PWA Pipeline - 2024 Construction Newsletter

PWA Pipeline

2024 Construction Newsletter

Local Touch. National Strength.™

“It’s been a good run” Entering 2024, that’s how we would describe the Canadian construction economy of the last 15 years. The post Great Recession era (2009 – 2023) has largely been a successful – if not thriving – period for contractors in terms of a steady pipeline of work opportunities, growing backlogs and balance sheets, access to cheap credit, punctuated by relatively low contractor failure rates. Of course, the industry has had to navigate formidable challenges along the way, but contractors showed remarkable resilience and entrepreneurship in rising to the occasion and plowing ahead. While our longer-term outlook for Canadian construction remains optimistic, we can’t help but brace ourselves for what could be some near-term bumps in the road ahead.

The bull run in construction was the product of a near-perfect confluence of favourable macro conditions over much of this period. Most notably, ultra-low interest rates, heavy government investment in infrastructure, and a heated (if not overheated) housing market fueled by record immigration, all working in sync to produce an era of generally robust construction activity in most regions and sectors across Canada.

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2024 | Construction Outlook

More recently, surging interest rates have slowed the pace and the effects are already impacting the housing sector, with new housing sales and starts dropping in most urban centres, which, if sustained, will be increasingly felt throughout the construction and general economy. A more immediate concern is the strain of tighter credit and higher interest on contractors and developers, many of whom have become increasingly leveraged and reliant on debt to finance operations and growth in the cheap money era. The risk isn’t isolated to just leveraged businesses, and a default by any party to the construction pyramid affects all parties in the pyramid. Our experience - and that of our surety company partners - is already bearing this out in the form of a noticeable uptick in contract disputes, surety claims, and losses. The prospect of a prolonged higher interest and tighter credit environment is our primary source of cautiousness in 2024, and necessitates a more vigilant and thorough approach to counterparty and contract risk mitigation by contractors and developers at all levels. Tap into the construction risk experts at PWA for more advice here.

Other themes shaping our construction outlook for 2024 and beyond include: A HOUSING REBOUND Housing of all forms (and the ancillary infrastructure investment it generates) is the proverbial lifeblood of the construction economy and should return with a vengeance. With the recent slowdown in new housing starts likely stalling future supply growth, and immigration expected to hold steady at roughly 500,000 new entrants a year to Canada for the foreseeable future – twice the historical average of the last 20 years – it’s inevitable that housing will make a roaring and sustained comeback. Increased government policy around rental and affordable housing incentives and funding will further stoke activity.

MEGA-PROJECTS The proliferation of mega-projects is igniting transformation in construction, with no end in sight. The numbers are staggering. Driven by unprecedented activity in transit, energy, and healthcare, the total value of the top 100 projects underway in Canada jumped from $158B in

2015 to $292B in 2024 (data provided by ReNew Canada). The number of $1B+ projects increased from 39 to 64 over that same period. The good: it’s driving innovation and advancement in areas like technology, data and analytics, risk management, procurement methods, collaboration, and others.

The bad: it inherently favours the biggest players, an overheated market segment with limited competition, and mostly excludes small to midsized firms and the needed capacity and expertise they bring to the table. The ugly: it attracts foreign entrants to the Canadian market, to the detriment of local, homegrown contractors on a long term and permanent basis.

WORKPLACE DIVERSITY The construction workplace is becoming increasingly diverse, forging ties to labour in traditionally underrepresented groups and communities, aiding the chronic labour shortage afflicting the industry and making it a better, more inclusive place for all.

CONSOLIDATION Higher interest rates and tighter money cooled construction sector M&A activity the last couple of years, but things should pick up again this year and next as capital markets open up, fueled also by record cash reserves held by institutional investors.

Acquisitions by private equity firms have become more prevalent (with mixed results), as has vertical integration and acquisitions of domestic firms by foreign (and other domestic) contractors.

