The construction credit crunch: A perfect storm
By David BowcottConstruction Financing Risk Management
Availability of capital, credit and cashflow is dropping at a shocking pace.
The construction sector, for the most part, has very thin margins, especially when viewed in the context of the risks taken via contract over the past decade. Of concern is the rapid rise in risk over the past three years as events such as the COVID-19 pandemic and geopolitical instability created by war in eastern Europe have added uncertainty into the marketplace.
Construction stakeholders need to be laser focused in the coming five to 10 years as the impacts of these risk-fuelling events continue to manifest within the global construction economy. The construction sector has already begun a journey down the road of a massive credit crunch and the availability of capital, credit and cashflow is beginning to drop at a shocking pace.
As forward-minded companies, there are some solutions that warrant consideration to help mitigate credit crunch impacts.
SUPPLY CHAIN DISRUPTION
The supply chain was, and continues to be, dramatically disrupted, resulting in many knock-on impacts. This disruption wasn’t just about paying higher prices to get what you needed, it was whether you could even get what you needed, regardless of price. Many best practices and solutions have been suggested to help deal with the impact, including:
- Conducting detailed assessments of materials and supply chain feasibility with the owner and specifier.
- Purchasing and storaging materials in advance of needs.
- More intense monitoring of vendors in your supply chain.
- The use of technology to monitor the supply chain.
- Calls for more use of domestically manufactured materials.
The inevitable next step after a supply chain disruption is an increase in prices for materials in short supply. We have seen massive increases prices for key materials like timber, steel, concrete, fuel, road building materials, copper, and virtually every other construction material. To combat the impact of inflation:
- Qualify bids to consider rapid price increases.
- Use escalation clauses in contracts.
- Educate your customers around inflation (show hard evidence).
- Use technology to track the supply chain and price increases.
- Press for government support.
- Consider paying a premium for greater certainty in pricing.
INCREASING INTEREST RATES AND PROJECT CANCELLATIONS
As inflation and prices go up, so too will interest rates. We have already seen massive increases in prime lending rates by central banks globally to fight inflation. This has led many projects to undergo a feasibility review as costs related to supply chain inflation and costs related to interest rate increases combine to put many public and private projects on hold. Expect to see more projects being “mothballed” or cancelled in coming months and years. To minimize your company’s exposures to project cancellations:
- Increase due diligence around the projects you pursue.
- Do a deep dive over the various sectors of the economy to determine which are likely to suffer cancellations.
- Assess the financial strength of the companies you work with.
- Consider proof-of-financing in bid security instruments.
ACCESS TO SURETY AND BANK CREDIT
As inflation, unpredictable supply chains, interest rate increases and construction project cancellations make their way through the global economy, the financial health of construction stakeholders will continue to face challenges.
Those supplying credit to the construction sector are already beginning to take notice. One can expect we will be entering a phase of tight surety and bank credit. Construction stakeholders should invest in strengthening relationships with their surety and bank credit providers. Sit down with your trusted advisors and ensure you have the right credit partners to weather the future tight credit storm. It is time to strengthen your credit relationships.
ACCESS TO LABOUR
Supply of materials isn’t the only area of weakness. The supply of labour is going from bad to worse. There is already price pressure on labour due to lack of supply. This will only increase as inflation starts being raised as grounds for seeking new employment.
Take all precautions within your organization to ensure you are assessing current talent needs, benchmarking cost of talent, and have tools to ideally allocate talent across your organization. It is also wise to adopt best practices to attract and retain top talent.
The past few years, and the coming several years, will be very challenging when it comes to financial health and access to credit. Be mindful of the various impact areas driving these turbulent times and harness the power of tools and best practices to ensure each of these disruptive areas do not have a material impact on your organization.
Once the storm has been weathered you want to be in a strong financial position to take advantages of the post-credit crunch marketplace.
David Bowcott is Global Director – Growth, Innovation & Insight, Global Construction and Infrastructure Group at Aon Risk Solutions. Please send comments to firstname.lastname@example.org.
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