The Bureau of Labor Statistics reports that in January 2007, the construction industry employed approximately 7.7 million people. By the time the bubble had finished bursting in January 2011, our industry had lost 2.3 million jobs.
From that deep trough, things have been easing upward—by May 2013, the market had added 400,000 construction jobs to reach a total of 5.8 million.
By this and other indicators such as new permits and housing starts, there appears to be a consensus that we are finally seeing a construction industry recovery, with both bid volume and projects actually starting to rise in most areas of the country.
But having endured the years following the 2007 market bust, one has to ask two important questions:
First, is this recovery for real; will the current trend continue?
Second, if that is indeed the case, will the market heat up to another bubble soon only to burst, or will we see a more moderate, longer-term recovery?
The answers to these questions depend on the outlook and actions of many players, including lenders, investors, owners, architects, general contractors and, of course, subcontractors.
In order to assess the current lay of the land among these players, we contacted a professional whose job it is to stay up-to-date on and consult all areas of the industry, from lender to subcontractor. Her name is Sacha M. Miner, and she is a Texas-based director of the Phoenix-based Fulcrum, a nationwide construction consultant.
We caught up with her between flights.
Is the Recovery for Real?
Wondering if this recovery is for real is probably the question foremost in your mind.
Miner says it is for real, “but the recovery process must be carefully managed and maintained. Developers rushed to find the markets and products that were leading the recovery. This is continuing, and the industry needs to be careful to avoid overbuilding in these markets. However, while there has been a steady monthly uptick in projects, labor and materials remain an ongoing issue for the industry, as does sources of funding for projects.”
How so?
Miner believes, though, that the material and labor situation will even out and return to some sort of normalcy as the recovery gains hold and more developers start new projects or revive old ones.
“As a result of the downturn, many construction workers were laid off and have found work in other professions. Here in Texas, for example, many of these workers found employment in the oil industry, and many of those haven’t returned as the construction industry recovers.
“As a result, a quick uptick in the market is straining the existing labor supply. Today, especially in the Texas marketplace, I see escalating labor prices due to the tight supply of qualified labor. Austin, San Antonio and Houston are actually booming (downtown Houston practically has a construction crane on every block) and many subcontractors cannot provide the needed crews for the projects that they’ve committed to.
“The increased construction activity has also resulted in material shortages. We especially see shortages of concrete in the current market. This drives up the price, and the lack of availability can also cause scheduling delays.
“As a result, we have found that old, now-revived projects potentially cost as much as 10 to 25 percent above the original estimate, and they are taking longer to complete than the original schedule estimated.
“Another result of unstable and increasing material prices is that suppliers and vendors often request deposits to lock in material prices. Generally, contractors can’t afford to stockpile all the materials needed for a project, and lenders are usually not open to funding the purchase of significant amounts of materials that are not yet incorporated into a project. And if contractors try to lock in pricing from a vendor, the vendor is likely to quote a higher price to cover for the rising prices and attempt to protect their own bottom lines.
“The material-supply market experienced the same sort of contraction as the labor market as a result of the downturn. I believe that the material and labor situation will ultimately stabilize as the recovery gains more support.”
Is the Recovery Sustainable?
Assuming that what we now see is a true recovery, is this going to be a short-term boom/bust cycle, or will it continue long-term?
Miner says, “This recovery is sustainable, but only if credit markets ease. Lending is still an issue. Building and labor material costs have increased in recent months and have become more unpredictable, even as construction production begins to see some gains. But as the recovery becomes more widespread and consistent, material price volatility should moderate on projects and so create a more sustainable market.”
Why is lending still an issue?
Miner says, “While we are seeing a fair amount of market-rate projects being built again, this is largely due to a large equity investment prior to any debt funding—up to 40 percent equity prior to lender funds being available. In fact, very few developers can come up with that kind of equity investment. As a result, we see primarily the cash/equity rich owners or developers are constructing projects right now.
“As a comparison, 10 years ago we saw equity requirement in the 5- to 10-percent range. I don’t think we’ll see that again anytime soon, but equity requirements should come down somewhat as the market recovers.
“As a result of the recent collapse of the real estate market, the damages lenders sustained and the increase of governmental regulations and oversight have made lenders more careful when qualifying borrowers. In other words, they are very keen to protect their investments and their overall interests in projects. Thus, careful oversight and risk management are required both prior to loan closing and during project construction.
“Many clients, including lenders and owners, engage us as their risk assessor and onsite project manager to review the project design and specifications, the project cost projections, project schedules and project quality in order to enable them to better manage their overall risk exposure. Consultants like us monitor and review potential risk issues and consult on recommended solutions and remedies.”
Why are the lenders requesting increased equity for construction projects?
“To protect themselves,” Miner says. “The lenders took a lot of risks prior to the bust. The market was appreciating so quickly that everyone wanted in on the action. There was a lot of competition, and many lenders aggressively chased loans, lowering documentation and equity requirements in order to secure loans. Some even made deals virtually only on a handshake—not anymore.
“Today, due to recent risk exposure and increased required oversight, lenders need to manage their risk properly, and this is where third-party consultants come into the picture. The crash is still fresh in lenders’ minds. Their desire to protect themselves coupled with new government regulations and oversight have led to a greater level of risk management, and this includes increased documentation requirements, higher equity requirements and increased oversight during the construction process
“This is where third party consultants can help. During our preconstruction review, we interface with architects, engineers, owners, lenders and general contractors, reviewing plans and project documents to ensure the project is reasonable and achievable prior to the lender’s commitment to the project.
