The current state
The state of the economy in Northeast Ohio has led to an increase in the competitiveness of the construction marketplace. The market has seen a decrease in the number of homebuyers, which has led to less demand for new residential construction.
According to one respondent, this may be partially caused by the media’s portrayal of the current housing crisis: “The uncertainty of the economy and the media’s portrayal of the housing industry, people are seeing these things and are not willing or looking to purchase new homes or spend money in general.”
This has made profitability difficult for many of the companies in our survey to attain, as indicated in their comments below.
When asked, “What is the greatest challenge that your company currently faces and why?” one respondent explained, “As the residential market dries up, competition is increasing on public construction projects. Due to the dynamic nature of the construction market in NE Ohio, it becomes more difficult for contractors to both obtain work and remain profitable.”
According to Ian Frank, a construction lawyer with Frantz Ward LLP, there is an upside for companies that keep a close eye on their bottom line.
“This increased competition provides opportunities for success for the disciplined construction company that has put in place strong estimating, cost, contract risk allocation and project management controls,” he says. “On the other hand, it can prove disastrous to those that do not take these precautions.”
The work force problem
Several respondents commented that their No. 1 concern moving forward is finding talented workers in an industry that is suffering from a shortage of employees with the necessary skills to perform the required work. Nationally, the construction industry has seen a realignment of talent take place. According to a study performed by The Associated General Contractors of America (AGC), nonresidential construction nationwide saw an employment increase of approximately 23 percent between February 2006 and December 2007, while residential construction saw a decrease of 33 percent. A majority of this gain and loss can be attributed to residential workers performing tasks such as installing wallboard, wiring, plumbing and other components in nonresidential projects.
According to the AGC, many of the residential workers making this switch may not have the skills needed for the high-growth construction categories of 2008, such as hospitals. These projects require extremely talented workers skilled in high-steel erection, heavy lifting and close coordination with a variety of crafts in confined or hazardous spaces.
Despite the gloomy outlook for many segments of the construction industry, there will be growth opportunities in various markets. Frank says that, “A substantial number of the industry respondents indicated that their greatest opportunities for growth in the next five years existed in the public construction market and institutional market (e.g., health care, hospitality, etc.). This is no doubt due in large part to the continued growth and expansion of The Cleveland Clinic and University Hospital Health Systems, more than four dozen projects still planned by the Cleveland Metropolitan School District, the ongoing Euclid Corridor Project, the anticipated redevelopment of the East Bank of The Flats by Developers Diversified/Scott Wolstein as well as a number of notable downtown projects, such as the future renovation of the Ameritrust Building.”
The survey revealed several interesting facts about the legal environment surrounding the construction industry.
“A majority of the survey respondents indicated that they believe claims for design errors and omissions will be the largest source of claims and change orders in the future,” Frank says. “These responses highlight the need for adequate project management controls and risk management techniques. These controls include a clear understanding and appreciation of the contractual risks assigned by the contract documents and a focus on timely protecting/preserving claim rights when they occur. Many recent legal decisions interpreting typical risk-shifting provisions are filled with cautionary tales of contractors that did not create or implement these risk management controls.”
With the continued rising cost of materials a top concern for construction companies, fixed-price contracts are becoming a more and more dangerous proposition. Frank believes that, “Given that nearly 70 percent of the respondents perform most of their work on a fixed-price or lump-sum basis, these concerns result in an increased risk of performance. Contractors eager to take work at little or no margins in order to keep busy often ignore contractual risk issues that will directly impact the project bottom line.
“Add to this dynamic the prospect of widespread price fluctuations for various raw materials and one can see the possibility for an increase in contractor defaults. Also, the recurrent concerns regarding material price increases demonstrate the need for a broader acceptance of shared contractual risk through the implementation of material escalation clauses.”
ROGER T. GINGERICH, CPA/ABV, CVA, is the principal-in-charge of the Real Estate & Construction Group at Skoda Minotti. Reach him at 440-449-6800 or firstname.lastname@example.org.
Special thanks to the professionals at Frantz Ward LLP, Parkview Federal and Associated Builders and Contractors Inc. for their assistance developing these surveys. Real estate survey results based on 51 companies.