March 2022

Despite Myriad Challenges, Construction Financial Professionals Remain Upbeat

Based on the Construction Financial Management Association’s most recent CONFINDEX survey, those who manage construction firm finances in America remain collectively upbeat regarding industry prospects. While the Overall Confindex reading remained unchanged on a quarterly basis during 2022’s initial quarter, the reading is up nearly 11 percent from a year earlier.

The industry’s ability to reckon with myriad challenges is the stuff of legend. Labor/skills shortages, supply chain disruptions, equipment shortages, and rising materials prices continue to hamper industry recovery. Nonetheless, a peek below the headline number reveals significant industry momentum.

True, more respondents believe their profit margins have shrunk over the past year than believe they have increased, but the gap is minuscule. The most recent Confindex survey indicates that 35 percent of contractors have experienced expanding margins over the past year compared to 39 percent whose margins have contracted. The balance (26%) report that margins have not changed.  Given that materials prices rose 24 percent over the past year and that compensation costs are rising with unusual vigor, the fact that the overall industry has retained margins is both remarkable and evidence that project owners have been willing to accommodate increased costs.

It gets better. With respect to the year-ahead outlook for profit margins, fully 43 percent of survey respondents expect profits to expand over the next year while only 20 percent expect them to decline. Many responses were received prior to the onset of hostilities in Ukraine, which among other things produced surging energy prices. At least prior to that, the expectation had been that demand for construction services would remain strong while costs would eventually stop rising quite so quickly. Fully 89 percent of respondents indicated that materials prices have expanded over the past year. When asked to peer into the future, “only” 42 percent expect materials prices to be worse a year from now.

Data regarding backlog tell a similar tale. First quarter survey data indicate that 64 percent of responding firms are associated with greater backlog revenue relative to a year ago. Only 15 percent report lower backlog. With respect to the year-ahead expectation, the proportion of those who expect backlog to be higher is almost precisely twice as great as the proportion who expect backlog to slip. Not coincidentally, just 11 percent of respondents indicated that they were concerned by demand for construction. Thirty-five percent of respondents indicate that demand for construction is of no concern to them.

This positivity is reflected in other indices. The Business Conditions Index expanded 6.5 percent during 2022’s initial quarter and is up 26 percent from a year ago. The Current Confidence Index increased nearly 2 percent on a quarterly basis and is up more than 19 percent over the past year. In short, the near-term outlook is benign.

As always, there are challenges. As is almost always the case, the leading challenge pertains to human capital or the lack thereof. Seventy-four percent of respondents indicated that the were “very” or “highly” concerned by skills shortages, though that was down from 81 percent during the previous quarter. 

Labor force participation has been growing for several months as more Americans jump back into the world of work. There are many reasons for this, including vaccinations, falling infection rates and hospitalizations, the return of students to in-person learning, stimulus payments that are increasingly in the rearview mirror, and rampant inflation, which is rendering it more difficult for many American households to pay essential bills. The recent surge in energy prices will likely induce more Americans to supply more hours to the labor market.

Evolving Federal Reserve policymaking also appears to be cause for concern. The Financial Conditions Index slumped nearly 5 percent on a quarterly basis and is down slightly from a year ago. CFOs, controllers, and others appear to be concerned by the specter of rising interest rates as the Federal Reserve readies itself to tighten monetary policy to begin wringing elevated inflation out of the economy and re-tether inflation expectations.

Perhaps construction financial professionals will become even more concerned by tighter monetary policy and rising interest rates during the months ahead. The Ukraine/Russia conflict has ratcheted inflation higher, producing even more demand among workers for higher wages. In short, the Federal Reserve has considerable work ahead of it to undo elevated inflation, and those efforts are poised to drive the project cost of capital higher.

This logic may help explain why the Year-Ahead Outlook Index also declined (0.9%) on a quarterly basis. The index is only fractionally higher than it was a year ago when the pandemic was still raging. Construction and real estate are especially sensitive to tightening monetary policy, and that appears to be a critical factor underlying respondent expectations.

Looking Ahead

The U.S. construction industry is charging ahead, with sales and employment climbing quickly. Despite rapidly rising costs of delivering construction services, there remain enough project owners willing to move ahead to keep industry momentum going. However, there are lingering challenges including elevated materials prices and long-lived skills shortages. The specter of rising interest rates has also dampened the industry’s prospects.