“During ongoing construction observation services, we ensure timely execution of the work and monitor the budget and schedule to keep the lender informed of the status of their collateral. In fact, many of our lender clients depend on us to build a good relationship between all parties concerned, which in turn facilitates project success.
“I feel the next 18 months will be critical. As the market continues to recover and build confidence, we should see the equity requirements return to a more normal range. When that occurs, we’ll see more entrants or re-entrants to the market.
“Currently, we are dealing mostly with major players capable of supporting a large equity investment, or capable of assembling a consortium of investors to provide the equity component. We are seeing an increased need for information from these equity partners, and often times are providing our services to them, either directly or through reliance on the reports that we are providing to the lenders.
“The bottom line is that sustaining this recovery will take careful fund management and project selection, and will require stable sources of public and private funding to facilitate a long-term recovery. Financing will remain the issue for many sectors.”
Another Boom to Bust?
Do you foresee another boom to bust in this construction market?
“The market bottomed out over the last several years,” Miner says. “I believe that slow and steady recovery is key, rather than a big boom recovery. As I said, the next 18 months will be key.”
What are you looking for in the next 18 months?
Miner says, “Well, you cannot measure growth in six months; you need at least an 18 months view to determine a trend. I’ve seen the market go from dead to reasonable in the last 18 months, and if it maintains the same pace for the next 18, I think we will have a solid recovery on our hands. At that point I believe that lenders will open their pockets a little more readily. Indeed, if the current growth-level sustains, we will find ourselves in a good place.
“Still, I hear different views in the market today. Some are still wary of this recovery and are complaining that financing is still difficult to obtain. Others are concerned that this recent recovery has been too quick in certain market segments and are cautioning against another boom/bust cycle.
“One of the strongest sectors in the last 12 months has been student housing. However, some market analysts are cautioning that certain markets have overshot demand and when all projects are completed, there will be oversupply in those markets and rents will feel downward pressure
“As a result, all stakeholders, lenders included, should look for the right projects, in the right markets, with a good, experienced project team. That formula will ensure the long-term recovery.”
Subcontractors
How do you, as a lender consultant, view subcontractors?
“Of course, subcontractors are a necessary and integral part of any project,” Miner says. “In fact, they are the foundation for any successful project. Poor subs will give you a poor product and project delays.”
What do owners look for in a subcontractor?
Miner replies: “The owner looks for a successful subcontractor who is well-organized and self-sufficient, and who has the means to staff adequately the project they are working on.”
Do lenders look at subcontractors when evaluating a project?
“Lenders usually don’t look beyond the GCs other than subcontractor bonding capacities,” Miner says. “Typically, when we evaluate a project, the lender looks for the general contractor to carry a Payment and Performance Bond or for the subs to be bonded or a Subguard® policy to be in place to minimize the lender’s risk.
“As mentioned earlier, in Texas as well as other markets nationwide, we’ve run into subs that cannot provide adequate labor for the project. So staff management is crucial.”
What can you do as a consultant to help ensure a subcontractor is paid for work done, and continues to be paid through the project if the general contractor goes belly up?
“I have worked on projects where the GC does not pay their subcontractors in a timely fashion, which in turn affects the project negatively,” Miner says. “We monitor, to varying degrees, subcontractor payments and lien waivers. If there appears to be a problem, we discuss the issue with the owner, general contractor, and in some cases, the subcontractor to determine the specific causes and potential remedies. This information is then discussed with the lender, who may in turn take steps to protect their interests and the project.
“If a general contractor is in danger of defaulting, the lender may put measures in place to pay the subcontractors directly as work is completed, rather than through the GC.
“This process is not the norm and requires careful review of the work in place and the coordination of direct payment to multiple subcontractors and of the collection and review of lien waivers after payments are made. However, if this process is managed correctly, it can protect the project and facilitate its successful completion, even if the GC has defaulted.”
Can this be initiated by the sub?
“Not as a rule” Miner says. “If and only if a project as a whole is in trouble, would we recommend to a client that the subcontractors be paid directly. If we see an issue with the general contractor, such as using sub payments for other purposes, we may recommend paying the subs directly.”
How do you best grow, nurture and protect the owner-lender-GC-subcontractor relationship to the long-term benefit of all?
“Construction relationships, much like relationships of any kind,” Miner says, “are built on trust and communication. It is imperative that all entities work together and communicate openly to ensure a positive outcome for all. All parties involved benefit from a successful project.
“Ultimately, our role is to protect our client, typically the lender, from potential risk. However, both the owner and the contractors often also benefit from our involvement in the project. We often provide insight or a perspective that they may not have seen, saving the project from potential risks.
“Good communication facilitates successful projects and successful projects will facilitate good relationships and help foster a strong market recovery.”
Final Word of Wisdom
In Miner’s view and experience, “the key to any successful project is proper oversight and project management. Too many projects are started on the fly without proper attention initially to the key details: the overall design, the schedule and the budget.
“Good oversight and project management, along with great lender-owner-general-sub relationships will sustain this recovery.”
Los Angeles–based Ulf Wolf is the senior writer at Words & Images.
You can reach Sacha M. Miner, CPC, by visiting www.fulcrumcompany.com.
