Despite battling rising interest rates, inflation, and sagging GDP, a financial accounting expert with deep experience in construction industry economics expects construction growth and profits to continue in the current year and through 2023.
Todd A. Feuerman, CPA, CCA, MBA, is a director in the audit and accounting department of Ellin & Tucker in Baltimore. Ellin & Tucker is an accounting and business consulting firm with construction clients extending along the East Coast from Maine to Florida but concentrated in the Mid-Atlantic. Feuerman said Ellin & Tucker construction clients post annual revenues ranging from $10 million to more than $500 million.
The firm handles financial reporting, tax compliance, and planning while Feuerman’s expertise also stretches to succession planning, which he characterized as a hot topic as baby boomers explore market conditions with an eye to exiting their firms, making way for the next generation of construction contractors.
An accountant by training, early in his career, Feuerman’s expertise expanded beyond accounting services. “In 1989 I had to learn job costing, job bidding, and how to address problem jobs. From there my firm, myself, and a few others developed a reputation of dealing with financially sensitive construction firms.” After 35 years with Ellin & Tucker, Feuerman’s reputation has propelled him to feature prominently as a speaker at the Construction Financial Management Conference, a leading forum for construction industry business owners and professionals. “Many times, I’m asked to just comment on the industry to provide insight on trends that I’m seeing—general business climate and financial trends,” he said.
According to Feuerman’s construction industry outlook research for 2023, construction revenues are expected to rise by 10%-12%. He expects this 2023 performance after the industry finishes with a strong 2022 with bond premiums in 2022 projected at $7 billion, “the most in history since that number has been tracked.”
Feuerman’s view of the construction industry outlook is supported by a mid-year update consensus survey of the American Institute of Architects that projects construction spending to rise 9% in 2022 and 6% in 2023.
Feuerman listed the elements leading to surging operating profits and improved balance sheets among construction companies as strong earnings and capital infusion from the Employee Retention Credit a and the Paycheck Protection Programs. Strong balance sheets have in turn led to low levels of claims in the bond market. Fewer claims and record $7 billion premiums spell healthy surety bond industry profits, he noted.
Recent government economic data recorded negative economic growth for the second quarter of 2022, marking the second quarter in a row of negative growth. The Bureau of Economic Analysis reports that second-quarter GDP fell 0.9%, while the first quarter declined by 1.6%. Two consecutive quarters of negative growth is often cited as indicative of a recessionary economy.
“Everyone is saying we’re in a recession,” Feuerman observed, but his outlook remains bullish for construction and surety bonding.
Feuerman pointed to the booming job market as a counter to recessionary pressures. The U.S. Bureau of Labor Statistics reports 528,000 non-farm job growth in July and unemployment at 3.5%. So weak GDP performance seems not to have hindered expanding employment, and commercial construction activity is not letting up.
Feuerman also sees signs that inflation is moderating, with respect to certain materials used in the construction industry. He cited lumber price statistics from tradingeconomics.com to illustrate the point. In October 2018 lumber was trading around $300 per 1,000 board feet. In March 2022 it exceeded $1,500 per 1,000 board feet, but it is now trading in the $500-$600 range.
Rising interest rates are another potential drag on economic activity, but Feuerman does not see the trend slowing big construction industry players.
“Interest rates are going up, and so the cost of construction projects from a financing standpoint is going up, but I don’t see that stopping the projects,” Feuerman said. “While it’s a wildcard, so to speak, everyone knows rates are going up, and financially strong developers and construction companies have built that in.”
Meanwhile, in response to inflation, construction contractors have shifted from the “Just In Time” to the “Just In Case” model for building supplies. The change in philosophy comes in response to rising prices and to supply chain bottlenecks.
“If they’re able to, contractors are pre-buying materials that they deem as generic for all jobs,” Feuerman said. For example, a “contractor that uses wood beams or plywood will overbuy and build inventory.”
Another inflation hedge is building price escalation clauses into contracts and being pickier about the contracts they bid on. “Contractors are being much more selective about jobs they are going for.”
Finally, Feuerman said, contractors are building “cost” cushions and price escalation clauses into contracts in case material costs continue to rise.
Feuerman also discussed coming accounting and tax developments that contractors and bond industry professionals should be aware of. Feuerman pointed to the new lease standard, ASC 862, that requires recording liability for operating leases. Recording liability for operating leases has been a rule for publicly traded companies that will be applied to private companies starting with year-end 2022 financial statements.
“The balance sheet for a construction company will start to look very different from 2021 and prior, and that’s because operating leases—building leases, equipment leases—will now need to be brought on the balance sheet as an actual liability,” he said. “It will change the leveraging look of the construction so surety underwriters will have to address this.”
On the tax side, rates will likely remain the same; but bonus depreciation will decline from 100% to 80% in 2023 and will continue to phase out going forward. Looking ahead to 2025, a valuable tax benefit is also set to expire. A dedicated 199A deduction ends that currently provides a 20% reduction in income for owners of S-Corporations and LLCs.
Feuerman also offered advice about management practices often ignored by contractors, which, if attended to, will improve the contractor’s business position.
He said the construction company should ensure proper cash reserves are in place in case of a business downturn. Similarly, the bonding agency can ask the same question of the contractor: does the company have reserves in place as a backstop against a downturn?
The second issue is attention to work schedules. “Clients always need to improve work-in-process schedules—tracking job costs and revenue recognition. Do a better job in making sure those are accurate and the bonding agent is comfortable with the accuracy of that information.”