Feature Stories - April 2004

Industry Focus: Commercial Builders

Contractors Struggle with Growth Issues, Costs

by Kathleen Foley

Representatives of commercial construction firms gathered at the Four Seasons Hotel on February 14 to discuss issues affecting their industry in Nevada. The gathering was part of Nevada Business Journal’s monthly Industry Outlook series. Connie Brennan, publisher of Nevada Business Journal, served as moderator for the roundtable, which included a lively discussion of growth issues, costs of insurance and materials, hiring and retention and other topics of concern. Following is a condensed version of the discussion.

Insurance: Too Little, Too Expensive

Connie Brennan (Nevada Business Journal): The last time we met, we talked quite a bit about liability insurance – its availability and its price. Has anything changed since then? Is there an end in sight to these escalating costs, and how are they impacting your business?

Dick Rizzo: We’re having horrible problems with insurance because of constantly increasing costs and a significant decrease in coverage, particularly as it relates to mold insurance. One of the more significant ways we’re dealing with the problem is to be more proactive in our post-construction. We try to make our clients more aware of their responsibilities to maintain buildings once we turn them over, and also try to assist them in that regard. We’ve actually set up a post-construction group just to do inspections, warranties, instructions and building turnovers. Since the insurance cost doesn’t seem to be capping out, we’re going to have to take on more responsibility to protect ourselves. The other part of that is condominiums. We’ve had a corporate mandate not to build condominiums for a long, long time. However, the insurance for it is now becoming somewhat available, although it’s very expensive, and we’re reconsidering entering that market. Across the board – liability insurance, builders’ risk, completed structures – we’re finding a huge increase in rates of about 33 percent in our firm over the last couple years. It went up about 25 percent last year alone. Fortunately, all of our business is negotiated, so we pass that increase on as a reimbursable cost, but this is inflating the price of construction.

Brennan: Does there seem to be a shortage in companies that provide coverage?

Rizzo: Actually, we’re partly owned by AIG Insurance, as one of our equity investors. They provide all our insurance, so we have coverage, which is good, but it’s noncompetitive, which is not always a good thing. However, they have pulled out of the condo market right now and really have pulled back on bonding with subcontractors. That’s another whole area we’re having problems with as well – the quality of the bonds we’re getting from subcontractors. We have gone into another program called Sub-guard, in which the owner’s insurance company carries the bonding for the subcontractors. That has enabled us to get relief to some of our subcontractors who have had a very difficult time finding competitive bonding rates, but you have to have a large program to take advantage of that. The last thing I’ll mention is that because of problems getting and paying for mold coverage, we are changing the way we build. It’s slowed us down a little bit, which increases the cost of construction. We’re saying now that we really shouldn’t be taking the risk of putting in finishes and drywall before the building is watertight and there are controlled conditions within the building. We’re spending more money to put temporary roofs or temporary windows or temporary heat and other things to control the environment, and all that means more money to the client.

Bob Wallace: We share Dick’s opinion of the insurance situation right now. Our premiums are going up, coverages are going down and exclusions are going up. We’re approaching it, in fact, from the pre-construction side. We’re trying to be proactive and preplan our projects. So we’ll have pre-steel-erection meetings and pre-roofing meetings; every major trade will have a "pre-" meeting. We’ll bring everyone in who’s involved in that activity, talk about safety measures and what some of the potential hazards are ahead, and then try to prevent them from happening to reduce our claims.

Brennan: Isn’t insurance a cost that’s passed directly to the developer or owner of the building?

Rizzo: We’re able to do that because all our work is negotiated, and so it’s a reimbursable cost, but in a competitive environment, I would find it difficult to compete on a low-bid basis because there is such a variety of rates out there.

Greg Korte: We actually became aware of the variety of rates about six months ago, when I discovered our premium was about half the cost of three competing general contractors bidding a job. I called our insurance guy back in the Midwest. He explained because we have been only a Las Vegas contractor for a short period of time – a year and a half – we’re not being weighed as much company-wide for our work taking place in Nevada. We’re still getting very competitive rates from the St. Louis area, where they don’t have liability issues.

