Construction Deep Dive
BRG Managing Director Rick Fultineer and Director Bob Lewis join host Eddie Newland to discuss trends in the global construction industry. Topics include current hot spots for infrastructure construction, shortages in qualified labor, and litigation hurdles to avoid during boom times.
TRANSCRIPT
S1 01:26
Rick, from where we sit here in the second half of 2018, the construction industry is booming. What sectors, in particular, are you keeping an eye on?
S2 01:35
We're always keeping an eye on the large industrial sectors. That includes the energy sector, which typically, we're talking about power, and oil, and gas type projects. These projects are complex. They're industrial projects. They're usually very large dollars. And we're seeing a lot of those both in the areas of new construction as well as potential disputes in the international arbitration area.
S1 02:04
Are you seeing similar things from where you sit as well, Bob?
S3 02:08
Yes. But perhaps on a more global issue, yes, construction's up. There are some significant trends in various parts of the countries. Obviously, here in the States, geographically, the growth is in the south and west sections of the country, as well as our local condition up here in Pennsylvania relative to the Shell gas expansion.
S1 02:35
In particular then, Bob, you just mentioned that geographically, there's certain areas that are growing in different sectors. What is it about the South, in particular, perhaps the West right now that is seeing the most rapid growth or is experiencing the greatest expansion?
S3 02:51
It is somewhat energy-related. It's also a population shift. And if you talk about some of the current events that are occurring, obviously, the flood damage that occurred from a previous hurricane has been a big boost for construction, as well as the current fires that are ravishing throughout the southwest.
S1 03:13
Yeah, and that's interesting that you mentioned sort of the natural disasters, if you will. Rick, when you guys are monitoring the market and keeping an eye out for bigger projects or ones that might be lagging a couple years behind because there was, say, a natural disaster three to five years ago, and the construction's coming up, are there any phases of which you would consider touch points in the industry where it's three years removed from a natural disaster or five years where construction has been greenlit but then might be running into some sort of issues?
S2 03:47
That's an interesting question because when we have natural disasters, it creates a whole life cycle of repairs, remediation, as well as new projects in those areas. So we see an immediate need, which has a significant drag on the local labor. It has a drag on the sourcing of equipment and materials needed to first get involved with the remediation and repairs, but later, to support the larger projects which end up being a year or two off. And three years is kind of on the outreach of that. Issues that we see, a huge grab for labor. And it becomes very difficult to get labor. And the labor that you get becomes less and less skilled. So you see the inability for these projects to be performed efficiently and within budget, which leads to disputes and litigation on projects.
S3 04:50
Those same demands actually influence the cost of the issues. Obviously, labor, Rick touched on. But we can look at a couple of significant elements relative to what this demand has done for the prices of materials. And in general, construction materials are up like 9% from this time last year. And lumber being a huge residential component in construction costs is up 19 and a half percent the last time I looked. So those are significant influences that are going to affect decisions on how things get built, when they get built, and how readily available materials are going to continue to be.
S1 05:38
When you look at it right now, without getting anywhere on the political spectrum, but do you think that the tariffs have an effect on where these material prices are going? Or is this just a natural cycle in the market that because construction's booming, suppliers are looking to get a little bit more for their product?
S3 05:56
I think we're looking at a period that these increases have yet to see the tariff influence significantly changing the amount. And that's concerning from the standpoint that, well, lumber was a significant increase. Obviously, the tariff's potentially being assessed on steel. Steel is already up 13.4%. And we could expect some greater influence as those tariffs take a greater participating role.
S2 06:27
It's an interesting time in the industry with the potential tariffs being put in. And again, it seems like it could get resolved at any time. But right now, it's certainly on the way of an international war. And that's a significant risk that I don't think we've really considered a great deal in the past. We've always thought about the effects of pulling on the labor pool, inflation, other issues that can affect the cost of equipment and materials. But that's a whole new one that is kind of in the picture. And it's potentially going to affect the work in our backyard, southwestern Pennsylvania, which is a bit of an oil and gas mecca right now. But it's going to affect the big projects down in Texas and on the coast of Louisiana in the oil and gas sector as well.
S1 07:24
Two of the things that you guys've mentioned here so far are the costs of labor and the cost of supply. So looking forward a little bit at potential disputes because that's a lot of the work that you all do, if I'm in construction right now and I'm planning to have a project, which would you consider to be the most volatile? Would it be a possible labor shortage in a particular region when you're trying to do a number of projects or put a project together? Or would you be more concerned about the possibility of rising prices for the supplies?