SHOCK EVENTS “Force Majeure” and unforeseeable adverse events have become…well…less unforeseeable. Wars and major global geopolitical unrest, extreme weather patterns and wildfires, lingering pandemic threats, and all the resultant disruptive effects these have on construction are fresh on contractors’ minds (and yet mostly unheard of only a decade ago), and remain very real risks going forward! The silver lining is that experience is the best teacher, and contractors today are better prepared than ever to anticipate and manage shock events.

Petrela, Winter & Associates

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Insurance Market Update The Canadian insurance market has had a tumultuous past 5 years. 2018 represented the industry’s worst performance in decades, resulting in a strong effort to return to profitability across the board. The hardening market thus began in early 2019 and persisted through 2020 and 2021 as the insurance market negotiated COVID, and has since been navigating the pandemic’s aftereffects, struggling to catch its breath and stabilize.

The rate increases and disciplined underwriting of the hard market inevitably did their job, and the industry has, indeed, returned to overall profitability. In fact, the results have been so sound that we’ve been expecting the market to soften, as has been the case historically with market cycles.

Industry leaders generally acknowledge 2024 is shaping up to see increased competition. What is also evident is that it does not feel like the start of the soft market cycles of the past - at least not yet - as the level of change and uncertainty in today’s environment is causing insurers to take a measured approach. Per Marc Lipman, President of Lloyd’s Canada, “Whether that’s major Nat [natural] or manmade Cat [catastrophic] events, whether that’s geopolitical tension and conflicts that continue or escalate…what we’ve learned from the past couple of years is something is always coming. You might not be able to predict what it is, but something will be there.”

As to insurers’ underlying costs, recent reinsurance treaty negotiations suggest mid-single digit rate increases for the January treaty period, meaning insurers’ costs to cede and spread risk are increasing. That cost, and other increased cost trends (weather events, inflation, vehicle thefts, and supply chain issues), combined with the looming economic uncertainty is tempering the improved performance of insurer portfolios such that 2024 is likely to usher in a rational (i.e. generally stable) insurance market cycle for commercial lines. New market entrants looking to seize market share will create opportunities to source competitive terms for certain classes.

The construction insurance segment often does not precisely follow the overall market pattern due to certain specific classes within construction tending to be more volatile and impacted by factors specific to them. That said, construction as an overall class is generally considered a preferred segment for many insurers across all key coverages (General Liability, Equipment, and Fleet), with some specific class-based exceptions, such as hotapplication roofers, mechanical contractors, and wood frame property construction, where appetite continues to wane due to loss experience.

Heavy civil contractors (road, bridge, and sewer/ water), and trade contractors that engage in torching and welding/soldering, and those involved heavily in industrial construction have more limited market options, typically restricted to specialized carriers with existing volumes of business and competencies in these areas.

Finally, Builders Risk/Course of Construction coverage, which saw an insurer exodus over the years as the low rates became unsustainable in the face of rising claims (particularly water damage), is now attracting more capacity due to improved results, driven by higher rates and the gaining traction of enhanced water damage mitigation measures in reducing losses. This should have a downward effect on rates over time (except, as mentioned, for wood frame projects, where high severity fire losses continue to make it a challenge to underwrite profitably).

Petrela, Winter & Associates

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Surety Market Update A lot has been written the last couple of years about how inflation, labour shortages, supply bottlenecks, and spiking interest rates have teamed up to create an elevated overall risk environment for contractors, so we won’t rehash that here. There are, however, important consequences playing out in the surety market that warrant mention.

The first is that with many contractors, contract prices and backlogs have grown at a greater pace than balance sheets (red flag #1). That means, broadly speaking, surety leveraging is trending higher (i.e. contractor capital backstopping surety credit is down on a relative basis), something no surety takes lightly.

These issues are having an outsized impact on subcontractors. Already at the end of the payment chain, many subs are now faced with managing and cashflowing bigger project values and backlogs with proportionately smaller balance sheets, against a backdrop of tighter money and heightened overall risk. What could possibly go wrong! Perhaps unsurprisingly, the industry has already seen some notable subcontractor failures in 2023, and more are anticipated (red flag #2), which, if they materialize at any meaningful rate, will have a ripple effect on the industry (red flag #3).

