Icebreakers are the worst.  I think we can all agree on that point. Yet, twenty years into my career I suddenly find myself as the “new guy” at Watt Tieder, with the opening of the firm’s newest office in Boston. So here I am, contributing to this newsletter for the first time, making first impressions, and wondering if icebreakers do have some value in becoming familiar with something new. Given this format, I think trust falls are out. Which has me thinking about the old icebreaker standby “Two Truths and a Lie.” For those not familiar, you share three statements about yourself, two of which are true and one that is … well, you get it. And since we are all here to talk about construction, I will gladly not make this about me. Instead, let’s explore “Two Truths and a Lie” about construction trends for 2019, and along the way get to know our industry a little better.

 

Truth Or Lie?  New Technologies Will Become Table Stakes For Staying Competitive In The Construction Industry

 

The Internet of Things (IoT) is here.  It’s in your pocket, in your home and car, and gaining traction at construction projects everywhere. What were recently viewed as gimmicky or premium applications of technology at construction sites are quickly becoming imperatives for pricing, quality, and safety. Construction professionals are not new to gathering data critical to a project’s success. But progress is lately exponential in how that data is collected and put to work. The proliferation at construction sites of technologies such as drones, RFID (radio frequency identification), GPS, Lidar (light detection and ranging – laser mapping), IR imaging, 3D printing, robots, and even smart hard-hats only scratches the surface. And though some of these technologies have been used in construction for some time, their initiation into the IoT is allowing the industry to super-leverage those tools. For example, drones were originally used to take aerial photographs and video of construction sites, most often to the benefit of marketing. Today, construction drones are equipped with and connected by the IoT to tools that move the needle on cost estimation, scheduling, security and safety. The data collected by drones is now routinely paired with systems providing virtual and augmented reality, predictive analytics (AI) and BIM (building information modeling) to drive context-based decision making from project bid to completion.

 

The utility and proliferation of technology in construction is without question. The same can be said about the cost of that technology, with respect to both equipment and personnel qualified to operate it. Will 2019 be the year the industry tips the scales on technology from a luxury to a competitive necessity? On one hand, the market remains ultra-competitive, profit margins are thin, and the increase in overhead associated with a push into new technologies will undoubtedly impact the bottom line. On the other hand, sometimes you have to spend money to make money. Which is to say that project owners, their finance partners, and design teams are becoming increasingly sophisticated in terms of progressive project delivery methods. In many urban areas project sites have small footprints, labor is tight, and material costs and supply chains are strained.  For those reasons, the push to lean construction and “just in time” delivery is considerable, and the technology increasingly utilized at construction sites is both the cause and effect of that movement.

 

The high-end of the market, particularly complicated private work, already requires contractor sophistication with new technologies. Public works and more moderately priced projects admittedly do not yet have the same standards, though it is only a matter of time until a truly progressive suite of construction technology is necessary to stay competitive – in both securing work and retaining the best employees. Given the substantial learning curve and pace of growth associated with those technologies, it may be too expensive to wait.

 

Truth Or Lie?  Increased Construction Costs Will Moderate Demand For New Construction Projects

 

Since the end of the Great Recession almost a decade ago, labor, materials and market conditions have driven construction costs higher every year. During the third quarter of 2018, the Association of General Contractors estimated unemployment for workers with construction experience at a historically low 3.4%, below what economists consider full employment. The recession forced many skilled construction workers away from the industry, and a disproportionately large segment of the existing construction workforce is older. At the same time, the rate at which millennial workers are replenishing the construction labor pool is lagging, blamed largely on perceptions of the industry as slow to adapt. In that respect, adopting construction technology and addressing the labor shortage may have a lot in common. All of those forces translate to a considerable increase in labor costs. A quick solution is unlikely to present itself, and overall construction costs are likely to bear a disproportionate labor burden for some time to come.

