Over the last 5 years, many contractors have seen their revenue grow as much as 40 percent, paving a path toward continued business growth throughout the industry. According to the latest Construction Financial Management Association’s (CFMA) national member survey, net profit percentages for contractors have grown significantly over the last several years. However, with all the change and positivity flowing through the industry, it’s still important to be prepared for a potential slowdown.
The majority of my construction clients are still looking to hire more project managers, superintendents, foremen and skilled laborers to complete the projects they already have on the books. Further increasing the pressure, employee compensation and benefits packages have grown at double-digit rates, costing a great deal more to complete the backlog of under-contract projects.
The pressure is so great that many overloaded contractors are paying more than the market rate to poach people from their competitors. This momentum will continue to raise the cost of construction going into 2019 and impact the future of the ability of new projects to provide a financial return to end users, companies, investors and developers.
Most economic experts say the construction market should have another 2 years of positive 2- to 3-percent growth. However, it all depends on what you build, who you build for and where your work is located. Some contractors are still booming and continue to grow, making very high margins; while many construction businesses in certain areas of the country have already experienced a slowdown in new opportunities within their local economies, causing an increase in the number of competitors bidding and negatively influencing contractor markup rates.
Looking at the big picture ahead, single and multifamily housing should slow down sooner than most other types of construction, as homes and apartment prices rise to an unaffordable level for buyers and tenants.
Remember when the economy shut down in just a few days back in 2008? Contractors who had bought new equipment, taken on high-priced employees and borrowed money based on their predicted ability to pay it back comfortably were stuck with more assets and payments than they could afford in a slower economy. They quickly learned that shiny new excavators aren’t worth much when the market is flooded with slightly used equipment for sale.
Work slowed; lenders stopped paying construction progress payment draws on projects; banks called their lines of credit loan balances; and contractors didn’t have enough money to keep their cash flow or profit wheel spinning. To make matters worse, developers couldn’t fill their projects with tenants or sell their projects, and, therefore, stopped paying builders and subcontractors.
Wherever you fit into the current industry scenario, now is the time to start reeling back your boom-time mentality and start planning for a slight potential slowdown, starting in the next year or two based on your location and the local economy. The future is definitely not certain—especially right now. Many factors can quickly converge and have a monumental effect.
Priorities & Options
Before you become too depressed, remember: The economy is still great in most areas, and there is plenty of work to complete. Still, it’s important to plan in case something happens that reduces the flow of business into your world. Consider the following areas in your plan to withstand a slower market.
- Cheap work—Do you really need to go out and win another low-bid job, which will, in turn, cause you to have to hire another project manager,superintendent, foreman, or crew member? Will this decision make a significant difference in your net cash over the next year? Are there some jobs that are too risky for the low margins they will likely generate?Stop seeking low-margin work against low-priced competitors. Be more selective in what you pursue, and only go after high-margin projects. Meet with loyal customers and ask them to negotiate their next jobs at a lower margin than usual to ensure you have a steady flow of good work with your best customers moving forward.
- Unused equipment—Do you own any highly valuable equipment that’s not being utilized or is only operating at a 75- to 80-percent usage rate? If so, now is the time to sell it, even if it is paid for. Cash is king, and today you can still get top dollar for new and old equipment, which will be difficult to sell at any price if the economy tanks. You can always lease when you need additional equipment.
- People—Are there new people you need to hire to complete all the work on your books? Draft a manpower work-planning schedule. List out all of your current and committed projects to determine how many field workers, supervisors and project managers you’ll need every week over the next 3 to 6 months. If possible, postpone starting any projects and use a labor rental company or subcontract some of your work.
- Cash flow—Are there ways you can generate extra cash to build up a reserve in preparation for a potential slowdown? Do you have inventory or supplies in storage you may never need? Are you watching your working capital, receivables and cash flow to make sure you can survive a customer not paying you or having to operate for 3 months without getting paid?
- Debt—With any extra cash you generate, pay off your high-rate loans and credit cards as quickly as possible.
- Outside help—Have you met with your financial advisor and business coach to discuss your current condition and business health? They can help you proactively manage your business.
- Personal expenses—Now is not the time to buy a new home on the lake, remodel your family home, buy a bigger car or boat, or take an extended vacation. Now is the time to prepare for a lower-profit construction market.
Don’t Wait Until it’s Too Late
Planning is hard. It’s even harder to change your business model, sell equipment, avoid hiring, or reduce expenses. Get your management team together and discuss the future. Set goals, make difficult decisions, and implement meaningful initiatives.
Those who postpone reality do not fare well. As another new year approaches, look at your business goals for the next 12 to 24 months and solidify them. Preparing for less than ideal times isn’t easy, but experiencing hard times in the absence of preparation is worse.