Brooks Williams: One of the biggest struggles we’re having is with subcontractors. A lot of subs can’t get the coverage we require of them. They can’t get the umbrellas, the subrogation and some of the other things we require. We have to either take more risks or choose to go to another subcontractor. Many of the smaller subcontractors, that maybe do $5 million or less annually, can’t afford the coverage we used to be able to get for them. I know that subcontractors’ rates have gone up severely, probably a lot more than the general contractors’ have.

Korte: That’s especially true for subs that have dabbled in the residential side. We’ve had to write off an entire subcontractor that we used to use quite extensively. Because of their ties to residential, they can’t get coverage in the commercial side.

Kevin Burke: For us in the public sector, it’s very difficult, because there’s no way of qualifying a lot of subcontractors up front, in terms of the type and the extent of their coverage. It’s becoming very risky, quite frankly, because if we can’t get proper insurance coverage from a subcontractor, all that risk transfers immediately to us. It’s not what happens today – it’s what’s going to happen in two, three or four years. If something happens to the project and the subcontractor’s coverage does not kick in, then all of a sudden it comes back on us as the general contractor.

John Frye: We found that insurance costs are now about 1 percent of the project value. Three years ago, they were probably 0.6 percent, so it’s been a huge increase. As one of the largest condominium contractors in the Southwest, we also find residential coverage here is just astronomical. In fact, it’s gone up 600 percent in the last few years. So now it’s about 6 percent of the cost of a building. So many people just can’t get residential coverage as a result. It’s all because of construction defects and the claims that started in California, but have come over to Nevada and Arizona. Condominium projects in the Midwest and the East don’t have this problem, but out here it’s a big deal, and it’s a main reason for the rising insurance costs. If contractors and owners don’t do what Dick is presenting as a part of a post-construction deal on these condominium projects, they’re just going to go out of business. You’ve got to curtail the homeowners association. You have to show them you constructed the building in accordance with the specs, and you have to then train the association on how to maintain the building.

Brennan: So, is the solution to put caps on insurance settlements?

Scott Loughridge: Well, the Legislature did pass SB 241, which is helping. First, it defined what a defect was, because there was no definition before. Secondly, it gave the builders a right to repair defects. Prior to that, the first thing you might hear of a problem was the lawsuit, at which point you couldn’t do anything. So steps have been made to try and resolve the issue, but the insurance companies are going to take a wait-and-see attitude to see if it’s actually going to stem the lawsuits.

Brennan: Do you think there’s a light at the end of the tunnel? Do you think it’s going to turn around?

Loughridge: Yes. My insurance agent was in Denver last week trying to get insurance companies to come back into the state. I think right now there are only two that are actively insuring in Nevada. Everybody said, "Come back and see me in a year. Meanwhile, we’ll sit on the sidelines."

Mike Fauci: Ninety percent of the lawsuits confuse warranty work with construction defects. Probably 90 percent of the lawsuits are really over warranty work. If they would just let the general contractors and the subs go in and repair what had to be repaired, there would be no lawsuits. I think that’s coming around now. I’m sure that mold has been around since biblical times. There’s always been mold. And I agree that there’s some mold that’s more dangerous than others, but I’ll bet anybody in this room can go into his house and open up the wall behind the kitchen sink and see a little mold back there. People are just making too big a deal of it, and that includes asbestos, too.

Frye: We’re about to start a renovation project for Harrah’s in South Lake Tahoe, and the first five days of this project is mold abatement. It’s the first time I’ve dealt with that. I’ve been involved with asbestos abatement, but now you have to have mold abatement. I thought mold was healthy – you eat it on cheese. But, not anymore.

Wallace: I find it interesting that people are shying away from condos right now, but because land prices are going up so much, we’re going to have to build vertically. If we want to build vertical residential condos, we’ve got to figure out how to overcome this insurance issue so we can all participate and build quality projects.

