While there’s reason for some optimism over what’s ahead in 2024 for the construction economy, it’s too soon for the industry to rest assured that inflation and its ripple effects on business are a thing of the past.
Sure, inflation relented in 2023, ending at 3.4% for the 12-month cycle—a statistical relief after hitting 9.1% in 2022, which was the highest level seen since 1981. But suggestions that the Federal Reserve Board’s tight grip on interest rates might loosen have yet to be realized. As ABC’s chief economist, Anirban Basu, stated in Construction Executive’s Mid-Year Economic Update and Forecast, “The bond market is indicating, and I think the equity markets are indicating the same thing, we’re going to see a quarter-point rate cut in September.” However, he included a political caveat: “The election will come just six or seven weeks after that… [I]s it conceivable that they might not cut rates in September because of the political consideration? I guess that’s possible.”
Builders have found ways to pivot in the face of inflationary impacts that have not yet settled down and continue to threaten the industry’s viability. This environment requires a new playbook for managing ongoing risk.
A SLOWLY IMPROVING LANDSCAPE
Construction spending is trending upward—in fits and starts. Overall, November 2023 ended with $1.8 trillion in construction spending, 6.2% ahead of November 2022 performance. However, the housing market continues to exhibit the effects of the tight monetary policy; the estimated 1,413,100 in 2023 housing starts fell 9% short of 2022’s finish.
Meanwhile, labor costs continue to rise amidst the sector’s chronic shortage of workers, and while supplies and prices of some materials have improved, there’s been no across-the-board relief. Prices on certain individual commodities and equipment are ratcheting up. Heavier materials like concrete that cost more to transport are particularly affected. Concrete is 9.7% more costly today than in 2022, for example. This is also reflected in Basu’s presentation, where 7% of those polled noted materials as a leading challenge, and 56% noted the worker shortage. Compared to the spring of this year—materials 7%, workers 60%—construction companies are feeling a slight relief in some aspects, but none at all in others.
The consumer price index, though, showed far slower growth in 2023—a 3.4% increase over 12 months versus 2022’s 6.5%. While costs have continued to increase, that trend could lower inflation while keeping a recession at bay.
THE COST OF COVERING RISKS
Escalating costs have also contributed to project delays and tight margins. Compounding the pain are higher insurance rates within an uncertain environment.
Extreme weather events have caused catastrophic property losses, with rates for builder’s risk skyrocketing 30% even as liability insurance for many projects has almost quadrupled.
Insurance costs for large-scale projects, such as condo construction in catastrophe-prone regions, can now surpass 8% of the total budget versus 2% prior to 2022.
The potential for disruption also has some construction underwriters wary, diminishing capacity and carriers’ appetite for risk—which means it may take multiple carriers to provide the same level of coverage for a large project that a single insurer would have underwritten five years ago.
Higher costs and delays also raise the risk of being underinsured. In the past, builders were able to cover those exposures through insurance enhancements, but carriers are now increasingly reluctant to extend these inflation buffers that increase limits. For example, 10% escalation clauses that firms previously could count on as a hedge against inflation are less likely to be offered, especially for higher-value projects.
PLAYING THE FLEXIBILITY CARD
These circumstances are pushing builders to pivot on what they’re taking on and evaluate the barriers in today’s economic landscape against project costs and the potential payout. High returns on low-interest rate projects are no longer available. The market remains uncertain. Fewer investors are willing to tie up their money in longer-play real estate projects.
But these challenges have increased creativity and strengthened interest in alternative materials and construction approaches. Companies building prefabricated concrete structures have never been busier. With timelines less impacted by external forces and a simpler supply chain, the prefabricated building systems market is increasing at a compound annual growth rate of 6% projected through 2028.
3D printing is also creating components for buildings, bridges and highways—in some cases saving as much as 70% in construction time and 80% in labor costs.
HOW TO MANAGE
In the face of an unpredictable environment, builders need to think outside their traditional playbook. To ensure their companies survive and thrive, they should enlist a qualified broker and:
- Make risk management a priority. It’s never been more important for construction firms to position themselves as a best-in-class risk. This starts with thorough risk-management plans for jobsites and investing in risk-mitigation technology. Products designed to prevent common issues, such as treated wood that curtails fire risk and/or alert systems to mitigate water leakage, can result in discounts on insurance rates.
- Show carriers the company is a good risk. Contractors seen as good risks by underwriters will receive the best rates and be in the front of the line for insurance when capacity gets tight.
- Focus on valuations. Proper valuations are critical for projects and equipment. Contractors making purchases must grapple with rising inflation, supply-chain delays and conversion rates. Closely read all contracts and share them with brokers to ensure valuations—and the associated insurance coverages—are accurate.
- Plan for the future of the workforce. Consider benefits that are both cost-effective and could help attract and retain workers. While pay is always important, health plans and financial wellness programs can be attractive, particularly for millennial and Gen Z workers.
