Tuesday, November 7, 2017

Current Outlook and Architectural Billings Index

One of the questions I’m often asked is “What do things look like out there?”, typically followed these days with “How long will these better times last, when will it end?”.  Every contractor has their own experiences, their own challenges and successes.  The generic answer needs to address the “typical” experience out there, the contractor who falls somewhere in the middle of the bell curve.

The answer I give today is things are generally pretty good out there, not as euphoric as it was just prior to the great recession, circa 2006 or 2007) but increasingly good in recent years.  My perspective is that things bottomed out, for the average private commercial/industrial contractor, sometime in 2012.  Each year since 2013 we’ve seen further modest improvement, stabilization and good earnings for contractors here in Southern California.

Frankly, a few years ago, I thought based on listening to economists and others that 2017 might be the peak and we’d fall off from there for a while.  Well we are within a handful of weeks from getting out of 2017 and things still look pretty good.  Backlogs are strong into 2018, with some of my clients reporting commitments into 2019. Business optimism remains strong.    Of course a large geo-political event could put work to a halt like we saw after 9/11, commitments notwithstanding.  That being said, it looks like we have good times for the foreseeable future and we can only hope it continues.  

The concept of "reversion to the mean" creeps into my mind as we currently enjoy the 3rd longest economic expansion in U.S. history.  Hopefully the Federal Reserve and others whom have control over how our economy behaves pull on the all the appropriate levers in all the right ways at all the right times, or something close to that metaphor.

A quick look at the Architectural Billings Index, a leading indicator we’ve touched upon a number of times over the years on this blog shows that here in the West, things appear to have softened some with a reading of 48.4 for September 2017.  These numbers are just indications of work to be performed, more of a guideline than a rule.  If you aren't familiar with how the index works, click on the link in the preceding sentence for more background.  One poster on the AIA website from the West indicated that a few of their projects were put on hold, citing rising construction costs and labor shortages.  Interesting, makes sense given the data out there, particularly with the historically low unemployment levels we are currently experiencing.


These regional numbers for September 2017 are shown in the table below:


West
South
Northeast
Midwest
National
September 2017
48.4
54.0
56.9
50.4
49.1

By contrast, taking a look back to July 2014 numbers, we see the following:


West
South
Northeast
Midwest
National
March 2013

51.9
53.6
54.6
53.9
51.9


Perhaps the lower input costs for materials in 2013 as well as the more available labor market created conditions for increased construction activity, correlating to our experiences in 2013 and the ensuing years.  At that time, the unemployment rate quoted by the Bureau of Labor Statistics for March 2013 in the West was 8.3%, the highest in the nation with supply of labor more available than today.

Could the current labor market and the implied labor shortages be a precursor to slowing construction activity?  Or possibly stable construction activity with increasing prices?  Inflation in construction inputs could also be a factor to watch.  For the immediate future, it seems to be steady as she goes.  

The actionable takeaway from this data is to always be vigilant regarding your fixed overhead, keep it low and be prepared to make dispassionate decisions regarding your variable costs, including your labor.


Sunday, November 6, 2016

LA Stadium Project - Marquis Projects, To Pursue or Not Pursue

The much anticipated Inglewood stadium project plans are well underway, and with that the construction marketplace resources required to execute on this $2.6 billion dollar project will be spread that much thinner.  The stadium itself is expected to be completed in 2019, with all the surrounding development (labeled a “mini-city” by some) expected to be finished by 2023.  Many contractors will eagerly pursue work on such marquis projects leaving limited resources in the market to conduct other, recurring construction activities.  This drawdown on the supply of construction resources to the LA stadium project, as well as a host of other larger high profile projects online or soon to come online, could be a support for the pricing of all other projects.  This is welcome news for the southern California construction economy.

Contractors who work on marquis/trophy projects most certainly have the privilege of saying they worked on XYZ project.  What I've seen over the years is often times, in the final analysis, the financial performance of those projects doesn’t work out quite as originally planned.  Contractors may end up “paying” for the right to say they worked on a special project.  That payment is only financial, the stress involved in executing these large projects is not measured in dollars.  Why do these projects, in some cases, not turn out as originally planned?  For starters these contracts aren't the type typically executed by the contractor.  The factors involved are usually different than most every type of job a contractor has ever done before.  Additionally, sometimes the owners of these projects can be very tough on changes, having the attitude that the contractor is “lucky” to be associated with such a name brand company/project.  Generally, the contractor just bit off more than they could chew.  The technical challenges could be new,  perhaps it's their largest contract ever, or working in a new geography they weren’t familiar with or able to effectively manage.