Brennan: Do you think increases in insurance rates will be slowing down?

Wallace: I hope so. People have to get proactive and achieve an incidence rate that’s lower. Only that will drive them back down again.

Brooks Williams: For years and years, the insurance companies and bonding companies were actually losing money on their underwriting, but they were making money in the stock market. When the stock market had three bad years, a lot of them got hurt, and that’s when they started really tightening up.

Water, Water Everywhere?

Brennan: Let’s talk about the water issue. How nervous are you about what’s going on with our water situation?

Fauci: There’s plenty of water under this ground here. That’s why they call it the Great Basin. I think there’s a little bit of a water shortage, but they’re overdoing it to scare everybody so they can raise the rates. Everybody will start conserving and get the water usage down, but the rates are going to stay up. They’ve done it in New Mexico, in Arizona, and a lot of other states. Right now, if they raise your rates $10 a month, you don’t complain because you think there’s a water shortage, but once they start lowering the usage, the rates are going to stay there. They’ve been talking about water shortages for 45 years now.

Brennan: Do you think concerns about water have the potential to stop growth?

Fauci: I think it’s exactly what Scott said. There’s a no-growth group here in town who came from California. They couldn’t stop the growth there, so they come here and try to stop the growth. The way they can do it is to hold up building permits for six months or a year, and they’re doing it now. Everybody here in this room is familiar with what they put us through, trying to get a permit.

Korte: Well, I’ve heard Pat Mulroy (of the Las Vegas Valley Water District) speak, and she raises some very valid points. Our use per capita in Southern Nevada is much, much higher than the surrounding desert cities – Phoenix, Albuquerque and so forth – and people from all parts of the country come here and want to replicate their Midwest or Northeast environments by planting trees and grass and so forth. We’ve got to start conserving, because there very well may be some serious water issues for us and our children down the road in the very near future.

Rizzo: We’re finding that in our design/build work, we’re getting a lot more restrictions on the use of fountain areas, lakes, etc. and also a requirement to use gray water for irrigation. So I think it’s causing us to do things differently, and certainly to the benefit of saving more water. We have to be more conscious of it, so they’re getting what they want, I think.

Staffing and Retention Concerns

Brennan: One of the things everyone was concerned about last time was the availability of qualified people, particularly project managers. Are you still having trouble finding qualified people?

Burke: Next to insurance, it’s probably our biggest challenge.

Brennan: Why do you think that is?

Burke: UNLV and UNR don’t have real big construction science or engineering programs, so we’re continuing to import talent from out of state, which is a shame. It would be nice if we could use our own graduates, but in the short term, they’re just not there.

Korte: My perception is a little different. I think it’s been so good for so long that employees here don’t understand what it’s like to be in fear of losing their jobs. The attitude seems to be, "If you don’t like what I’m doing – the heck with you, I’ll go across the street and work for the next guy for the same money or more." In a way, it depresses the work ethic and the motivation of the employees.

Loughridge: I agree with Greg 100 percent on that. Our younger people – I’m talking about people in their early 30s who have worked for us for 10 years – have never experienced a slowdown here. They don’t know what it’s like to be concerned about getting a pink slip, and that attitude to us is everything. What we do is not that complicated. We can teach people what to do if they come to work with a good attitude and a desire to be honest and to work hard, but unfortunately, we’re having a heck of a time finding both superintendents and project managers who have that ability or that desire. We get a lot of résumés where somebody has worked for seven or eight people in the last nine years. So why do I want to be the next place he’s only going to work for 18 months?

Frye: Typically, we have the mentality of hiring for the future. We’ll probably hire 30 new college graduates this year as a company, and so we’re hiring project managers for eight years from now. The recruits we hired six to eight years ago are our project managers today. We find them the best performers. Go hire the young guys and put them to work later supervising your jobs.

