In the face of today’s economic landscape, the construction industry is facing a variety of business issues and challenges. These issues are not uncommon as far as business dynamics go, but there are certain characteristics that make them uniquely taxing and require specialized strategies to provide impactful outcomes.

The issues affecting virtually all construction businesses according to their unique circumstances or nuances include:

1. maximizing business operations as expenses rise and profits narrow.
2. controlling labor issues and costs at a time when wage inflation still exists, and
3. identifying and leveraging the benefits of technology without investing too heavily with human or financial capital.

Maximizing business operations and profitability

With the volume of construction projects slowing because of the economic climate, there likely will be increasing competition for projects which may put pressure on companies to sharpen their pencils to win. With other expenses including materials, labor and insurance increasing, profit margins already are being squeezed.

This makes efficient operations and a focus on profitability even more critical.

Profitability can vary significantly among general contractors, subcontractors, and specialty trades, depending on size, sophistication, and management practices.  According to the Construction Financial Management Association’s 2023 benchmarking study, in 2022 the top quartile performing construction firms averaged a 9.9% net profitability level. The overall average was a net 4.9%.

The difference between “best of class” and “average” likely can be attributed to greater efficiencies, more accurate estimating, better managing of overhead expenses, and quicker responsiveness to challenging business issues and market conditions.

Monitoring and paying close attention to cash flow trends and benchmarking profitability are among the best solutions for construction and related companies of any size to mitigate certain pressures associated with improving business and financial operations.

• Cash flow options— examining payables and receivables is imperative to understand cash flow patterns and concerns. If it takes longer for money to come in than it does for it to be dispersed, the gap can cause significant operational problems. The greater the gap, the bigger the problem(s). Typically, the only way to address that gap—as it is occurring—is to take cash from the business or to rely on the availability of a business line of credit. Each of those “remedies” has a cost.

Taking cash from the business may deplete capital that was targeted for investment in the business to allow it to grow and expand. Delaying certain accounts payable can result in credit issues. A business line of credit can be expensive, especially because of interest rates that have risen dramatically in the last 18-24 months. The long-term solution is to narrow the gap between payables and receivables. In fact, managing the gap should be part of standard operating procedures.  There is hope on the horizon however as many leading economists are projecting interest rates to start decreasing in 2024.  In a recent survey of 40 economists, completed by the Financial Times and Kent A. Clark Center for Global Markets, 35% of the respondents believe interest rates will decrease by 50 basis points, with another 26% believing interest rates will decrease between 75 and 150 basis points. 

• Benchmarking profitability is another effective solution because it identifies what processes and procedures are working well and making a positive contribution, and those that are creating a financial deterrent to the business. For example, the benchmarking analysis should lead to identifying systems that can improve operational efficiencies by capturing overhead expenses in the bidding process. This analysis can also look more closely at and evaluate alternative ways of doing business that may have become standard but should be re-evaluated, such as whether to buy, rent or lease equipment.

Controlling labor issues

The cost and availability of labor are increasingly important and challenging issues. Based on data from the Bureau of Labor and Statistics, in the construction industry there is an employment gap of more than 4 million jobs: the difference between the number of job openings and the number of people actively looking for employment.

While there may be seasonal peaks and valleys, it generally is an issue that knows no geographic boundaries. Further, the issue is not unique to the availability of labor, but the costs too. Traditionally since at least 2016, construction wages have increased on average 2.8% to 3.8% per year, according to the Bureau of Labor Statistics. However, in November 2022 the annual rate of increase averaged about 6.1%, according to ConstructionConnect. That’s a sharp increase, even if the rate has experienced a slight flattening lately.

Historically, employment in the construction industry, which is physically demanding, could be lucrative, especially considered with other employment options. More recently, the gap has been narrowing. With employers like Amazon and McDonalds paying $18 to $20 an hour with limited or minimal physical demands, people who otherwise may have opted for a construction job are finding other opportunities. The older people get, the more they look for a job that isn’t as physically taxing.

