The supply constraints caused by the COVID-19 pandemic brought about significant upheaval in the construction sector and continue to drive increased costs, risks and delays. Here are four ways to mitigate the impacts.
It’s no secret that many industries faced serious and damaging consequences as a result of the pandemic – and the construction industry was among the most significantly affected. Cost volatility, supply issues and on-again/ off-again lockdowns created turmoil – while demand within the industry skyrocketed. As developers face ongoing uncertainty, strategies to mitigate impacts are essential.
The impact of rising costs on project financing
Driven by supply constraints in 2020/ 2021, construction costs across the country began to noticeably rise. Early in the pandemic, lumber prices reached an all-time high at $1,670 USD per 1,000 board feet. In July 2021, steel prices were up 51 per cent year-over-year, the biggest YOY increase on record. Today, window and metal costs remain volatile.
As costs elevate, the margin on any given project could shrink if not offset by an increase in revenue, causing a once-profitable project to become unviable and difficult to finance. Project delays caused by supply shortages can also lead to further cost increases, fueled by additional interest and change orders. If there is a budget increase mid-construction, lenders may not be willing to fund the full increase (if any), which could force the project sponsor to inject additional equity.
It’s hard to say how long this volatile and uncertain environment will last. Will supply chain issues be resolved in the next year? Can contractors reliably bid on construction elements? Will demand for materials subside as easing travel restrictions decrease the pace of home renovation?
Unfortunately, we can’t predict the future. Instead, developers and sponsors can plan ahead to limit the impacts that could jeopardize the profitability of projects. Here are four ways to do so:
1) Have sufficient contingency
A contingency is always an essential part of any construction budget, but given the current landscape, it’s worth building in more buffer to account for fluctuating costs of materials, equipment, labour and subcontractor work. A recommended contingency to plan for is 5% of hard costs or 3% of the entire budget (excluding land), will help maintain the viability of your project’s financials, protect yourself against risks and safeguard your margin.
2) Initiate fixed-price contracts
Establishing a fixed-price or lump sum pricing method during your pre-construction phase is usually a favourable move when there is a clear scope and defined schedule for your project. It also makes good sense when the future cost of materials is uncertain. In today’s environment, when it’s tough to know if supply or transport issues will continue, locking in a price now can help protect your bottom line.
3) Pre-purchase supplies
Shortages in lumber, windows and copper (to name a few) left many developers in the lurch in recent months, as it became difficult to finish projects on time and on budget. Buying supplies in advance, especially if they’re manufactured or sourced from outside of Canada, is a move that can help you preserve both your profit margin and your project timeline. Need garage door openers from your supplier in Mexico? Drywall from China? Consider buying and storing in a secure location so you’re not stuck later. It is recommended you make arrangements with your Lender prior, to ensure they have security over materials funded.
4) Consider phased projects where appropriate
Canadians have been buying up new construction properties at record speed recently, and developers want to satisfy the demand. However, it’s wise to exercise caution and not sell too far in advance – in doing so, closing dates get pushed later, resulting in an increased risk of rising costs. Releasing homes in phases can help sustain market interest while giving developers the opportunity to set prices closer to a home’s completion date.
The last two years have been some of the most challenging times in the construction industry. By recognizing and mitigating the ongoing risks, you can reduce the impacts of rising costs and safeguard your margins.