Construction has been booming for the last several years. As a result, many new companies have been formed to meet the demand. There are plenty of projects to go around, and it looks like more of the same for this year.
But if you’re considering a building project, be warned: The construction boom has created a shaky foundation for some contractors.
“Subcontractor default is up significantly,” says David Strauss, president of Houston-based Funds Administration Services, the leading provider of construction escrow services. “If contractors or owners don’t protect themselves from exposure, there can be a significant risk.”
There is so much work, people are leaving established companies to start their own businesses. As a result, many companies don’t have the depth of working capital to weather a storm in the economy.
“These companies tend to not be as sophisticated in their control systems,” says Strauss. “They are terribly vulnerable to any downturn.”
As people spread out, there are fewer bodies to do the work, causing a labor shortage, which in turn means it takes longer to complete a project. With longer turnaround times, a miscalculation on one project can send a company into a death spiral — possibly in the middle of constructing its new headquarters.
“The market is still good, but as interest rates tick up, it will put pressure on these companies,” says Strauss. “The industry appears to be very healthy, but there are significant cracks in the foundation.”
If you are considering a building project, consider protection to go along with this major investment:
Surety bonds. These give you some protection to get the project completed, but aren’t always available. Keep in mind that just because a contractor can’t get a surety bond doesn’t mean he or she is dishonest or unreliable.
Bond issuers, like banks, are very risk averse. If a company is trying to get bonds for a project that is larger than anything it has ever done, the bond company may turn it down. If available, they should be used. Bond companies will sometimes issue bonds only in conjunction with funds administration.
Funds administration. This can work to the benefit of both the business owner and the contractor. The funds administrator acts as an escrow service for the project. Funds are transferred from the lender or business to the escrow company, which makes sure they are spent on the parts of the project they are earmarked for before releasing them.
This prevents the contractor from using funds from your project to pay for parts of another project, but also means the contractor gets paid more quickly, alleviating cash flow problems caused by slow payers.
“By doing this, you can mitigate the largest percentage of loss in the construction industry,” says Strauss.
Fees start at 1 percent of total project cost and flatten out as the project gets larger. The average project is $1.4 million, with many in the $300,000 to $500,000 range.
How to reach: Funds Administration Services, www.fundsadministration.com or (800) 327-2503
Todd Shryock ([email protected]) is SBN’s special reports editor.