 

As to material costs, tariffs and global trade tensions are most often cited as driving the steady increase in prices. Indeed, there is a growing chorus of economists downplaying the actual impact of tariffs on material costs, instead citing the self-fulling prophecy caused by the heavy media coverage of tariffs and contractors’ particular sensitivity to cost uncertainty creeping into bids. Those economists maintain that, in fact, material costs are up as a result of fundamental economics, namely that the overall demand for construction projects is high. If that’s the case, this trend may ultimately be defined more by the capacity of the market to sustain that demand.

 

The private sector has seen strong activity, but its future appears to be a toss-up. Recently, interest rates and the stock market are most often attached to the word “volatility.”  Underwriting for project financing remains conservative, and that mindset has leaked into the availability of contract surety credit, a factor that is more influential today given the increase in private owners requiring payment and performance bonds to mitigate default risks. A divided Congress, a peculiar political climate, and the run-up to the 2020 Presidential election do not promise stability or inspire risk.

 

Though speaking of our government, the prospect of public works continuing to drive construction momentum is strong. The government shut-down is over, the term “infrastructure” appears in response to literally every Google search pertaining to the future of the construction industry, and our federal, state and local governments are by far the most prolific funders of construction projects from Maine to California. And speaking of California, there are even whispers of a $5.7 billion public works project running from San Diego to Corpus Christi.  Opportunity zones, an influx of federal funding into local public works, incentives for renewable energy, and a backlog of necessary education and transportation projects constitute a considerable share of today’s construction demand.  And though there has been very little consensus about how to fund it so far, it is widely accepted that Congress and the President will find common ground on considerable infrastructure legislation in the immediate future.

 

Premium labor costs are likely here to stay for now, and increased material costs may just be the price to pay for a robust construction market.  So far, overall demand for projects appears to be absorbing those costs, and the broad shoulders of public construction look poised to continue supporting the industry.

 

Truth Or Lie? Surety Will Continue Its Run Of Premium Growth And Low Loss Ratios

 

For some time now, surety has been outperforming other financial service sectors, with years of steady and substantial growth.  According to the Surety and Fidelity Association of North America, surety has seen the most growth recently in contract bonds for private construction projects. At the same time, surety is achieving historically low loss ratios, credited to advances in underwriting, prequalification, and expense efficiency.  With growth in private sector bonding, and a steady diet of public works, can sureties maintain the high-wire act of strong premium and minimal losses? Surety consolidation and sophisticated approaches to leveraging risk through reinsurance and co-surety have largely supported that effort to date, though there are clouds on the horizon.

 

First, look no further than unstable construction costs to upset even the best underwriting. With respect to labor, the risk to a surety goes beyond the precision of its principal’s bid. Labor shortages are impacting the ability of contractors to prosecute quality work on schedule, directly threatening sureties with performance obligations. And when faced with a default, sureties do not presently have the pool of historically available replacement contractors hungry to complete the work at surety friendly pricing.

 

Further, domestic sureties have seen recent success moving into global markets, seeking premium traditionally available to international banks.  Their achievements, though, may also pose a threat in the form of international insurers now eyeing the U.S. surety market given the mandatory bonding requirement for qualifying public works, the cresting wave of infrastructure projects, and low loss ratios. Competition from financially strong international sureties, willing to take market-entry risks domestic sureties have effectively avoided for years, may put pressure on surety underwriting, with the effect of exposing the industry to a higher risk of losses.

 

Surety is cyclical. Expansion ultimately leads to a peak, with contraction and a trough to follow. It is difficult to forecast if that will happen in 2019, though increased economic pressure on bonded principals, a labor shortage, a likely surge in public infrastructure works, and the threat of competition from abroad will certainly pose challenges.

 

So, Which One Is The Lie?

 

As it turns out, we will have to wait and see. There is likely some “truth” in each of these trends, though the prospect of any one having a considerable impact on the construction industry remains to be seen. Construction technology is no doubt on an upward trajectory, but its proliferation may not reach any sort of competitive critical mass for years to come. Construction costs are up and likely here to stay, but overall demand may be sufficient to absorb them and maintain momentum.  And though surety profits presently tower over losses, what goes up must come down. Regardless of how things play out, getting to know the industry trends is important to understanding what opportunities and challenges 2019 may present.