In times such as these, where there may be a limited number of potential job candidates, construction firms can turn their attention to a couple of different solutions, one that is direct and one that is more universal.

• Incentive and compensation planning—when the pool of available workers is constricted it becomes more important than ever to retain the employees the company already has in place. Further, employee retention isn’t just about the hourly wage and paycheck. Therefore, a more comprehensive incentive and compensation planning exercise may be critical. Such an evaluation can help conceptualize creative programs that will keep people engaged and loyal to the company. Among some of the examples that can provide tangible, quantifiable employee loyalty and performance incentives include:
• Clearly defined future advancement opportunities.
• Bonus structures for those who are integral to projects staying on-time and on-budget; this typically applies to estimators and project managers.
• Phantom stock options that reward employees who contribute to overall company performance.

Innovation and artificial intelligence

Artificial Intelligence may be one of the most consequential developments impacting all types of businesses, including the construction industry. Yet like all forms of technology and innovation, the extent to which it is being utilized varies by company and industry.

In the construction industry, the two most prominent uses include a focus on safety and 3D modeling. Drones and cameras are commonly found on job sites not only to track construction progress, but also to monitor safety issues as well as potential hazards. For example, a drone camera flying a job site can identify whether construction workers are following all safety protocols in the work they are doing and appropriately wearing goggles, hard hats and other equipment. Further, 3D modeling can help the construction team see what’s going to happen with each subsequent stage of construction.

With AI early in its infancy, especially in the construction industry, there almost assuredly will be significant change in products and capabilities over time. Of critical importance to construction firms, whose profit margins already are being squeezed, is the ability to calculate the return on investment associated with any given AI solution. This requires an analysis of the different solutions that are available, and the costs associated with acquisition and training.

Navigating today’s business challenges is increasingly challenging. Yet in most situations, with innovation, expert assessments and well-thought-out plans, there are ample opportunities to make improvements in business efficiencies, operations and profitability.

Brian Kassalen is partner and construction industry leader with Baker Tilly.

JLL Capital Markets arranged the sale of two industrial logistics centers, Northwest Logistics Center in Houston and CentrePort 2 in Dallas/Fort Worth.

JLL represented the seller and procured the buyer, Sterling Investors.

CentrePort 2 is a 430,852-square-foot, cross-dock building, built in 2017 and featuring 97 dock doors and 32-foot clear heights. The property is located in the Upper Great Southwest submarket, directly south of DFW International Airport and with direct access to Highway 360 and Highway 183.

Northwest Logistics Center is a 411,460-square-foot, cross-dock building, built in 2018 and featuring 138 dock doors and 32-foot clear heights. The property is located in the Northwest submarket of Houston, within three miles of US-290.

In 2023, DFW and Houston achieved a combined 50 million square feet of positive net absorption, which accounted for over 80 percent of total net absorption in Texas and over 23 percent of the U.S. total. Both markets continued to see accelerated rent growth in 2023, with rents outpacing the prior year by 15.6 percent in Houston and 16.6 percent in DFW.

The JLL Capital Markets team was led by Industrial Group Co-Head and Senior Managing Director Trent Agnew, Senior Directors Charlie Strauss and Parker McCormack, Directors Tom Weber, Lance Young and Pauli Kerr, Associate Matthew Barge and Analyst Brooke Petzold.

The industrial sector faced a challenging year in 2023, marked by sluggish growth attributed to various obstacles such as elevated interest rates, inflationary pressure and reduced sales and leasing volumes, according to the fourth quarter 2023 JLL industrial outlook.

According to data released by JLL, net absorption in the U.S. industrial sector remained largely unchanged in the fourth quarter from the previous quarter, standing at 44.1 million square feet by the end of 2023. This brought the year-to-date net absorption figure to 214.8 million square feet.

Markets traditionally known for robust absorption figures, such as Atlanta and New Jersey, experienced reduced or negative absorption in the fourth quarter, according to JLL. Factors contributing to this downturn included deferred occupancy plans in new deliveries and occupiers opting for more cost-effective markets.

