The second quarter of 2023 saw a construction industry continuing to thrive. As we enter the heart of the summer and the third quarter, the trend doesn’t seem to be slowing. But there is concern that the somewhat unusual economy, as well as the effects of the Federal Reserve System’s interest rate policies, might dampen things a bit. That being said, backlogs are substantial; demand is high; employee-retention credit monies are being refunded to contractors; and President Biden’s 2022 $1 billion infrastructure spending bill is slowly making headway into the construction economy. Consequently, the nonresidential construction market could increase by as much as 5%, according to the American Institute of Architects’ construction forecast, and the residential market will likely increase by more than 9%.
Alongside the construction industry, the surety industry will likely continue to show growth and an expansion of project-surety programs, which are needed to support a robust construction market. For the remainder of 2023 and into 2024, the surety market will be keeping a close watch on the precarious upward trend while evaluating and assessing bond programs for construction firms.
And watch they must, because a thriving market is not entirely good news: The surge in construction is straining a limited labor pool, and the unpredictability of materials pricing continues to cause instability and an increase in project disruptions. Additionally, interest rates will continue to rise because of the Federal Reserve’s repeated attempts to reduce inflation and stabilize a runaway economy.
As such, the surety market must make difficult decisions as it weighs many complex factors. For contractors who have established effective risk management policies and displayed excellence in their operations, the surety market ensures plenty of underwriting capacity. But contractors whose businesses are less financially sound may struggle to find a surety or bank program that is eager to offer them credit.
The biggest risk factors that may cause trepidation for a construction company’s financial partners, including the construction surety market, include the following:
- Labor shortages
- Rising interest rates
- Rising materials prices
- Project delays and cancellations
Labor Shortages
A continually tight supply of skilled workers has been an issue for the construction industry for many years. Specifically, two reliable classes of workers are both currently diminishing. On one end, the youngest of the baby boomer generation is retiring, and on the other, a new labor force from Mexico and Central America has been reduced by the intense pressure on the federal government to limit immigration. Of course, the COVID-19 pandemic also made everything worse. Amid this ongoing struggle, construction companies are trying to find new and creative ways to attract young people to the industry, which is especially hard if they have a negative perspective on the value of skilled labor. It is no understatement to say that finding workers is a monumental task right now.
When insufficient labor is available to support a project, the production schedule gets the pressure and, ultimately, so does the job’s profit. A major focus during underwriting of surety credit has been monitoring labor challenges. To counteract these pressures, the construction industry must find ways to welcome a new generation of workers with new compensation programs and workflow changes, while looking to untraditional workforce groups.
Rising Interest Rates
Since the Federal Reserve started its aggressive interest rate hikes in 2022, and to a lesser extent in 2023, construction firms and project owners have seen borrowing costs skyrocket. Since May 2023, the Federal Reserve bank funds rate has increased to 5.25% and this, of course, has increased borrowing costs to record highs when compared to 2020 and 2021. As of the most recent meeting on June 13, 2023, the funds rate was not increased, but all indications point to two additional rate hikes remaining in 2023. Regardless, general borrowing costs will continue to remain high, thus impacting decisions on current and proposed projects.
Rising Material Prices
Throughout 2020, the cost of materials was very predictable, trending to only nominal increases, but during 2021 and 2022, material prices increased dramatically. According to the U.S. Bureau of Labor Statistics, the increase in overall construction material prices in 2022 was 16.4%, and even higher in the office and industrial building construction segments. These price increases have continued to cause issues with general contract estimating and bidding issues, as well as material-procurement sequencing problems. With concerns about rising inflation, a possible economic slowdown on the horizon and China’s attempts at achieving “zero-COVID” through shutdowns, many industry experts predict that construction material prices will continue to remain high in 2023.
Project Delays & Cancellations
The last major issues construction companies, developers and project owners are facing are ever-increasing project delays and cancellations. As interest rates have risen and continued concerns over the economy and inflation loom, developers and project owners are reassessing the “go versus no-go” decision for pending projects. At a national and international level, this trend of project delays and cancellations can be found in areas like Arlington, Virginia, where Amazon has paused the building of their second headquarters, and Denmark, where Meta has ceased development plans for a new data center. These types of issues will likely continue, which could squash some of the optimism those in the industry felt at the beginning of the year.
The Bottom Line
The construction industry, though faced with rising material prices, rising interest rates and potential project delays, is seemingly poised to have a strong 2023. Banks and surety firms will continue to provide financing and bonding programs, and while they may vary in terms and conditions, the strongest, most well-managed companies will be rewarded with more generous programs. However, the contractors who have not managed themselves or their construction businesses properly will face more tightly controlled program options and a much more uncertain future.
