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Construction industry 2023: Thriving through the challenges ahead

Dec 12, 2022

The COVID-19 pandemic (and its related labor issues, supply chain challenges and rising interest rates) has recently tested the construction industry. It will continue to do so in 2023.

However, companies that are nimble, tech savvy and strategically focused should be able to weather obstacles, differentiate from competitors and prosper.  

Caution ahead but with notable bright spots

Following positive trends in nonresidential construction over the past few years, recession risk looms due to high and rising interest rates which drive cost increases and a decline in spending. These pressures may turn 2023 into a year of caution for project owners concerned about their ability to obtain necessary financing.

These issues and the ongoing labor and supply chain challenges add a layer of complexity that will impact activity volume in 2023. As a result, construction activity may decline, especially in industries like retail and office.

However, even with the current economic challenges, construction there are bright spots in the year ahead, including warehousing, distribution, healthcare and public infrastructure. 

Warehousing and distribution continue to experience strong demand due to e-commerce, while healthcare continues to need growth to meet the aging population. Infrastructure demands are high because of population growth and migration, as well as the necessity to repair and replace aging roads, bridges, power supplies and other public works.

In addition, meeting evolving energy initiatives and the transition to alternative energy sources will require nonresidential construction in 2023 and beyond.

On the residential side, the pent-up demand for housing, especially at more affordable price points, has bumped up against steep inflation and supply chain issues for materials. The recent jump in inflation is keeping more consumers on the sidelines as these would-be home buyers find themselves priced out of the market, creating an added headwind for new-home construction.

Multifamily residential strength

However, multifamily residential construction is expected to remain robust into 2023, especially in certain geographical locations, such as Dallas/Austin, Texas; Denver/Rocky Mountains, Colorado; Utah and Phoenix/Scottsdale, Arizona. Housing shortages will continue to exist, especially in many lower- and middle-income markets.

Construction costs jumped about 9% on average in 2022. While inflation will continue to be a concern in 2023, the rate is expected to be in the more manageable 4% to 6% range on an annualized basis.

Here are four focus areas for the year ahead:

1. Focus on recruitment and retention

The labor shortage is an ongoing challenge for contractors due to retirement and an insufficient number of people entering the trades. The war for talent has become a top initiative for contractors focused both on attracting new hires and retention of existing workers.

Construction companies are becoming more involved in creating apprenticeship programs and working with local high schools and technical colleges to spur awareness and interest in the construction trades. They’re also initiating signing bonuses and offering other benefits to attract the next generation of employees.

Beyond the recruiting challenges, construction companies are doing more to retain their current workforce through retention bonuses, deferred compensation and other incentive-type plans.

Less tangible but just as essential to retention is working on culture issues. Construction companies that develop strong teams and foster collaboration to create a sense of appreciation and value are likely to have more satisfied workers who stay around — this is as important for the office employees as those on job sites.

2. Address succession planning

The pressure some owners are feeling from labor shortages may be accelerating their exit from the business. The brisk pace of recent M&A activity has highlighted this trend: Contractors, often headed by an older generation with no viable succession plan, are looking to retire and more likely to be acquired by contractors with younger leadership looking to grow.

Opportunities to maximize value can be missed when contractors fail to properly address succession. Often consumed with their day-to-day work, they are not focused on planning for the next generation of leadership, whether it’s for a family member to take over or to sell to existing employees or an outside party. Succession planning should be a component of an overall growth and perpetuation strategy, not a standalone event.

The labor shortage with suppliers of materials has an indirect impact on the construction industry as it has created supply chain issues and has attributed to material escalations. These issues are likely to continue into 2023, so it’s critical that contractors understand and address these issues as they bid and schedule work. This should start with a review of contract terms and procurement policies. Changes may be necessary to address uncertainties with pricing and delivery, as well as the impact on schedule. Job oversight will need to tighten in order to avoid profit fade and claims.

For general contractors, subcontractor qualification is becoming more important as a risk mitigator. Ensure the subcontractor is in good financial health and has the capacity to perform the work. Be aware of how they will be procuring materials.

3. Manage digital transformation and cyberthreats

Technology adoption in construction has lagged compared to manufacturing and other industries. But game-changing opportunities are emerging.

Advancing technologies may alleviate some of the labor pressures as robotic process automation, machine learning/AI and virtual design tools lower the need for many mundane manual tasks and allow for current employees with depth and breadth of industry knowledge to work on value-added tasks. Many field employees, for example, have taken over as or become leaders of their organization’s virtual design and construction teams or innovation teams.

Data integration and analytics should also streamline functioning of the front office, field and back office. Business development, estimating/bidding, project management and accounting can (and should) all be connected — with transactional or time/quantity data entering enterprise systems just a single time and flowing through to other systems or dashboards automatically. The opportunity to get away from the siloed, disparate systems will be a boon for firms that embrace these opportunities, empowering people to make data-driven decisions with timely information.

While the industry overall has not been quick to sign on to new tools, preliminary interest is growing as parties come to understand the improved efficiency and cost effectiveness. Bottom line: Construction leaders committed to performance optimization stand apart from their competitors and are well positioned to grow their business faster and withstand any economic downturns.

Accompanying digital transformation are increased cybersecurity risks. Smart firms recognize the need to upgrade security and conduct regular and thorough threat assessments of their systems and organizations (including their most important asset — their people). Multifactor authentication, end-point detection and response, and social awareness and engineering efforts are critical to promoting online safety. Cyber insurance policies, though expensive, are also an essential cost of business that offer protection and peace of mind.

4. Take advantage of favorable tax policies

New and expanded green-building tax incentives for the construction or improvement of real property are among the hallmarks of the Inflation Reduction Act, enacted in 2022. With changes to the 179D commercial building deduction and the 45L home tax credit, the act incentivizes the construction and renovation of energy-efficient buildings. The measures expand the qualification requirements for the deduction and raise the maximum deduction value from the current maximum of $1.80 per square foot to $5 per square foot.

With the government pushing alternative energy manufacturing, the potential for additional tax credits related to solar and other renewable sources is high going forward.

Additionally, while the bonus feature of 100% depreciation of equipment ended in 2022, the 80% write-off continues for next year and continues to be a valuable opportunity for reducing taxable income. Because eventually this accelerated deduction will wind down completely, contractors should seize the opportunity for tax savings while they can.

Another issue of concern is eligibility for the Employee Retention Tax Credit (ERTC). While employers may still be eligible to make those claims for 2020 and 2021 wages by amending tax returns for those years, business owners should use caution when determining if they qualify for the credits. The “safe harbor” rule using a reduction-in-revenue test by quarter is the safest option for determining qualification. Some businesses, like many contractors, were deemed essential business during government shutdowns and may not be entitled to claim the ERTC without demonstrating the reduction in revenue.

How Wipfli can help

The economic conditions and related uncertainties facing the construction industry raise various challenges that can threaten your business. Wipfli’s construction team can help guide you through these challenges and provide solutions to optimize your performance and prepare you for the future.

Contact us to learn about our construction industry support services.

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Author(s)

Brian Bohman, CPA
Partner
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Matt Gelb, VTSP, MCTS
Principal
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Anita S. Mahamed, CPA, CFP
Partner
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