensure quality work.
You should also reevaluate your risk transfer strategies, particularly if you’re transitioning to different types of construction work. Ensure you have the appropriate insurance coverage and limits to address the specific risks associated with the new endeavors.
Be adaptable and well positioned in 2024
Although many of the trends outlined above contain numerous uncertainties, there is plenty of opportunity for construction firms that are well-prepared and adaptable. The commitment of the United States to national infrastructure improvements and the anticipated growth in building renovation and rehabilitation projects offer opportunity. These prospects suggest that construction companies, armed with resilience and strategic planning, can not only weather the storm of uncertainty but also thrive in the face of ongoing challenges.
