Welcome to the world of opportunity, risk and reward in what we call construction. A year ago I wrote about the coming housing downturn, and I’m sad to say it’s here. In my opinion, this housing market downturn is far different from past downturns since it was more the result of Wall Street’s business tactics rather than anything else.
When you couple the stock market crash we experienced several years ago with Wall Street’s idea to sell billions of dollars in home-loan securities, you have to wonder why the little guy ends up paying for these schemes. What is interesting is the fact that there are “little guys,” who took advantage of the high-flying stock and housing booms and made a lot of money knowing the cycle would change.
Wall Street and constructionCurrently the commercial construction market is booming and has been booming for several years. Wall Street is once again involved in financing this boom, as it was in the housing market. Wall Street is good at finding and creating markets for their money where they can earn a good return. Construction lending is a huge market worldwide, and Wall Street is in the commercial construction lending business.
What does all this mean to subcontractors? It means the cycle will change, and unless you are preparing for the cycle to change you will most likely not reap the rewards of your willingness to take on risk and work hard. Try to imagine the impact this housing “crash” is having on homebuilders and their subcontractors. Here are just a few:
• Inventory of unsold homes is increasing.
• Home values are decreasing.
• Builders are running out of money to make interest payments on their inventory.
• Builders are stuck with land they can’t build on or sell.
• Builders don’t have the money to finish their homes.
• Subcontractors are not being paid.
• Banks are foreclosing on homes which nullify subcontractor liens.
• Subcontractors and construction workers are quickly running out of work.
• Lenders have tighter lending requirements.
• Fewer qualified buyers.
I imagine some builders are feeling the grip around their necks getting tighter and tighter. As time goes on, there will be many builders and subcontractors who lose control of their businesses to creditors because they didn’t anticipate the cycle, or the fact that cycles are sometimes artificially created. If you know construction cycles are “cycles,” and if you understand where the money comes from to create these cycles; you can determine if the cycle is artificial or not. If you really understand your market, and are willing to be flexible, you can be one of the “little guys,” who makes a lot of money during these cycles.
Commercial PressureHistory tells us that housing downturns usually affect commercial construction profit margins. For example, you will most likely see housing subcontractors enter the commercial market, creating more competition which will result in reduced profits. Most likely you will also see the costs of materials go down, which also reduces profit margins.
You may also see trade-union memberships swell with people coming out of the residential market who may not have the expertise needed to keep jobs profitable. At some point in the near future it will become a buyer’s market. Owners (buyers) will have their buildings built or remodeled for 20, 30 or more percent less than current construction costs. These owners will be able to attract tenants from other owners who built when costs were high.
Some of us are old enough to remember the days when commercial construction profits were diminished due to a housing downturn. We also remember owners who started building during a buyer’s market at substantially discounted rates.
Skanska Construction is a publicly traded company doing business worldwide with revenues in the billions of dollars. Skanska originated in Sweden in 1887 and expanded internationally in the 1950s. One of Skanska’s key advantages is the fact that it is an international company and is not solely dependent upon one geographic location for its revenue. Skanska has created many partnerships and consortiums throughout the world that continue to grow their revenues.
It is public knowledge that Skanska’s financial targets are in the area of 18 percent return on equity. Although this is interesting information, what is more important is what we can learn from Skanska. What I’ve learned is that they manage risk better than most. They are geographically risk-adverse and they have generated one of the most comprehensive contracts I have ever seen, which also greatly reduces their risk.
Skanska does most of its work in Sweden, Denmark, Norway, Finland, Czech Republic, United Kingdom, the United States, and Argentina. The United States spends about 9.2 percent of its gross domestic product on construction while Argentina spends about 9.7 percent. Currently, Norway spends about 11 percent, Finland, 14 percent, followed by Czech Republic at 15.3 percent.
According to the Federal Department Commerce Bureau of Economic Analysis (www.bea.gov), domestic corporate profits for the second quarter fell 1.4 percent. However, net corporate profits earned in other countries increased 21.3 percent. Again, it is interesting to understand why huge organizations like Skanska are doing so well. One reason is because it has been in business for 120 years. The company has seen many cycles and they are guarding against these cycles by being geographically diverse.
Reality CheckYou may not be Skanska, and you may not be Wall Street. You may be the “little guy,” who works hard everyday doing business in a small geographic location with an unstable stock market and a weakening housing market. What do you do? It depends.
When Skanska entered the U.S. market, it bought a “little guy” to get a foothold in this market. This is a viable option for small contractors and subcontractors. Another option is to move to an economically healthier geographic location. You also have the option of “sticking it out” until better times return, or carefully adding practical scopes of work to your current product line that you can manage.
The point of this article is to remember that when a good cycle hits you have to take advantage of it and retain all the earnings you can because you know it won’t last forever. Profit is what allows you to grow, if you want to grow. Profit also allows you to stay small if you want. In other words, if you’re highly-profitable, you get to do what you want with your earnings.
There are a lot of very young owners of small construction companies who are being hurt by this downturn, but they have learned and will never forget how quickly a market can change. What they are going through right now will make them a better contractor next time, if they look at this downturn as a maturing experience.
My son has a good friend who started a roofing business four years ago. He would come by the house once in a while to show me his new truck, car, boat, or motorcycle. Business was booming for this young man and he was making more money than he knew what to do with. His roofers were all driving company trucks, and he had special trucks built to handle all of his construction projects.
Suddenly, the roofing market has become much more competitive and it’s becoming more difficult for him to keep his crews busy. He is a sharp, energetic young man who will do fine in the long run. The reason I know he will do fine is because of what he said, “I’d sure like to have a shot at another hot market, because I won’t make the same mistake twice.”
Remember Team Work Begins with A Fair Contract!