While the historical quarterly net absorption high of 141.7 million square feet recorded in the fourth quarter of 2021 remains unmatched, analysts emphasize that the current absorption levels indicate only a slight decline compared to pre-COVID levels, which averaged around 59 million square feet quarterly.

Over the past five years, just more than 2 billion square feet of new industrial space has been delivered in the country, with 593.5 million square feet added during the pandemic, contributing to a 3.8% increase in total industrial inventory in 2023.

With the influx of new deliveries, vacancy rates saw an uptick of 230 basis points from the previous year, settling at 5.7% by the end of 2023. Similarly, new industrial construction starts continued to decline in he fourth quarter of last year, with only 407.6 million square feet currently under construction. Factors such as the cost of capital, inflated land prices and fluctuating material costs have contributed to this slowdown in construction activity.

Despite the challenges, leasing volume experienced a 14.8% increase from the previous quarter, reaching 105.7 million square feet. Rental rate growth, however, saw only a modest 1.6% increase quarter-over-quarter, although the year-over-year increase measured 12.3%, elevated from pre-pandemic averages. Occupiers remained cautious in finalizing new lease agreements, prolonging the decision-making process.

Looking ahead to 2024, JLL analysts anticipate a positive outlook with an expected increase in activity driven by pent-up demand from occupiers who delayed new deals over the past year. New deliveries surged 14.8% year-over-year, reaching a new high of 171.8 million square feet. The top five markets for deliveries in 2023 were Dallas/Fort Worth, Houston, Eastern & Central Pennsylvania, Savannah and Chicago, collectively delivering 187.6 million square feet.

Despite the challenges, there were some bright spots in the industrial landscape. The preleasing rate on new deliveries rebounded slightly with a 3.4% quarter-over-quarter increase to 33.8%. Manufacturing projects, in particular, saw a significant uptick, now accounting for 10.5% of the total square footage under development.

The Savannah, Phoenix, and Austin markets emerged as hubs for large-scale EV and chip manufacturing endeavors, with manufacturing sites recording a 74.8% increase in square footage under development compared to the previous year.

Looking forward, JLL analysts predict that new construction starts will be driven not only by the nearshoring trend affecting manufacturers and their supply chains but also by the need to replace aging industrial buildings with more efficient ones. Locations capable of providing heavy power and water are expected to be in high demand as manufacturing activity continues to progress.

Mention rates in a room of commercial real estate professionals and their first thought likely goes to interest rates. As crucial as the actions of the Fed are to development, there’s another rate property owners need to keep tabs on: insurance rates.

“Insurance companies had to raise their rates due to losses over the past few years,” explained Ryan Nolen, an independent agency owner with Goosehead Insurance in Richmond, Texas, citing Hurricanes Ian and Ida in recent years.

Navigating the complex landscape of commercial property insurance has become increasingly challenging in the face of those rising risks and costs. According to Joe Minden, Producer at Swain & Baldwin Insurance in the Dallas area, the trends observed in 2023 reflected a consistent theme in risk management.

“Rates had increased. Markets had hardened on their coverages. Capacity had shrunk in certain areas, particularly coastal exposures,” noted Minden.

The challenges faced by CRE owners were notable, particularly in managing higher insurance costs that impacted their bottom line more than anticipated in their financing models. These elevated insurance costs posed a challenge to their net operating income and became a factor complicating the feasibility of penciling profitable deals in 2023. It’s a scenario in which a competent and trusted insurance partner is critical.

“I was extra proactive during this time, reaching out to my clients and going over their coverage and ensuring I’m doing my job,” Nolen shared.

This proactive approach underscores the importance of constant communication and reassessment to adapt to the evolving landscape of commercial property insurance.

“It is important to work with owners well ahead of time to prepare precise data for underwriters to assess and price habitational risks as accurately as possible,” he explained.

Additionally, having strategic conversations with owners about structuring insurance coverages and deductibles plays a crucial role in aligning with their risk tolerance while meeting loan compliance requirements.