The great retirement wave is also well underway, and we’re seeing a growing pattern of construction business owners selling for succession purposes, with ensuing change and disruption to the business (red flag #4). In the last few years, we’ve also seen an increase in private equity and institutional investment firms entering the contractor space, awakened to the opportunities in the sector. The problem? M&A transactions tend to add suretyunfriendly debt and goodwill to the balance sheet (red flag #5) and often don’t bring the necessary experience, skillset, or long term commitment to run a successful construction business (red flag #6).

Surety companies are generally conservative operations, and those are a lot of red flags, even for the most aggressive or optimistic of them.

It all points to a tighter surety underwriting environment ahead, however, the good news is that well-managed, financially sound contractors will continue to have good options to choose from, as always. In times like these, the services of a specialized bond broker advocate can make all the difference.

DOES YOUR BUSINESS DIRECTLY IMPORT ANY SUPPLIES INTO CANADA? If so – and we expect that many contractors import something – then you should be aware that you will now be required to post a bond with Canada Border Services.

If you missed our blast on “CARM”, the CBSA’s new importer management portal, you can visit https:// petrelawinter.com/carm for details on what’s required, and how we can help get the bond in place.

The US surety industry is an $8 billion behemoth. The largest players in that market have all had meaningful acquisitions along the way (just as Intact’s position as the largest in Canada has been driven by purchase of GCNA, Jevco, AXA businesses). Here’s a neat visualization of the US surety industry consolidation over the last 35 years: https://public.flourish.studio/visualisation/14642965/

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2024 | Construction Outlook

Navacord Update The Navacord story continues to resonate with clients and brokers. Through 2023, “The Great Canadian Brokerage” is now the 4th largest in Canada, stretching coast to coast and boasts the leading construction practice in the country. Not bad for a concept that was born on a napkin less than ten years ago.

While the cost of acquiring good new brokerages has risen, Navacord still executed over twenty deals in 2023. The strategy? Targeting leading businesses that bring a specialty offering, are in a strategic geographic location, and have strong leadership. The allure for those brokerages?

To leverage Navacord’s world-class business resources, insurance market relationships, and

entrepreneurial spirit to better serve clients and propel them higher, while preserving their individual culture and identity in a decentralized business model.

Complementing acquisitions is strong organic growth, including Navacord’s own line of insurance product offerings that are quickly expanding.

Already a market leader in providing Wrap Up liability coverage, Tripoint (a Navacord MGA) is rolling out solutions in other underserved areas, including Contractors Pollution, Builders Risk, and Directors & Officers Liability. We are excited to share how all these efforts will help your business this year.

PWA Update As goes the construction industry, so goes PWA, and we’ve been fortunate that an active construction market has kept us busy in 2023.

that our specialized business model and clientcentric approach continues to resonate with contractors and developers.

We welcomed aboard several outstanding new employees over the past year, and enter 2024 with the strongest and deepest team in our history, reinforcing our ongoing commitment to client service excellence.

We ended the year with some big news - PWA is launching an Ottawa office - and are forging ahead with that plan, having recently finalized a lease for space at 1545 Carling Avenue in west-central Ottawa. Heading up the office is Alexander Petrela, who is relocating to Ottawa with his young family after 8 years honing his construction specialist acumen with PWA and Navacord in Toronto.

Joining Alexander is long-time Ottawa resident and seasoned insurance professional, Karen Baines, bringing over 20 years of experience in commercial insurance and bonding to the Ottawa team. Look out for more Ottawa personnel announcements soon!

PWA was, once again, a top performing broker amongst the Navacord Group, an accomplishment we’re proud of given that Navacord is now over 50 brokers strong and includes many elite brokerages in the country.

The accomplishment we’re perhaps most proud of is our nearly 100% client retention once again in 2023, and the consistently positive feedback we receive from our customers. This is a great motivator for all of us at PWA, and an affirmation

BENEFIT FROM OUR SPECIALIZATION

Visit us us at Visit at www.petrela.com www.petrelawinter.com

Good luck out there!

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Local Touch. National Strength.™