With the above being said, one strategy might be to steer clear of the stadium project and focus on other opportunities.  Like I mentioned, there may be a built-in support for pricing giving the supply/demand impact the stadium project is likely to have on construction resources.  It might be worthwhile to not participate on the stadium project and do other work which should have good pricing opportunities. 

Some contractors I’ve spoken with have relationships with large contractors already committed to the project and consequently, will also need to work on the project due to that relationship.  Those cases are fine as long as the history generally supports that the smaller contractor will be taken care of in a fair manner.


I am not saying that a contractor should not consider pursuing large, trophy projects.  I am saying to carefully measure the opportunity, reconcile it with your capital (including bonding capacity utilization) and personnel structure, capacity, skillsets, and your other backlog.  Also consider the opportunity cost regarding other potential projects if you don’t take on such a large contract.  Although it may be more expensive to administer ten $2MM projects, the concentration risk associated with executing one $20MM project could be too great.  So consider whether it makes sense to pursue a large, marquis project…especially if it is different than anything you’ve done before.  Remember the old saying…”discretion is the better part of valor.”

Sunday, November 15, 2015

Piece-Rate Compensation - AB 1513 and its impact on contractors

On October 10, 2015 Governor Brown signed AB1513 into law.  The modifications to employment law that AB1513 made deal with workers’ compensation and piece-rate compensation.  This post addresses the latter.

A few industry associations asked a law firm to provide an opinion of the new law as it relates to piece-rate compensation.  The law firm did an excellent job addressing the various points of the new law.  You can view their memorandum here.  Their memorandum outlines the “safe harbor” provisions contractors will need to comply with, by December 15, 2016, in order to avoid fines and penalties.  The changes required by the new law may prove costly for contractors whom have historically compensated their workers on a piece-rate basis.  At a minimum, changes to how these contractors compensate their employees in California appear to be on the way.

A significant element of the changes have to do with contractors being required to pay workers for rest and recovery periods and other non-productive time.  The administrative requirements being imposed by this new law all but assure the demise of piece-rate pay, at least as it has been known historically.  If you have been compensating workers on a piece-rate basis and you want your voice to be heard regarding these changes, I suggest either connecting with an industry association (as referenced in the memo linked above) or contacting your local state representative directly.  In the meantime, you need to become aware of the issues and requirements surrounding the new law and act accordingly.

Sunday, February 22, 2015

Controlling Workers Comp Costs - Mobile First Aid

One of the highest costs to businesses in California is Workers Compensation Insurance.  For those that have done business in California for at least the last 15 years, you have experienced roller coaster like moves in rates.  Those rate swings seem to have come out of left field some in some years, with political and other market forces working behind the scenes to artificially impact those rates.  Those factors are mostly out of your control.  What is within your control is how you approach the issue of safety, how you handle incidents when they do occur, what processes you have in place to mitigate false claims as well as managing other variables.  How you address these areas will have a tremendous impact, positively or negatively, on your experience loss modification. 

One way to deal with potential negative events that would adversely impact your experience modification is to address problems at the earliest opportunity.  Some of my clients use this mobile first aid service, click here for details, to help address work site injuries as they occur.  The service is a 24 hour, 7 day a week operation and they offer a host of other services, as listed on the document along with pricing, designed to help run a tight ship with respect to your field workers.  Beyond the services they offer, I think it is a good idea to have an independent third party tend to these matters as that could benefit you in the event of litigation.

As usual, I am not affiliated with this organization in any way.  It seems like a good service worth investigating to help address these injury events as they occur.  As I mentioned earlier, there are some factors that are out of your control with respect to Workers Comp Insurance.  Creating and maintaining a culture of safety is within your control and you should do everything you can to maximize this area as it will result in substantial savings over time.

Wednesday, January 7, 2015

Tax Increase Prevention Act of 2014 (HR 5771)

Last month, Congress passed the Tax Increase Prevention Act of 2014 and the President signed it into law.  Over 50 popular incentives and credits were extended through 2014, some of the more popular of these “extenders” as they are called are highlighted below.

