What’s Next for the Construction Industry?

Projecting the performance of the U.S. economy has always been a difficult task, even given a relatively constant and agreed-upon set of variables. This year the exercise is even more challenging considering the unprecedented nature of the economic environment. The specter of a new presidential administration, the shifting balance of power in Congress, and how leaders in different states across the country will react to spikes in cases of COVID-19 add to the uncertainty that most businesses have felt since we became aware of the pandemic.

Will additional relief spending be authorized in Washington? Will inflation be used as a means of reducing the $27 trillion national debt thereby driving up business costs? Will freezes on evictions be extended and what will happen to the residential and commercial real estate markets when they are lifted? While we can’t yet answer many of these questions, businesses can use the information we do have to prepare for the year ahead.

Through the end of November, the construction industry recovered 80 percent of the jobs lost during the first two months of the pandemic. However, many challenges remain. The Associated General Contractors of America (AGC) conducted several surveys of construction companies throughout the last year to gauge the impact of COVID-19 on contractor operations and they provide the information we can use to analyze where we have been and plan for where we could be headed.

Due to lockdowns, many contractors had to cut back on their planned spending and find ways to ensure positive cash flow. One of the first cuts was to unnecessary improvement projects, resulting in the cancelation of planned jobs. The number of AGC survey respondents reporting they had canceled scheduled jobs grew from 32 percent in the AGC’s June survey to 60 percent in August and 75 percent in October. Meanwhile, only 23 percent of the October respondents reported winning additional project bids compared to 21 percent in June. The trend is sure to result in diminished backlogs for contractors.

Historically, smaller contract backlogs have led to increased competition on new bids, driving down contract prices. Over prolonged periods of time, this economic trend puts a strain on contractor cash flows. To guard against diminishing cash flows, contractors should ensure they have reviewed their overhead costs and included changes in those costs in their estimating and bidding strategy. Additionally, forecasting cash flows over the next 12 to 18 months is essential to planning for any lean months throughout the coming year.

The shortage of new jobs and increased cancelations has not been the only problem facing the construction industry. Many firms are finding it difficult to find the resources they need to complete jobs. Shortages in both materials and equipment were up from 25 percent in June to 42 percent in October. Meanwhile, 35 percent of contractors experienced disruptions due to the scarcity of skilled workers and/or subcontractors. These trends are troubling because not only are material costs likely to increase, but project delays create issues with scheduling, which could impact multiple jobs as well as increase the likelihood of cost overruns and liquidated damages. Project management will be more important than ever to make certain that work is completed as efficiently as possible. Contractors should invest the time to ensure their project managers understand how individual jobs impact the company’s bottom line and how they can help strengthen the company through superior performance on their projects. Additionally, a review of a contractor’s past completed projects could uncover strengths and weaknesses in their project management team that will help with staffing decisions on future jobs.

One bright spot in the industry over the last year has been residential construction. Both new home construction and renovations have seen positive gains with bid prices up over 10 percent since the start of the pandemic. Alternatively, on the commercial front, there has been less demand for retail, office, and higher education construction, a trend that could be long lasting as many operators in these spaces are transforming the way they conduct their businesses.

What was a slow trend of declining demand for a brick-and-mortar presence in retail was accelerated by COVID-19 lockdowns and social distancing guidelines. As well, many businesses have found ways to reduce the need for office space by conducting both internal and external meetings online, and numerous universities have moved to a distance-learning model to minimize physical contact between faculty, staff, and students. Even after vaccines are available en masse, a rebound in brick-and-mortar projects is likely to be sluggish if present at all.

Contract backlogs have historically delayed the impact of economic downturns on construction companies by 12 to 18 months. As contractors work through their projects under contract at the start of a recession, they may appear to be insulated from the downturn. However, as that backlog shrinks and is replaced by jobs bid in the depressed economy, they are likely to experience diminished margins. Planning ahead in these scenarios is the key to a soft landing.

Many of these trends are geographically focused, as states with the strictest lockdown measures have seen the most severe impact on local businesses. Shifting populations could soften the effect of negative trends in the states that are seeing population increases such as Arizona, Florida, Idaho, Nevada, and Texas while exacerbating the negative impact in states like Illinois and New York which saw their populations decrease by half a percent between 2018 and 2019.

Nearly all businesses have been forced to adapt on the fly to an economy in the throes of the COVID-19 pandemic. Those that continue to be nimble and innovative will put themselves in the best position to weather any storms that come their way in 2021 and beyond.

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About the Author(s)

Brandon Dougherty, CPA, MSAT, MBA
Brandon is a Senior Manager in the Naples, Florida office of HBK. He serves as the Director of the Florida region of the Construction Solutions Group and has extensive experience in the areas of accounting, auditing, and taxation with an emphasis on construction contractors and real estate. He can be contacted at 239-263-2111 or by email at bdougherty@hbkcpa.com.

Justin Ledford
Justin is an Associate in the Naples, Florida office of HBK. He participates in preparation and review in the areas of accounting, auditing, taxation, and performs research in a multitude of industries ranging from cannabis to construction contractors. He can be contacted at 239-263-2111 or by email at jcledford@hbkcpa.com.

Hill, Barth & King LLC has prepared this material for informational purposes only. Any tax advice contained in this communication (including any attachments) is not intended or written to be used, and cannot be used, for the purpose of (i) avoiding penalties under the Internal Revenue Code or under any state or local tax law or (ii) promoting, marketing or recommending to another party any transaction or matter addressed herein. Please do not hesitate to contact us if you have any questions regarding the matter.

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