Construction projects take 20% longer to complete and 80% are over budget. Raise your hand if you want to invest!
At 13% of GDP, construction is the largest industry in the world. It’s also the least productive by wide margins. Above all issues cited for the industry’s failures —for decades we hear about labor shortages, supply chain interruptions, price spikes of commodities used to build, regulation — we believe the foundational problem plaguing the construction industry is an broken finance stack that deters lending. Investors don’t like risk, and the financial infrastructure serving construction creates a lot of it.
Unlike other loan types, construction lenders insist on loaning money in arrears for construction builds. They do this to mitigate risk because they have little transparency into builds and don’t trust the supply chain with their money without hard evidence of tangible work product. Fair enough — it’s true that misaligned incentives are rife throughout the construction supply chain; Project A’s money routinely finances Project B; sticky fingers make money disappear.
But looking more closely at how work progresses and is paid for, misalignment is inevitable and high investment risk is certain. That’s because modern construction finance requires that builders spend their own time and money to finance construction well before getting paid for doing so , even if they have title and even if the homes are pre-sold. This “milestone” lending practice forces builders and their supply chains to wait for payment, even for completed and inspected work — they wait an average of 83 days to get paid.
That’s three months.
What would you do if you ran a small business facing this epic mismatch between costs you incur and payments you receive? Is it surprising to learn that you might be incentivized to, say, show up to jobs that you expect will pay you sooner rather than show up to a scheduled job for which you haven’t been paid in months? Might it be difficult to keep your supply chain intact and on task when they haven’t been paid?
Is it any wonder that construction projects take 20% longer to complete and come in at 80% over budget?
This systemic AP/AR mismatch creates work coordination chaos and mistrust. The industry outputs 66% less productivity all other industries combined.
Today’s construction finance processes, themselves, perpetuate lending risk.
So we have shortages of vital infrastructure, like homes. In the U.S. alone, we’re short 6.8 million homes, the result of decades of underbuilding. Housing starts as a share of the population have decreased since 1970, falling 39% since 2006 alone. As a result, more people than ever are excluded from home ownership as home prices rise faster than wages in 80% of US metros.
Would you invest in new construction? You’re not alone. Of all real estate financing, only 3% goes to new construction.