50% Bonus Depreciation -  The 50% bonus depreciation provisions for new, qualified business property would be extended for property placed in service before January 1, 2015.
§179 Expensing Thresholds -  Section 179’s increased expensing amounts would be extended through 2014. Specifically, for qualified property placed in service before January 1, 2015, the Act extends for one year the increased $500,000 maximum expensing amount under §179 and the increased $2 million investment-based phaseout amount. Afterwards, should there be no further extensions, the maximum expensing amount is scheduled to revert back to $25,000 and the phaseout will dip to $200,000.
Additional 179 Property – Allows taxpayers to treat capital expenditures related to qualified leasehold improvements, qualified restaurant property and off the shelf computer software as 179 property eligible for the accelerated deduction.
15-Year Life for Qualified Leasehold Improvements - Qualified leasehold improvement property, qualified restaurant property, and qualified retail improvement property will have a 15-year depreciation recovery period if placed in service before January 1, 2015.
S Corporation Built in Gains Tax – reduces the recognition period from ten years to five years on the sale of qualified small business stock held for at least five years.
Work Opportunity Tax Credit – Allows a credit of 40% on a maximum of $6,000 in qualified wages for employers who hire military veterans or other qualified personnel who began work for an employer prior to January 1, 2015.
Energy Efficiency Deductions for Commercial Buildings -  Under §179D, deductions of up to $1.80 per square foot for energy efficient commercial building property would be extended for property placed in service before January 1, 2015.
R&D Tax Credit -  Tax credits for qualified increasing research activities would be retroactively extended for one year to apply to amounts paid or accrued before January 1, 2015.
IRA Distributions to Nonprofits -  Individuals age 70 1/2 and older can make tax-free distributions of up to $100,000 per year from their individual retirement plans to charitable organizations for tax years beginning before January 1, 2015.
State and Local Sales and Use Taxes -  The Act retroactively allows taxpayers who itemize deductions to deduct state and local sales and use taxes instead of state and local income taxes for tax years beginning before January 1, 2015.  This is beneficial for taxpayers living in a state with no income tax.
Exclusion for Discharged Home Mortgage Debt -  Discharge of indebtedness income from a qualified principal residence — up to $2 million and $1 million for married filing separately — is excluded from gross income. The Act extends this exclusion to apply to home mortgage debt discharged before January 1, 2015.

Should you have any questions on any of these, as always feel free to contact me.

Sunday, November 16, 2014

Have You Revisited Your Buy-Sell Agreement Lately?

As the business owner’s average age continues to increase given the demographics of our population, there are a number of issues that may not have been perceived as important a few years ago that gain increasing attention as time marches on.  The truth is that these issues (e.g. buy sell-agreements, business continuity plans, etc.) have always been important.  There are a number of ways one can exit his/her business.  Many of those exit plans are voluntary and planned while some are not.  These agreements are often times overlooked as there is no sense of immediate need/urgency, etc.  They also generally deal with less than pleasant scenarios that people prefer not to think about.  The reality is that if you want to take care of your spouse and children, you really need to think about how your business is going to produce a liquidity event, in a timely, efficient and fair (think valuation) manner so your family can be well taken care of.  It can also be helpful to you as a shareholder if for some reason you find yourself, or your partner, having to divest from the business for whatever reason.

In basic terms, buy-sell agreements deal with situations whereby a business owner leaves the business through death, incapacitation or some other unexpected set of circumstances.  These agreements are also important in that if your partner is the one who is unexpectedly unable to continue in the business, the buy-sell agreement is the vehicle which will preclude his/her spouse from becoming your business partner.  This last item alone can be very motivational for business owners to address this issue.  

Some of the key terms addressed via a buy-sell agreement include who may buy the business interest, the events that trigger the agreement and the price to be paid for the business interest.  All of these are very important elements and must be addressed thoroughly and with professionals who are expert in preparing such agreements.  There are a few major, critical considerations which also must be addressed when structuring buy-sell agreements; 1) valuation criteria and 2) properly funding the buy-sell agreement.