S3 07:54
Labor becomes the more difficult one to assess from the standpoint that it's not so much the dollar wage that you need to anticipate, but it becomes the productivity issue, the quality of the workmen that become available. And that's much more imprecise in being able to make an assessment. I think you can look at the trends in material and make a realistic projection as what your expectation might be over a period of time; a little bit easier to refine a projection.
S2 08:27
I think I agree with you completely, Bob, because it's in the labor category, which typically represents an area that is very difficult to gauge. It's where we see the overruns really increasing dramatically by exponential numbers rather than via certain percentage. I also see the ability to deal with volatility in the equipment and materials from a contractual standpoint where you can justify that a certain cost of that material due to the unknowns went up or down significantly. But you do need to get that point into your contract between an owner, and the EPC, or whatever kind of contractual arrangement that you have.
S1 09:21
And that makes plenty of sense. Let's take a step back then from a broader perspective. And Rick, I'll ask you this question first. Right now, the good times are kind of rolling. Do you think that this is something that will continue with the construction industry for a while? Or do you see possibly the cycle changing soon on the horizon?
S2 09:40
I don't see a break right now. I see, from an economic standpoint, the US is very strong. China appears to be very strong. The markets, the different locations in the world, are asking for infrastructure and projects. So I really don't see an end in sight. It will clearly be a cycle. Whether it's a three to five year or greater is really an unknown.
S1 10:09
Would you have anything to add to that, Bob?
S3 10:12
The rate of increase will continue to be a relatively steady base growth as certain regions get some sort of build out and other areas come up to play. And I think an example of that would be the hurricane damage in the South. Once that's done, focus would have to be in some other regions, which would likely occur.
S1 10:34
But what happens when-- it's now hurricane season. It's coming in the Atlantic. We just saw it a little bit in the Pacific with the near-miss in Hawaii. But if you've got a construction project going on right now, and it happens to be in the path of, say, in Florida or Georgia, in the path of a hurricane or hurricane season, what sort of contractual things would people want to make sure that they have if you're operating in these regions to ensure that you're not eventually leading yourself into litigation because of disruptions that come from natural disasters? Is that baseline? Everybody has that? Or do you find that some people don't do enough to incorporate or protect themselves in that regard?
S2 11:15
I'll go first here because we have been involved with a number of projects that've been hit by hurricanes. One actually was hit by seven hurricanes, which was a very large oil and gas related project. Generally, there are policies and procedures. It's important to be prepared to comply with those policies and procedures that are in place. I don't think anybody is ever prepared for a massive hurricane like we've seen in the early 2000s, which just caused massive destruction. But it is important to follow your organization's plans, disaster recovery, and be prepared if a hurricane goes off target and ends up hitting one's project.
S3 12:04
Yeah. I think contractors in themselves are prudent with regard to what steps they can take to try and minimize the impact. But at least in the last two or three years here, we've seen not just hurricanes as being issues, but significant rainfall conditions and tidal movements that may, in essence, need to rethink stormwater management controls in various regions. That can be an expensive endeavor in urban areas as well as some of the lower living cities. They've got to comprehend things in New Orleans, and Hawaii, and probably Venice that the rest of us don't even have on our radar.
S1 12:55
Yeah. I imagine certain regions probably pay a little bit more attention to these things as they go about their planning and due diligence. Circling back to the labor shortage just because you guys have mentioned it a couple of times now. When you've been working with different companies facing these problems, are there any takeaways or lessons that you have for clients going through past boom periods to how they can address the labor shortage? And then when it comes to having to maybe drop down in the skill level of the workers, are there ways that you can sort of ease that problem? Or how do you advise companies and contractors when you're working with them in that space or in relation to that issue?
S2 13:39
My general comment here is that you need to recognize it as a significant risk. Many contracts put the onus, or responsibility, or risk of this onto the contractors. And it's almost incumbent upon them to realize it's out there and either prepare with a contingency or at least get the discussion out with the owner on what may be coming and how it may affect their pricing. That said, I've very seldom really seen that put in place. Now, from a monitoring or mitigation standpoint, there are controls that can be put in place both by the contractor and owner to attempt to recognize it as it's happening and potentially reach out with incentives or accessing labor from different urban areas across the country to mitigate the impacts of this. A big concern is finding labor where a lot of these manufacturing, or power projects, or oil and gas projects are because they aren't by an urban area. They're potentially out in the middle of nowhere. And the recognition that it's going to be an issue getting labor for that particular project needs to be recognized early, and discussed, and addressed in a contractual way if possible.