Rizzo: We do very much the same thing, and we’ve had such growth that the sheer quantity of them has been a challenge. We’ve put on probably 50 people this last quarter who were all professional graduates with the basic programs, but we try to groom them from within as well. We have an internship program while they’re in college, and we also have a three-year training program once they get out of school. The only way to get quality people, and get them the way you want them, is to train them and make that investment.

Fauci: I always wanted the old-timers who had been around for a long time, but they have a lot of bad habits. They want to do it their way, so maybe the way to go is to bring in the younger generation. I have to concede that now.

Brennan: How successful are you at retention?

Rizzo: Pretty good. There’s always 20 or 30 percent who turn over, but a lot of people have been with us a long time. Training is always a challenge in budgeting, but you have to decide how much you want to invest in your future.

Brennan: And it is an investment.

Rizzo: It truly is.

Development Fees

Brennan: There’s been a lot of talk recently about development fees. What’s going on?

Williams: They’ve gone up across the board. Impact fees went up another 15 percent; water connect fees go up every six months; sewer connects are going up; public works went up; permitting went up. Everything is going up, and the building departments keep following each other in raises. If you add in the new real estate transfer tax and the cost of land, and increased prices for steel, wood, rebar, copper and all those things, construction costs have increased pretty severely just in the last six months.

Brennan: How much do you think it’s gone up, on average, from last year?

Williams: I’ll bet it’s a good 10 percent, maybe even 20 percent.

Brennan: Is there an end? Do you see the development fees continuing to increase?

Fauci: Eventually, it’s going to get where you can’t afford to even rent a building. It’s just completely out of control.

Korte: One of the biggest dangers to the construction industry in Nevada is this cavalier attitude by the government entities that we’re the only place to be. They ignore the Indian gaming and the competitive rates Utah is offering, and all of a sudden the same factors that brought everybody here in the last 10 or 15 years are going to start sending people elsewhere.

Wallace: I agree with Greg. Folks from California are coming to Nevada because they have high costs and high regulations there, and all of a sudden Nevada is following suit. At some point, the prices here will rise to the level of California’s, and those folks will be going to Utah or New Mexico or elsewhere.

Rizzo: In terms of raw materials for construction, we have a serious problem right now in rebar, and we’re anticipating a problem with structural steel. China has bought up every piece of raw iron in the United States, so we’re having difficulty finding it and, if we can find it, in getting reasonable pricing. It’s also hard trying to anticipate where the cost is going to be six months or a year from now. Market experts are also advising to be concerned about drywall and gypsum products, as well as structural metal studs. We’re buying rebar to inventory it, so we can protect our clients from price inflation. We’re really concerned, and, particularly, where we have to guarantee prices up front a year or two in advance. We’re assuming a lot of risk on it.

Wallace: We’re currently paying for rebar before we get it.

Frye: We can’t book our rebar fast enough before the price goes up.

Outlook for the Future

Brennan: I know most of you have seen some growth, and there’s a pretty good market right now. How is your industry going to look next year, as compared to now?

Rizzo: We are predicting that – company-wide and nationally – we’ll have record years over the next three years.

Frye: We are projecting growth of over 15 percent in the next three years. That’s on top of 2003 being the best year in 140 years. So we’re going to have a string of four record years.

Dennis Smith: Ours is a fairly small company compared to everybody else, but we generally do about $4 million or $5 million a year. We deal mainly with remodel and tenant improvements, but in just the first month of this year, we booked over $1 million dollars worth of sales. So we’re looking at continuing that growth. Now, it’s the challenge of our production department to keep up with that.

Brennan: Because of the high prices of land, do you think more people are going to be remodeling instead of building new? Is there going to be more interest in rebuilding?

Smith: Definitely. That’s the reason we got into the niche we have. We have a smaller sales volume, but our profit margin is probably larger than most. We look at the bottom line, not total sales.

Burke: We’re very happy where we are, and the key for us is controlling our growth and making sure we have the professionals to manage it. The key developers we work for are growing, and that’s been fueling our growth, as we maintain a balance between the public and private sector.

Kathleen Foley
Kathleen Foley is a freelance writer based in Southern Nevada.