Nolen also offered a crucial piece of advice, emphasizing the importance of comprehensive coverage tailored to specific needs: “Just because it’s cheaper doesn’t mean it’s better. Ensure you’re fully covered!”

As businesses look ahead to 2024, Minden advised a cautious approach.

“News sources seem to be pointing towards a moderate year for insurance in 2024. It is advisable to still be conservative on budgeting given how volatile the markets have been over the recent years,” he suggested, highlighting the need for continued vigilance and strategic planning.

In light of these challenges, Minden highlighted the proactive role that Swain & Baldwin Insurance has played.

“Our agency has helped owners place their risk with unique programs that we operate tailored for their asset type,” he shares.

Furthermore, Swain & Baldwin Insurance has implemented captive strategy programs for owners with sufficient size, offering a financially feasible solution that provides owners with more control in their risk management.

Nolen also extended his commitment to assisting businesses with their insurance needs.

“I’d love to help them out. At Goosehead Insurance – The Ryan Nolen Agency, I can shop more than 70 companies in the State of Texas to help protect your personal or commercial risk,” he offered.

As businesses grapple with the uncertainties of the commercial property insurance market, insights from Minden and Nolen highlight the significance of proactive engagement, strategic planning and a nuanced understanding of economic trends to make informed decisions in an ever-changing environment.

The NRP Group in partnership with The City of Killeen Public Facility Corporation, J.P. Morgan, and Texas Capital Bank, last week celebrated the grand-opening of Station42, a 368-unit mixed-income multifamily project in Killeen, Texas.

Station42 showcases NRP’s dedication to offering quality housing for Central Texas residents at all income levels, with a focus on the “missing middle” who face challenges affording market-rate rents amid the region’s rapid population growth. To meet this demand, more than half of the property’s units are reserved for residents earning less than 80 percent of the area median income (AMI).

Located near the corner of W.S. Young Drive and East Veterans Memorial Boulevard, adjacent to Conder Park, Station42 boasts a robust onsite amenities package. Residents will have access to a 24-hour fitness center, club room, gaming area, kitchen and dining space, and a coworking lounge space complete with two tech-enabled conference rooms.

The development’s outdoor amenities include a dog park and entertainment area with dining space, a resort-style pool and a grilling deck. A package concierge and private, detached parking garages with EV charging stations are also available. The property is in proximity to Killeen’s historic downtown.

In-unit finishes include keyless fob entry, in-suite washers and dryers, LED backlit mirrors, built-in USB ports, and, in select units, balconies are available. Kitchens feature stainless steel appliances, maple white quartz countertops, white brick kitchen backsplashes, undermount sinks and under-cabinet kitchen lighting.

Killeen has a population of nearly 160,000, making it the 19th-most populous city in Texas and the largest of the three principal cities of Bell County. Due to the city’s proximity to Fort Cavazos, Killeen’s local economy is interconnected with the activities of the post, and the soldiers and their families stationed there. 

J.P. Morgan partnered with The NRP Group to provide equity investment in the project, while construction financing was provided by Texas Property Bank.

OHT Partners LLC has broken ground on its second upscale apartment community in one of Houston’s busiest submarkets.

Lenox Timbergrove, the 293-unit, five-story complex is rising at 2825 W. 11^th Street. The site is in the heart of a burgeoning area just west of the Houston Heights and north of the Washington Avenue corridor in the Lazybrook/Timbergove area. 

The 5-story, Class-A complex will feature studio, one, and two-bedroom units ranging in size from 500 to 1,150 square feet. Each home features: modern designs, stainless steel appliances, quartz countertops, smart-home technology and more. Community amenities include: a resort-style pool, outdoor pavilion with gas grills and kitchen, indoor pet spa, 24-hour co-working space, artificial turf game lawn, and more.

This is the second recent luxury apartment community start in the Greater Heights / Washington Avenue submarket of Houston for OHT Partners. This past May, the firm broke ground on Lenox Heights, a 359-unit community less than three miles away at 333 W. 24th Street.

The project is slated to open its doors near the end of 2025, and rental ranges will be determined closer to the project’s opening date.