The coronavirus crisis will hit the construction industry – but much later
Now is the time to position yourself successfully in the market.
Looking at the impact of the coronavirus crisis on liquidity and profitability, the German construction sector is in a good position compared to other industries, and also other countries. We don't anticipate seeing the crisis hit companies in the construction trade until the first two quarters of 2021.
Naturally, the construction industry is not going to come out of the crisis unscathed. The various players will all be affected in different ways. And of course, demand will fall sooner or later as the crisis continues, which will squeeze profits throughout the entire industry. However, the course of the crisis in the construction industry will differ from the way it goes in other industries. And given all the measures currently being debated by policymakers to stimulate public demand, the industry will recover from this acute crisis soon enough, and perhaps even emerge the stronger for it.
Scenarios for the construction industry
The construction industry in Germany is not on the brink of collapse. The problems currently facing companies in the sector are primarily of an operational nature – from social distancing on construction sites to the absence of foreign workers. The effects will therefore vary depending on when the economy as a whole ramps up again. So the uncertainty is mainly around how the construction business will develop in the medium term.
We therefore put together a number of future scenarios for the construction industry that take into account general economic parameters (such as GDP) and sector-specific indices (construction price index, mortgage interest rates, construction investments, etc.).
We currently expect the economy to ramp up eight weeks after it shut down. However, even if the shutdown lasts twelve weeks, the economic impact on construction right now will still be limited. According to our estimates, gross value added in real terms will fall by 2.7 percentage points in 2020 and 4.1 percentage points in 2021 compared to forecasts from before the crisis.
The basic assumption in this scenario is that projects currently in the concept and planning phase will be put on hold by commercial or private investors or developers. That said, in a low interest rate environment with few other lucrative forms of investment, the fact that investments in real estate remain attractive partially counteracts that trend. The strongest impact from a crisis is normally felt in commercial construction as commercial enterprises are quicker to put a stop on investments.
In this scenario, we assume that the coronavirus crisis will hit the construction industry with a 9-12-month time lag. Full recovery from the coronavirus shock will therefore come in the fourth quarter of 2021.
It's only if the economy does not ramp up after eight to twelve weeks and the German economy actually slides into a prolonged recession that the impact on the entire construction industry will be much more significant in scale. According to our calculations, gross value added will then fall by 4.7 percentage points in 2020 and 7.8 percentage points in 2021. In this scenario, there will be a sharp contraction in supply and demand in all construction segments. A gradual recovery can be expected in 2021, with full recovery not before 2022.
What does this mean for the individual construction segments?
Commercial construction is the segment most affected. If we stick to the scenario in which the economy ramps up eight weeks after it shut down, there will be a massive impact on commercial construction, with renovations hit from the second quarter of 2020 and newbuilds affected from the fourth quarter of 2020 for a period of three quarters. Ongoing projects will be put on ice and follow-on projects will not be extended. With commercial construction the hardest hit of all construction segments, there is anticipated to be a shift in building activity toward residential and public sector construction.
Regardless of which of the outlined scenarios actually materializes, public sector construction is the segment that will feel the least impact of the coronavirus crisis. Public sector funds will not be withheld – the economic effects of publicly funded construction activity are way too significant for that.
What does it mean for the construction industry?
The outlined scenarios will have different impacts on the different stages of the construction value chain and its players – now and in the months and years to come. We present here a selection of forecasts for different players.
Investors and property owners already have less scope for making investments owing to market uncertainty, and in the future their budgets for planned projects will be smaller. Architects and engineers face the possibility that planning processes for ongoing or new projects could be scrapped. They will be confronted with a decline in projects and orders in the future. In building management, there will be increased demands on hygiene and safety. Companies will find cost pressure ratcheting up and renovation projects postponed.
Building materials companies and builders' merchants face restricted cash flow owing to lower demand and they may also experience difficulties with product distribution and find gaps in their supply chain as the international flow of goods is disrupted.
