Dirk Schafer’s desk at J.E. Dunn Midwest is about as close to the middle of America—or about as far from an international border—as you can get in this country. But on that desk he keeps a constant reminder that Kansas City is not insulated from global economic factors.
It’s a construction cost index, and most of those factors on it are headed in one direction: Up. Sharply. One key element among them is the cost of steel. The reason for that? “Overseas construction,” Schafer says, noting that plenty of other economies are booming, if not our own. That, and infrastructure construction worldwide, have ginned up demand for steel by an unsettling 4.6 percent through the first half of 2011.
Overall, seven key materials Schafer monitors are up 3.64 percent this year, covering such construction staples as concrete (up 5.9 percent), lumber (up 6.4 percent) and even redi-mix, which is rebounding in price after dipping last year. And then there’s oil, the driver of construction products ranging from roofing materials to asphalt to PVC pipe.
Plus, “every material that comes to a job comes on a truck,” Schafer said. “Oil costs ripple through construction costs.”More than four years after America’s construction sector became a disaster zone—and with few signs of long-term rebound to indicate the worst truly is over—the additional pressures on general contractors are squeezing profit margins with almost unprecedented strength.
Those costs are part of a one-two punch delivered concurrently with higher labor costs. Those may not be showing up on paychecks for workers in the form of higher wages, but increases in benefits costs surely are, Schafer noted. About the only upside of what’s going on with the labor side, he said, is that “the contractors and sub-contractors have laid off their marginal performers and are down to their core or best performers—their most productive, their most efficient people.”
That tactic is about the only means, he said, to offset the labor and material increases. “But the reality is, these have taken a big bite into margins,” he said. “There’s just no way these kinds of increases in material and labor can be made up in productivity and efficiency gains. So we’re all lowering margins to get work.”
In January 2007, before the bottom fell out, 7.72 million Americans were at work in the construction sector. Preliminary estimates for June of this year showed that number at 5.51 million—a loss of 2.21 million jobs. That translates into roughly 225 jobs lost every hour of every single workday since that peak in 2007.
Were materials costs the only consideration, getting those people back on the job site would be tough enough. But other factors are getting in the way of that, as well.
Construction spending nationwide came to a seasonally adjusted annual rate of $772 billion in June, down 4.7 percent from June 2010, according to Census Bureau figures. While there are a few bright spots in construction, notably with power construction up 13 percent over June 2010, other elements that have been carrying this sector showed ominous declines. Large-scale hospital projects have been completed without a corresponding refilling of that pipeline, leading to a 3 percent decline in year-over-year figures.
After the 2009 infusion of federal money intended to stimulate the economy, even public construction fell by nearly double-digit margins in 2010, driven by declines of 10 percent in highway and street construction, and 13 percent in projects for schools and universities. Office construction? Down 10.1 percent in that time frame. Manufacturing: Down 11.8 percent.
Things were just as bleak on the residential side, with new single-family construction down 11 percent and new multifamily work down 10 percent. Those are national figures; the local numbers, when broken out, are likely to be more sobering, given that the 10th Federal Reserve District, which includes Kansas City and the region, is one of three where new home construction has been hammered because of the increasing inventory of unsold homes.
Where does that end?
According to sureties who underwrite sub-contractor performance, Schafer said, the last half of 2011 and 2012 will yield an increase in contractor failures.
“This has been going on since fourth quarter of ’08,” he said. “People with healthy balance sheets that can sustain the downturn and make good business decisions have been able to ride it out. Those living off cash flow? It’s got to come to an end one of these days, and the surety market says we’re approaching that time.”
Which, though painful on one level, means longer-term benefits for the survivors.
“We think we’re going to come out of this a stronger, more efficient, more productive company,” Schafer said. “We’ve done it by investing in technology, in building information management, and in reducing our overhead, and we’ve learned how to do more with less.”
“I think for those companies, contractors or sub-contractors that can do that, they’ve got a bright future.” 