Contractor Strategies for Thriving in High-Interest Environments
As 2024 progresses, it’s becoming increasingly clear that interest rate cuts are unlikely before early 2025. This high-interest environment poses unique and complex challenges within the construction industry.
Given that construction projects tend to rely on debt financing, as the cost of this debt rises, they become less profitable and, in some cases, financially unviable. High rates also continue to exacerbate supply chain issues, driving up prices for essential building materials. This has led to a slowdown in new projects and delays or scaling back of ongoing ones.
Tough economic conditions are like storms: You can’t stop them, but you can find ways to persevere through them and thrive in the long run if you take a proactive approach.
The Uneven Impacts of High-Interest Rates in 2024
According to a recent report by Marcum, a top construction accounting firm, the number of companies that found it difficult to obtain financing doubled between 2022 and 2023. This tightening credit environment is especially challenging for firms with leveraged balance sheets or thin capital.
The National Association of Home Builders (NAHB) has reported that overall housing starts decreased by 14.7% in March 2024 — a 2.7% decrease in single-family homes and a 1.6% decrease in multifamily units from a year ago. And the Architecture Billings Index (ABI) — “a leading economic indicator that leads nonresidential construction activity by approximately 9-12 months” — fell to a low not seen since December 2020.
At the same time, The Construction Association notes that certain sectors are experiencing marked growth, particularly new data center construction, hotel construction, and public-sector and infrastructure construction.
The uneven impacts of high rates underscores why a one-size-fits-all approach to pipeline management is impractical. However, in my years of experience helping a wide array of construction businesses become top earners, I’ve found that firms that follow four simple rules can capitalize on the ever-changing business environment rather than being victimized by it:
Pay attention to leading indicators.
Embrace diversification.
Adjust your pricing strategy.
Double down on relationships.
What are your leading indicators telling you?
The warning signs of factors that can disrupt your project pipeline are always present if you pay close attention. Of course, one news item should not spark panic, but you shouldn’t ignore leading indicators of developments that could affect your company, either. Even if a given trend does not seem to be harming your business now, that doesn’t mean it won’t down the line.
When developers struggle to find investment for building projects or pass rising costs onto clients, it has cascading effects on contractors’ future work pipelines. If you’re an excavation contractor who goes out to building sites to prepare them for construction, a lack of new starts will immediately hit your business. However, if you’re a landscape installation firm, you might be working at capacity for a year or more before the lack of new starts affects your bottom line.
So, whenever you come across a seemingly legitimate early warning sign of disruption, it pays to initiate an external SWOT (strengths, weaknesses, opportunities, and threats) analysis: Conduct interviews with customers and critical business partners, pull benchmarking data from around the industry, and research economic trends that may affect your current markets or lead you to consider new ones. If you find evidence that a threat is plausible, it’s time to act.
Diversify to thrive
Ideally, you should explore how you might expand into other markets before you see a sizeable hit to your income stream coming. The next-best option is to put a strategy in place as soon as you become aware of a legitimate threat. Without such a plan, you’re functioning like a family who builds their house in a flood zone without trying to grade the property for ideal drainage and build on a deep pier foundation: You’re begging for disaster.
Diversification is almost always worthwhile, even when your business is on a hot streak. Say, for example, you work in a recession-resistant sector like school construction, and the opportunity to expand into multifamily residential building presents itself. You make the most of this opening, but because that market is more volatile, you also continue to devote time and resources to maintaining your foothold in your original sector. When rates rise, putting downward pressure on residential building, you can quickly shift approaches and start pursuing more work in your original sector.
Start doing market analysis and speaking with customers and existing and potential industry partners as soon as possible to determine which alternate sectors, geographic areas, or kinds of clients might offer new opportunities for your firm.
Measure what matters
The top reason contractors go out of business is continued negative cash flow. However, negative cash flow is only a symptom of a more fundamental problem: a lack of timely, clear financial information.
The current high-interest-rate environment has made closely monitoring your business metrics and planning ahead for pipeline slowdowns even more vital. One major concrete contractor was forced to lay off more than a third of its workforce between 2022 and 2023. The move helped them remain profitable, but it’s possible that the cuts could have been avoided.
If you understand your overhead costs and the gross profit you need to cover those costs, you can be very aggressive with your pricing during economic storms. You can secure enough work in advance at enough margin to keep you from having to take less-than-desirable steps to fend off financial disaster.
Don’t chase projects, pursue relationships
This rule shapes the other three: Without a strong network, you will struggle to identify legitimate threats to your business, diversify into new markets and win projects, even with rock-bottom pricing.
Contractors often erroneously think they’re in the project sale business. But if you focus more on landing individual projects than on the people involved, you’ll waste 90% of your time and energy. The people who award projects to GC/CMs have more projects coming down the line, just as those GC/CMs have for trade contractors. Even when an owner or developer doesn’t have future projects lined up, the architects, engineers, and brokers they hired might.
In a high-rate environment, keeping relationships “warm,” even when work isn’t immediately forthcoming, can pay huge long-term dividends. Consider the developer who, today, doesn’t have many projects underway. The contractors focused on landing their next projects won’t keep in touch with these developers. They won’t invite them to sponsor charity events or to attend the usual golf gatherings because they’re only thinking about the work these developers can’t offer now.
Relationship-focused contractors don’t make that mistake. They know that the developers will remember the people who kept in touch — the ones who invited them for coffee, just to chat, and, perhaps, freely offered advice on how to cut construction costs for the existing projects. These efforts will pay off when those developers exit this down cycle.
This article has been previously featured in Commercial Construction Renovation.
The Spark Notes:
As 2024 progresses, interest rate cuts are unlikely before early 2025, posing complex challenges for the construction industry, particularly in financing and material costs.
High interest rates have made debt-financed construction projects less profitable or unviable, slowed down new projects, and exacerbated supply chain issues, leading to increased costs and project delays.
According to Marcum, the number of companies struggling to obtain financing doubled between 2022 and 2023, and the National Association of Home Builders reported a 14.7% decrease in overall housing starts in March 2024.
Despite these challenges, sectors like data center construction, hotel construction, and public-sector projects are experiencing growth, highlighting the need for construction firms to diversify, monitor leading indicators, adjust pricing strategies, and strengthen relationships.