S1 15:11
Would you have anything to add to that, Bob?
S3 15:13
There has to be some consideration of an expanded partnership with construction trade unions also. I think they have, during the slower times, somewhat restrained the expansion of their craft personnel lists. And they need to shift their paradigm to an expanding role if they're going to continue to provide sufficient qualified employees. What also you need to be concerned about, I think, is some of the contractors are using this shortage as considering going non-union. That definitely can have a impact on quality and productivity because it's much more of an unknown than perhaps lesser skilled resource of labor.
S1 16:04
Now, have either of you guys, in the different consulting work that you've done, run into the issue of just-- when it comes to labor shortage, it's not that the laborer is less skilled or the union hasn't brought it up, but maybe that the union itself doesn't have enough interest in a particular region to be able to supply the workers that are needed for a given project so that perhaps they're having to actually bring in folks from different areas just to be able to meet the demand because there's not enough people period, let alone, those that have any form of skill in a certain area?
S2 16:40
That becomes a very significant issue is that an area doesn't have the labor or the specialized labor to support these projects. And it is not atypical at all to see labor drawn from many areas in the country; optical travelers. They're generally housed within the area or near the project. So that's not an uncommon situation at all.
S1 17:11
Taking another step back, obviously, a lot of the work that we do here at BRG and that you guys do is around litigation that comes out of the different areas of expertise. So in your instance, it's construction. What we find in a lot of different industries is that when times are booming, there seems to be a little bit of a slowdown in litigation. But then when it slows back down, issues pop up, and that's when people turn to the lawyers and things come about. What are some of the pitfalls that businesses, whether it be owners or contractors, leave themselves open to during the good times but perhaps come back to bite them down the road? We'll start with you, Bob.
S3 17:49
A very evident one is the good times promote very aggressive scheduling, and time demands, and restraints on when the deliverables must be completed. And sometimes they create very unrealistic expectations. And that ends up resulting in disagreements or disputes at the completion of the work. Obviously, we've gone through cycles where changes in financing and funding in the capital markets have influenced construction activities.
S2 18:26
In good times, we see contracts written on the back of a napkin. They might be a purchase order with instruction to a contractor to just get the project done. And we'll worry about issues later with the thought that issues won't come up. And they're often issued under very aggressive completion dates. I like the word, Bob, that you used, expectations. And when those projects go south, or if you start to see significant overruns, you do have a challenge between the owner and the contractor who may've spent all the money at that point that they had budgeted in resolving the matter. And we've seen numerous disputes occurring as a result of this situation. One area that I'd highlight is kind of the pipeline industry in oil and gas. I mean, our recommendation is regardless of the project, make sure you, as an owner, have somebody involved making sure that you're got a fairly tight contract, there's an agreement in place, and there's something that you can really hold the contractor to as the costs are to skyrocket due to many of the issues that we've been talking about.
S1 19:48
It definitely sounds like, in a lot of these instances, sometimes I'm sure you have more sophisticated owners and contractors. But a few too many might just be looking to do this to get advantage and get as much work on the books as they can. And unfortunately, sometimes that can come back to cost you. Let's just sort of end this conversation with a little bit of historical perspective. Is there a point in either of your careers-- you've both been involved in the construction industry in different parts for a number of decades at this point. Is there any point in your career that this particular time the industry reminds you of?
S3 20:22
Well, certainly can take us back into the last time we had good times and we saw some of the wheels fall off of it back a couple of decades ago. But I think in my crystal ball, I would reflect on recommendation that everybody who is involved in a construction project realizes that making a decision has played such a significant role, or the absence of making a decision, into the crisises that evolve on the projects and be focused on the need to be objective and fair in a timely manner to provide clear direction when issues need to be defined or adjusted.
S2 21:10
It reminds me of many upswings and downswings. Well, really, more upswings, I guess I should say, that we've had in the infrastructure area. Power, and oil, and gas always come back to mind. And I feel like we were on an upswing a matter of 8 to 10 years ago that've had some very large projects. We're seeing problems with them now. We went through a bit of a downswing with the effects of the oil prices. And now, you're seeing an upswing again. So it reminds me of many of the cycles. I'm not sure how strong this one is relative to the last one. But each one are unique, and they affect the industry differently. But there's some obvious lessons learned that you can take and apply to your upcoming projects during all of these cycles that've been out there.
S1 22:06
Well, guys, thank you so much for your time.