It was the best of times, it was the worst of times. This may be the mantra of 2013 as the United States economy is on a rebound, and the sudden healthiness in the construction market is taking many in the industry by surprise. This article discusses the positive news coming out about the construction industry and why it’s more important than ever to manage your company’s credit risk.
Is The Construction Market Growing Faster Than Expected?
The construction industry is a lynchpin in the American economy, and when the economy tanked it impacted those in the construction business more than any others. According to reporting from McGraw Hill’s Dodge, the value of construction project starts dropped by nearly half between 2006 and 2011.
Banks cut back on construction loans, realtors and property sellers were faced with a saturated market, home builders stopped building, jobs dried up, and the like. Take away half of any industry and you’re likely to see the same impact.
But what happens when an industry so beaten suddenly pops back? That is the topic of a New York Times article this week: Sudden Rise in Home Demand Takes Builders By Surprise.
Although construction economists had predicted only modest growth in the construction industry this year, signs are suggesting that actual performance is more optimistic. Check out these interactive charts from the NYT’s article which shows pretty significant increase in building permits and home values, and on the other side, pretty low existing housing inventory. Ancillary stories support these models, such as the story this weekend that Lennar plans 140 homes in Clark County.
According to the New York Times article many businesses are struggling with the challenge to both keep up with demand and fight their natural inclination to be a bit gun shy. There is more to this story, however. While the economic rebound is good news from every angle companies must be proceed with care to avoid financial risk or loss.
Construction Market Rebound Is Laced With Financial Risk For Your Company
I am not being a Debbie-Downer. We’re very excited about the optimistic news that seems to be pouring in from every direction, and again, the fact that the economy is rebounding is good news any way you look at it.
I merely offer caution so that you can scale your business back up without subjecting yourself to loss.I merely offer caution so that you can scale your business back up without subjecting yourself to loss in the event the rebound slows or reverses, or in the event the rebound is too much for your customers to handle.
Assuming that the economic upswing continues its trajectory (a reversal has obvious consequences), I think the associated credit risks can be assigned one of three categories:
Earlier this year we wrote an article inspired by an ENR story from Thomas Schleifer, a Ph.D. professor at the Del E. Webb School of Construction who warned: Beware The Recovery: What History Teaches Contractors and Sureties.
The discussion there was simple: During a recession everyone’s cash gets tight. When asked to scale a business back up cash is in high demand and companies over stretch, which results in defaults and insolvencies.
While the recovery is generally good, it can create a bad situation for some companies who try to lean into the recovery too quickly. If one of your customers is guilty of this, you’ll be left with aging receivables and bad debt.
Delays And Challenges With Scaling
Another problem isn’t necessarily the cash flow issue, but is more of an explanation of why the cash flow issue is a concern. Interviews with various parties in the NYT’s article suggested that it’s hard to hire laborers who are no longer available or even to get permits when the demand is high and so many government agencies have significantly scaled their labor force back.
The result is delays, and the result of delays is money, and the result of money problems permeates through the construction contracting chain.
General Credit Risk Issues That Always Exist
While the economic upswing is a cure for a lack of business, it is not a cure for a lack of business sense.Finally, it’s important to remember that credit risk is not an invention of the recession, it’s a fact of life in business.
So many times people come up to me and talk about how business must be “great” because of the recession. They think that mechanics lien filings are up because people can’t pay. The opposite is true, however. Mechanics lien filings are down because of the economic turn. There’s simply less volume of projects and less volume of disputes. The problem isn’t getting paid as much as it’s getting work.
The need for credit departments and security interests like mechanics lien filings is completely independent of the economy. Don’t forget that these things have been around for hundreds of years, and while the economic upswing is a cure for a lack of business, it is not a cure for a lack of business sense.