Construction companies and trades are currently having to deal with a variety of operational problems: Access to construction sites is often not possible or is severely restricted; labor is scarce, especially because workers from Eastern Europe are not able to enter the country; invoices are being paid late, causing liquidity problems. The decline in demand that is coming down the line will potentially lead to market consolidation.
What needs to be done? Measures for the short and medium term
The various players in the construction industry will be affected by the coronavirus crisis to varying degrees of intensity and at different times. We recommend a two-pronged approach. A combination of short-term and medium-term measures will enable the construction industry to emerge from the crisis stronger than before. We're assuming that most players will already have initiated or even completed the measures made necessary by the coronavirus crisis.
360° Checkup: This identifies operational and organizational risks connected with the coronavirus crisis:
- Fast action: Protect the health of the workforce when the business is ramped up and rule out any spread of the disease within the workforce.
- Safeguard the company's operative business despite the safety measures and the possibly reduced demand – across all links in the value chain.
- Ensure that all functions and areas of the company can continue to operate, not only on the construction sites, but also in admin.
- Targeted and professional crisis communications – both internal and external – are absolutely essential now.
Scenario Analysis: It's vital to quantify the financial impact of the various scenarios. Then you'll be able to calculate your liquidity requirements and take the figures to investors and banks or use them to apply for state aid. You'll need to take a strategic look into the future and to recognize that the full impact of the crisis on the construction industry will not unfold until the end of this year or the beginning of next year.
Emergency Room: What you need now is a coronavirus task force to monitor further developments daily and promptly, and derive immediate actions for the company to take. These include submitting applications for short-time work and government guarantees, developing measures to be taken in the event of a possible second wave of the virus, and securing the supply chain so that your production operations can continue smoothly.
Cash Office: It's important to set up a cash office to constantly monitor and control the liquidity situation. You'll need to take the appropriate measures without delay. With order books still healthy and payment morale good at the moment, the cash office will really come into its own in the second half of the year.
Performane Improvement Program: This involves setting up a program for the stabilization of the company in the short and medium term: What are the challenges and costs involved in ramping the business back up? How do these measures affect the long-term business model?
In the medium term, the productivity of businesses across Germany and Europe must be planned and optimized and the corresponding logistics need to be ensured for these markets.
Besides securing the supply chain immediately, measures will need to be taken to reduce risk in the supply chain on a medium-term horizon. In particular, companies will need to become less dependent on foreign suppliers.
The crisis has brought home to the construction industry just how important it is for companies to automate production and digitalize processes. And not just to make their business more crisis proof and their operations more cost effective. The crisis has also shown how companies can reach direct and indirect customers through digital media and e-commerce. So we are seeing digitalization in the construction industry being accelerated as a result of the crisis. New business models will evolve.
The crisis has also shown that it is possible to make digital sales direct to customers, circumventing the building materials market, which previously operated on three main levels. This brings higher margins.
The coronavirus crisis offers the construction industry a raft of new opportunities: With a focus on the top line, players can increase their market share by maintaining and intensifying their sales activities, implementing new business models and a digital go-to-market approach, safeguarding production and delivery capabilities, as well as potentially making acquisitions of parts of other businesses that find themselves in trouble.
For the construction industry, the new normal means adjusting to a world that will be the same yet different
The world will be a different place after the coronavirus crisis. First, the virus will be with us until an effective vaccine is found. That may take some time. By the time it happens, the economy and society at large will have adapted to the new conditions and learned to work differently, produce differently, buy differently, do business differently.
It is becoming increasingly clear that one response to the coronavirus crisis is that we must become climate neutral in the future by being highly innovative and competitive. The realization of a real "green deal" with extensive CO2 minimization depends on us having a construction industry that works with green products, employs climate-friendly production and logistics and champions the circular economy.
And finally: The coronavirus crisis has moved the digitalization of the construction industry a huge step forward. This will soon be evident both on construction sites and in the digitalization of the value chain throughout the production and trading stages. Every player in the construction industry must now think about what the new normal will look like for them and consider how they can best benefit from it.