Is another housing bubble about to burst? Are record-breaking real estate prices about to plummet? Is demand still outstripping supply or have conditions changed?

The outlook for the construction sector is sending mixed signals. Read the news and headlines where words like “slowdown,” “slump,” and “signs of decline” describe recent trends in housing. Mortgage rates are rising, but home sales are still exceptionally strong. As we said – mixed signals – that have builders asking one question above all else: What do we do next?

Changing market conditions pose a risk to any business owner, but especially to construction companies, which take on a lot of risk every time they break ground on a new project. With high upfront costs, significant supply chain delays, and shrinking profit margins, most construction companies cannot afford to be caught off guard by a sudden shift in the housing market. That’s why the most successful construction companies are constantly assessing market risks and adjusting their strategic goals accordingly.

A changing market is one of the most volatile and potentially devastating risks a home builder can face. If you time it right, the company can make record profits. If you predict it wrong, the costs can be catastrophic.

Fortunately, building a home doesn’t have to be a guessing game. Builders can take strategic steps to achieve a good return on investment by following these three steps to assess market risks.

1. Monitor market conditions

Rising interest rates, changing demand, high prices, inflation at a 40-year high and the current state of the real estate cycle are just some of the ever-changing factors that impact builders. Conducting a detailed market analysis is an important step in any construction project. But when it comes to builder risk management, a one-time analysis is not enough. Builders must continually monitor market conditions to stay ahead of a changing risk landscape.

This means tracking key market and economic indicators such as:

• Interest charges – Today’s home prices are keeping many potential buyers out of the market. Rising mortgage rates will also drive other buyers out of the market. The Federal Reserve is sending warning signals before making a rate change. Current forecasts assume small rate increases in the next few quarters.
• Building permits and new home sales – The total number of building permits issued and home sales in the U.S. is a less important indicator than data by geographic area. Track trends for places with development interest. For example, while April and May saw slight declines, there are hot markets across the country where demand significantly exceeds supply – the ideal scenario for a homebuilder. Macro trends can obscure micro opportunities for builders who have focused on the wrong information.
• Price indices – Housing prices also vary geographically. The pandemic caused people to leave big cities and move to the suburbs. The overall decline in housing prices indicates an economic recession that could slow the construction sector. However, a better tool for builders is to review housing prices by zip code to find current and future growth markets for investment.
• NAHB’s Housing Market Index – The HMI is based on a monthly survey of NAHB members that measures the pulse of the single-family housing market by assessing current market conditions. On a scale of zero to 100, the higher the score, the more positive the outlook. The preliminary national score for May is 69, down eight points from April. However, the regional HMI score for the Northeast, South and West regions has higher scores in the mid-70s.

Evaluating the market locally and nationally by monitoring interest rates and other economic trends can help in deciding the right time to build and the right number of homes.

2. Create a risk assessment table

When monitoring the real estate market for potential problems, you need a mechanism to assess and prioritize emerging risks. You can calculate your risk level using a simple formula:

Risk level = probability x impact

First, you need to assign a numerical value to the probability of the risk occurring and the severity of the impact on your business. Example:

probability

• Very likely (4): Occurs more than once a year
• Probable (3): Occurs about once a year
• Unlikely (2): Occurs every 10 years or
• Very unlikely (1): Happened only once

Effects

• Severe (4): Financial losses exceeding $50,000
• High (3): Financial losses between $10,000 and $50,000
• Moderate (2): Financial losses between $1,000 and $10,000
• Low (1): Financial losses of less than $1,000

These are sample numbers. Replace them with values ​​that fit your company’s business. As you assess each risk, plug the scores into the formula for an overall risk score. A risk with a high score requires immediate corrective action. A low score requires limited or downgraded action. This can be a powerful quantitative tool to help with strategic decision making.

3. Hold regular risk assessment meetings

A study on risk management in construction found that nine out of 10 construction companies cited better collaboration as a key to mitigating future risks. The report found a strong link between regular team meetings and formal brainstorming and improved project outcomes. Benefits include increased reliability of overall project performance, reduced construction costs, improved project planning and increased safety.

“The most effective risk assessment strategies, according to the study, are holding regular risk-focused meetings with the entire project team and developing a risk management plan,” reports Dodge Data & Analytics, which conducted the study. “Both approaches help increase the reliability of project performance, maintain project quality and improve project safety.”

Because real estate markets can be volatile and construction risks are constantly in flux, regular meetings will help your team stay on top of changes in market conditions that could impact your company’s risk levels. Bringing a variety of voices and perspectives to the table has the added benefit of drawing on multiple areas of expertise when assessing your company’s risk landscape.

One form of collaboration that can make a significant difference in assessing and managing risk is partnering with a third-party construction warranty provider. By mitigating the risks associated with construction defects while improving the builder’s reputation management through expert handling of homeowner complaints, a construction warranty company like PWSC can take on a large portion of a company’s risk management needs. This frees up builders to focus on other important factors – like assessing ever-changing market risks and figuring out where to start building their next home.

By Lindsay Tingler, Head of Construction Practice at PCF