The construction industry, like many others, has faced numerous challenges created by the pandemic, which are now being exacerbated by inflation and rising interest rates. Labor costs have been high, the price of materials has steadily increased, a recession is expected, and concerns about delayed projects are growing. All these factors are contributing to several critical changes in the construction industry for 2023.
Contracts will face more scrutiny
Contracts executed in the past two to three years haven’t fully accounted for the increase in costs – and contractors are taking a hit. From the increase in material costs, to more than a $1 per gallon increase in gas prices since 2019, construction costs are significantly higher, and contractors are taking on the brunt of the costs.
As a result, we’re advising our clients to review current contracts to find opportunities for price escalation or riders for items such as fuel costs. In 2023, it’s likely contractors will add language to new contracts to further mitigate risk or pass some of the risk to the owner and developer. When the uncertainty of the economy is putting added pressure on developers, it’s important to stay focused on what can be controlled, and contracts are a prime example of that.
Contractors may consider switching sectors
If the construction market slows down due to economic uncertainty, private sector projects like multifamily housing, office buildings, distribution centers and more, are typically the first jobs to face delays or cancellation. On the other hand, public sector jobs, like infrastructure, hospitals, or schools, tend to move forward as the government works to pump money back into the system to improve the economy.
This momentum swing between sectors can tempt contractors to switch from private to public sector. However, we advise our contractor clients to stick to what they know. Each sector has different risks and bid completely different, so it’s not just a simple switch. Consider the risks and the opportunities before moving forward with long-term business changes, including performing a financial forecast and discussing the switch with your financial partner.
Developers are tightening purse strings
When money was flowing in early 2022, developers may not have been as concerned about costs. However, according to a recent survey from The Federal Reserve‡, banks are reporting tighter standards for all commercial real estate loan categories, as well as commercial and industrial loans.
Now that funds are tighter, developers will be looking for ways to cut costs throughout the building process. We anticipate more general contractors will be involved in projects during the design phase to identify cost-effective measures. This could mean actions like top-of-the-line finishes being swapped for more cost-effective options or an owner downsizing an office space from a 12-by-12-foot area to a 10-by-10-foot floorplan.
Value engineering will take precedent as developers strategically reduce the costs of new builds in the coming years. With this in mind, work toward a balance of helping your clients’ dollars go as far as possible, while maintaining your profit/loss margins.
Projects will likely continue in 2023, but concerns are growing
While there have been concerns about a recession in 2023, many projects are still moving forward in Colorado. Thanks to the demand created during the pandemic, and funding provided by the government, many subcontractors and contractors have jobs lined up. Nevertheless, they’re still uncertain about the demand for new jobs in the future.
According to data from the Colorado Secretary of State‡, Colorado continues to rank above average for economic growth despite the headwinds of the current market. We’re optimistic that projects will continue to move forward to meet the need created by the increase in residents and businesses coming to the state.
We may not know all that the new year holds for construction lending, but we do know that the industry will continue to learn and adapt to the new challenges at hand. Having a strong lending partner is a crucial step for successfully navigating any environment.
If you are interested in learning more about how UMB can help your business as a financial partner, visit our website.