The valuing of a business, or a share in a business, is an undertaking that can produce varied results.  I’ve said many times over the years you can have one valuation expert arrive at different valuations for different purposes (there are a number of reasons a company may need to obtain a valuation) at the same point in time.  You can also have different valuation firms arrive at very different results all valuing the business for the same purpose at the same time.  The best way to mitigate the potential for an unexpected and/or unfair result is to hire valuation experts familiar with your industry and business.  One size does not fit all when it comes to valuation and the selection of the right valuation firm is critical.  Valuation is contingent on many factors including methodologies, styles and perspectives, who the valuation firm is hired by (buyer or seller), etc.  Within the context of a buy-sell agreement, valuation is further challenging in that the principals are not necessarily looking for a value today, rather the goal is to ascribe a value to a business, or share of a business, at some unknown point in the future. 

The best way to handle the valuation issue in a buy-sell agreement is to have a valuation performed in the first year and then get annual, less expensive updates to that valuation in subsequent years.  Using this process, the many variables associated with properly valuing a business can be addressed given the set of conditions present at that time.  It is impossible to build a formula that will successfully process all of the variables that can change in the future.  That being said, in addition to building in a valuation requirement, it makes sense to insert a formulaic approach into your buy-sell agreement if for some reason a valuation wasn’t performed at the scheduled time(s) as a backup safety valve.  A dynamic formula is better than none at all and can be critical in the absence of a valuation being performed.  Arriving at a fair value for the business is essential to ensuring you and your family’s interests are protected.

Another important consideration in structuring buy-sell agreements is the funding of the liquidation event.  Depending on the particular set of circumstances, there are a variety of ways to fund buy-sell agreements so that the business is not disrupted.  Also, insurance can be an effective tool serving as value preservation in the event that the loss of a key individual adversely affects the valuation of the business.  Generally speaking, there are a number of insurance products used to fund the buy-sell agreements so that the business has the liquidity it needs to pay out the proper value of the business to the appropriate parties.  

A buy-sell agreement that isn’t properly funded is similar in many ways to establishing a living trust without funding it (i.e. converting title of assets into the trust, etc.)  It ends up causing additional heartache and stress and the good intentions of putting such structures in place are nullified by the failure to complete the job and address all the issues up front.  If you do not have a buy-sell agreement in place, or if you are unsure if it’s properly funded, you should reach out to your trusted advisor team and address it immediately.  If your agreement hasn’t been reviewed in a number of years you should revisit it to ensure it will achieve your objectives so you and your family are protected in the event the agreement is triggered.

If you would like assistance in reviewing the terms of your buy-sell agreement and/or developing the funding model, please do not hesitate to contact me.

Sunday, October 12, 2014

California Competes Tax Credit

There are many programs in the state of California designed to foster and incentivize business growth.  The California Competes Tax Credit is an income tax credit available to statewide businesses in all industries looking to invest in California. This is a dollar for dollar tax credit against income tax due in California which can also be used against the Alternative Minimum Tax (AMT).

This credit is limited and will be evaluated and awarded based on the respective company's situation. The investment agreements are negotiated by GO-Biz and approved by the California Competes Tax Credit Committee, consisting of the State Treasurer, the Director of the Department of Finance, the Director of GO-Biz, and one appointee each by the Speaker of the Assembly and Senate Committee on Rules. The program started January 1, 2014, and is scheduled to sunset on January 1, 2025.

It is important to note that no more than 20 percent of the aggregate amount of the credit will be available to any one taxpayer and 25 percent will be reserved for small businesses. This process is competitive, so submitting information timely is essential in obtaining these potential credits.

The factors determining how much credit a taxpayer will be allocated in a fiscal year include:
  • The number of jobs created or retained in California;
  • Compensation levels paid to employees;
  • Investment amounts to make in the state;
  • Levels of unemployment or poverty in the area where the business is located;
  • Incentives available to the taxpayer in this state and in other states;
  • Duration of the project for which the taxpayer commits to remaining in California;
  • Overall economic impact of the taxpayer's business, including opportunity for future growth in the state; and
  • The extent to which the anticipated benefits to the state exceed the projected benefit to the taxpayer from the credit.
The program will accept applications during the following dates:
  • September 29, 2014 through October 27, 2014 ($45 million available)
  • January 5, 2015 through February 2, 2015 ($75 million available)
  • March 9, 2015 through April 6, 2015 ($31.1 million available plus any unallocated amounts from the previous application periods)
We can help identify, at no cost, if a business is eligible for this lucrative tax savings opportunity.  As always, if you have any questions please contact me.