Business

Deconstructing Slow Payments in Construction

Subcontractors and general contractors include a combined average 5.3% overhead in project bids to finance slow payments. In 2019, this ultimately costs the construction industry an extra $64 billion. Here's how that can change.
By Will Mitchell
January 9, 2020
Topics
Business

Fifty-one days sales outstanding. It’s not a surprise to anyone in construction that it takes this long to get paid. In fact, construction suffers from the longest average DSO of any industry in the country—and it comes with a massive price tag.

To quantify the cost, construction finance software Rabbet surveyed 184 subcontractors and general contractors in the United States and published the results in their annual Construction Payments Report. Rabbet found that both parties include a combined average 5.3% overhead in project bids to finance slow payments. In 2019, this ultimately cost the construction industry an extra $64 billion.

Developers and construction business owners have a vested interest in lowering their project costs and achieving faster payments. To understand the impact, project stakeholders can take a look at the jobsite.

Subcontractors Bear the Greatest Burden

There are often dozens of subcontractors on a commercial construction project, and each operates his or her own small business. Subcontractors pay wages to workers weekly or biweekly, and they’re typically purchasing materials on 30-day invoice terms. Covering payroll and supply costs while waiting 51 days for project payments creates a huge cash flow problem for subcontractors. Rabbet found that only 39% of subcontractors can rely on working capital to cover their payments. Most use a line of credit, credit cards, or personal savings to float payments.

This creates a vicious cycle for subcontractors: incoming revenue immediately goes out the door, making it nearly impossible for them to grow business as they’re struggling to keep up with existing projects. In fact, many subcontractors’ businesses fail in a growing economy because they lack the resources to keep up with demand.

How can subcontractors combat slow payments? Their only options are to file liens or stop work. Rabbet found that 63% of subcontractors opt to circumvent the problem entirely by choosing not to bid on a project due to a general contractor’s or owner’s reputation for slow payments.

If more than half of subcontractors aren’t bidding, how are project stakeholders getting the best people and rates on projects? They’re not. Yardi reports that the average project length has increased by 37% in recent years, primarily due to labor shortage—which is ultimately driving up project costs.

General Contractors Face Similar Challenges

General contractors also experience the stress of floating payments and managing business growth. Additionally, they must mitigate secondary effects such as inflated project costs and delays, which may come out of their profit.

While nearly all general contractors surveyed by Rabbet said they see the value in paying their subcontractors faster, they’re also in a cash flow business. More than 20% of general contractors say they have delayed payment to subcontractors in order to improve working capital. Notably, general contractors with revenue under $5 million were twice as likely to report this—indicating that it’s still a response to slow payments, not a tactic to earn more interest.

Projects Suffer—But Don’t Have To

With the monetary constraints on jobsites, project stakeholders see massive impacts on their projects. Because subcontractors and general contractors are compensating for the cost of floating payments, developers receive inflated bids—totaling $64 billion in 2019. Stopped work creates delays in project delivery and stabilization. Additionally, a poor payment reputation could impact lending terms for developers.

There is a silver lining. More than 70% of subcontractors reported that they’d be willing to offer a discount for payments made within 30 days. The average discount is 3.7%, which would result in an estimated industry-wide savings of $44 billion.

Project Stakeholders Can Take Action

At the start of a project, all parties should agree to a monthly schedule. The agreement should outline the dates each month when invoices are due, draws are funded and payments are received. Having this clearly stated from the beginning helps everyone understand what’s expected and commit to outcomes.

Those willing to offer discounts for payments made within 30 days should clearly communicate those savings to developers. Developers who haven’t been approached about net-30 discounts should negotiate terms with their teams. Once terms are agreed on, everyone can ensure their subcontractors and general contractors are paid on time to take advantage of savings.

Project stakeholders should implement a draw management platform and use a shared communication tool. B2B payments are complex and include layers of internal approvals and document sharing often managed in emails, PDFs and spreadsheets. By transacting on a shared platform, project stakeholders enable information to flow more smoothly, and money flows from lender to developer to general contractor to the trades who do the work.

By opening lines of communication and adopting technology solutions, project stakeholders can drastically reduce the cost of slow payments and improve the construction industry for all.

by Will Mitchell
Will Mitchell is the co-founder and CEO of Rabbet, the only construction finance software that intelligently connects relevant information for frictionless transactions between real estate developers and lenders. Originally from Denver, Will has spent more than a decade in commercial real estate and completed his undergraduate studies in architecture and structural engineering from the University of Virginia. Learn more at www.rabbet.com, or connect with Will directly at www.linkedin.com/in/mitchellrw.

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