We have braved the cold, short days of winter and are squarely in the start of spring as the weather is warming and the sun is setting a touch later. And with this change of the seasons comes the start of the second quarter of 2023, a year the construction industry came into with caution and uncertainty.
We kicked off the year with plenty of unanswered questions around awarded projects commencing, when we will start to see infrastructure spending, labor challenges and the ongoing battle with inflation, which continues to spur interest rate hikes.
With the first quarter of 2023 behind us, do we have any clearer answers now? As an advisor, student and practitioner of the construction industry, it felt only natural to reflect on and share some observations and takeaways from what we have experienced over the last three months.
Financial Results Are Shaky. The renaissance the construction industry experienced in the years leading up to and through 2019 are well documented: record levels of spending across all sectors and employment at its highest. And we all know what happened as we pushed into 2020, specifically March 2020 (the irony of writing a state-of-the-industry piece almost exactly three years later is not lost on me).
When the COVID-19 pandemic hit, nearly every business, regardless of the industry, was impacted. But the construction industry had one thing others didn’t: committed backlog. Plus, most contractors qualified for the Paycheck Protection Program (PPP) and Employee Retention Credit (ERC) programs, so the financial pain of the pandemic was masked. Flashforward to 2022, and backlog had dwindled, replacement work was hard to find, government assistance programs had ended and the natural lag of the construction industry caught up to us. Not surprisingly, financial results of contractors for 2022 were meek. Put more directly, the 2022 financial results that surfaced during the first quarter of 2023 are showing the construction industry is experiencing what most companies/industries felt in 2020.
Adjusting To Inflation. Another economic event that does not discriminate, inflation has made its mark across most businesses and households. And while it continues, the construction industry has adjusted to the rising costs of materials, taken proactive steps to alleviate supply chain issues, and modified employee compensation packages accordingly. While the absorption of rising costs depends on the circumstances at hand, the primary tool to battle inflation – interest rates – has cost contractors real dollars in their bottom line as rates have increased and continue to rise. The private construction sector has experienced substantial fallout as spending has slowed due to the cost of borrowing. Not to mention, the common practice of utilizing a line of credit to mobilize projects as requisition funding is pending has become extremely costly. The best summation is what one industry executive shared with me, “It scares me when I see contractors bidding a project at a margin that is less than their line of credit rate.”
The Banking Shakeup. The country hadn’t seen a banking crisis since 2008. Coming into this year, a banking crisis – or maybe this was more of a shakeup – was an event we didn’t expect to encounter. Seemingly emerging overnight in mid-March, Silicon Valley Bank and Signature Bank made headlines as a result of weak investments and cryptocurrencies. In an age of market perception becoming reality regardless of fact (thanks to social media and the 24-hour news cycles), confidence in both banks was shaken to a point where we saw depositors lining up to withdraw enough funds to cause the banks’ collapse. Like 2008, the federal government stepped in to assist by securing all deposits, and in Signature’s case, facilitated a soft landing for customers and personnel. Regardless, the damage was done as numerous contractors either moved or started the process of moving away from Signature. For the New York construction market, there is one less bank dedicated to the construction industry, and we will need to watch closely how Flagstar Bank navigates the market after acquiring Signature. If you missed our recent guidance on what your construction company should do to mitigate banking risks in this environment, click here to read the full article.
Infrastructure Spending. The need for the United States to invest and improve our infrastructure is dire. And Washington has recognized and taken steps to address this by passing the Infrastructure Investment and Jobs Act, which will see $1.2 trillion authorized for transportation and other infrastructure spending, with $550 billion earmarked for new programs. Interestingly enough, a tradeoff in the passing of this legislation was the repeal of the ERC program for the 4th quarter of 2022, which most contractors qualified for in the first three quarters. Even as we hear about the billions of dollars being released and allocated to the states, the projects are MIA. Looking at where we are locally and the robust capital spending plans our public agencies have teed up, we cannot help but wonder how much is reliant on federal dollars?
Looking back, it was an eventful three months, even though it was only three months. The construction industry will look at the rest of 2023 to rebound from shaky 2022 financial results, stabilize their banking positions and hopefully start to see work in both sectors emerge. The industry continues to be a major driver of jobs and opportunities across the country.
As the second quarter continues, Grassi’s Construction team will continue to monitor industry trends and share proactive advice and insights to navigate the landscape.
