Each year Rabbet surveys commercial real estate lenders and developers to uncover the latest industry trends in CRE. In 2019’s report, we revealed a huge shift towards automation and uncovered... Read More
Contract Simply Uncovers $40 Billion of Excess Costs in Construction Industry
Contract Simply is now Rabbet. We’re the same company – just with a new name – building the only intelligent construction finance platform. The content of this post has been preserved with the Contract Simply name.
General Contractors are familiar with the risks associated with liens. More often than not, subcontractors file them to ensure payment for invoiced work. It’s a regular part of doing business, but liens are a costly and potentially time-consuming risk for builders and lenders.
Contract Simply conducted an industry-wide study to better understand how slow payments affect costs, the risk of liens, and project completion. We distributed a survey to 1,300 contractors representing a wide diversity of trades at the American Subcontractors Association (ASA), Texas Contractors Association, Contractors within the Building Connected and Contract Simply databases.
According to our study results, only 12 percent of subcontractors receive payment net 30. Another 42 percent wait between 30-60 days and 46 percent of those surveyed must wait 60-90 days for payment. According to PWC, the Engineering and Construction industry suffers from the longest days sales outstanding in the US at 54 days. Our survey confirmed that data.
There are a whole host of factors that make it challenging for General Contractors to pay net 30 days. Perhaps the most significant factor is the collection of documents needed by the builder or borrower to request a draw from the lender to cover costs and fund the project. What’s a draw request? For larger commercial projects, a draw request is a package containing 500 to 1000 different documents like invoices, PDFs, receipts, lien waivers, emails, and more. They can be overwhelming to pull together and even more difficult to process.
Once the draw package is received by the lender, it must then review and reconcile the draw package with the budget to ensure everything submitted aligns with the project plan and payment schedule. Once approved, payment is released. At this point, the General Contractor can disburse payments to contractors and suppliers, but must also ensure lien waivers are released so the project can continue to the next phase. We go into greater detail on the entire construction draw process in our blog.
“Slow payments have caused a strain on working capital for contractors who typically employ fewer than 20 people. These are small businesses that must float payments for other financial obligations while waiting for disbursement from the general contractor, which results in subcontractors often feeling like they are financing projects.“
Will Mitchell, CEO of Contract Simply and Former Real Estate Developer
The amount of effort involved in preparing for a monthly draw request doesn’t take the pressure off of the General Contractors to pay as quickly as possible to avoid the risk of liens derailing the project. The fact that the entire process takes longer than anyone would like explains why 83 percent of the study participants have filed liens due to slow payments.
While waiting for payment, contractors must float payments to their subcontractors and suppliers. The majority of them are using a line of credit or business savings to float the payments, and 75 percent say that they incur additional costs in the forms of finance fees as well as extra administrative time.
Construction is a $1.2 trillion industry and subcontractors are paying nearly $40 billion in fees to finance projects due to slow payments. These fees are built into their proposals, so expediting payments has the potential to remove an existing “cost” in the current ecosystem.
For example, 70 percent of study participants indicated they would offer a discount in exchange for net 30 payments. When applying the average discount percent to the entire industry, we identified an opportunity for developers, builders, and lenders to capture over $18 billion of value and alleviate the potential for project-halting risks.
Draw package management aside, the administrative time it takes to manage payments to subcontractors, hunting down 1099 information, and tracking lien releases is another pain point. According to the survey results, nearly 50 percent of the contractors surveyed spend six to 10+ hours per month cutting physical checks and journaling the payments. Add a few more hours tracking down unconditional lien releases and 1099 information and you see how all the administrative time eats into profits.
Although no silver bullet, trends in construction payment processing include software that automates the payment stream between all parties.