How COVID-19 is Affecting Construction Equipment Lending in Q4 and Beyond
by Tom Reilly, President of the 1st Source Bank Construction Finance Division
Looking into the New Year, a continuation in the rising number of new residential and commercial construction projects is expected. With the construction and engineering sectors showing resilience with a heightened demand for new homes, as people continue to move away from multi-family city living. Businesses are investing in ways to adapt their operations for ongoing virus-mitigation measures and barriers to promote social-distancing.
As a byproduct of economic uncertainty, some lenders are more conservative in taking on new borrowers. As we progress through Q4 of 2020, to a large extent, accessibility to funding for new debt is available providing lenders with accessible capital.
However, although loans are available, several questions are at the forefront for businesses looking to take on new debt in this unfamiliar economic climate. Should businesses look to take on new debt for equipment in this environment? Has the pandemic economy changed the requirements for lenders and borrowers? And, how can businesses, in the industrial manufacturing, contracting, and agriculture sectors make the most of available equipment loan capital?
COVID-19 and the Impact of Spending on the Construction Industry in 2020
Since COVID-19 is dictating the course of the global market, it is only fair to look at the future equipment lending forecast through the lens of current circumstances. Every sector is being impacted, by and large, negatively by the COVID economy, but some are more vulnerable.
In March 2020, construction crews and contractors across the United States halted plans for upcoming projects to accommodate stay-at-home orders. With the vast decrease in volume for new construction projects, beginning with the State-wide pandemic shutdowns in March 2020, middle-market subcontractors have been one of the hardest hit in the construction industry. Small and independent construction contractors might be more at-risk to suffer hardships in the event of more state-closures in the months to come.
The CARES Act provided funding for small business Paycheck Protection Program (PPP) loans, made available through the Small Business Administration. The dispersal period for PPP loans closed on August 8, 2020, but as of today, there remains over $1 billion allocated to PPP dispersals. The most visible hope for businesses in these vulnerable segments of the economy is another round of Federal stimulus payments or business tax credits, which has been proposed by both sides of the political aisle, with no avail – as of yet.
Coming into June, States began reopening and many construction projects picked up again. And, even though construction saw a 6% decrease in spending between February and June, the industry overall has been resilient to hardships resulting from the pandemic.
Between February to September of 2020, construction spending for publicly funded projects increased by 0.3%. Comparatively, of course, this growth is a fraction of the 6.2% increase the industry experienced during the same period of 2019. But it is indicative of industry resilience.
As for the private sector construction industry, spending between February and June experienced an 8% decrease, and spending in June experienced a decrease of nearly 1.9% compared to the same period from 2019. Commercial building projects have seen a slowdown, as most businesses are simply trying to keep the doors open.
But the impacts are not limited to variable demand, as supply chain disruptions are a substantial part of the economic volatility felt across the construction industry. Specifically, to the construction and engineering sector, a lumber shortage is currently standing at 11% more scarcity than Q3 of 2019. The reason for this shortage is, in large part due to an upsurge in demand for homes in the residential housing sector. The demand coincides with the beginning of the Stay-at-Home orders, which commenced in March. Some families are finding their city condominium constricted for space when, both the children and the parents are going to school and working (respectively) from home. As of now, demand remains high in the residential housing sector, with an average home listing duration of 14-days in July, according to Zillow, compared to twice the duration in the same period in 2019.
Retrospectively, these declines in new spending are to be expected, given the nationwide shutdowns shaking the economy throughout the summer. Now, the construction and engineering industry wants to know, when spending on commercial construction will return to normal, and how the current economic slump is affecting the availability of construction equipment financing.
A Look to Construction Equipment Financing in the Near Future
Overall, the industry remains “essential,” which puts businesses ahead of where they were a year ago. Several factors, however, will impact the direction of the industry in the months ahead. But, by-and-large, construction equipment is in-demand and profitable. New construction projects are being backlogged due to labor availability and raw material shortages – but construction fleets are seeing a boom in construction equipment rentals.
If States experience additional setbacks and shutdowns from a resurgence of COVID-19 in the near future, spending on construction will see another reduction. If coronavirus cases recede going into the winter, there will likely be plenty of new project spending and lending in the new year.
Should businesses buy or rent new equipment in the current economy?
Assessing whether a business should rent, lease, or purchase new fleet equipment is an important method of decreasing financial vulnerability. When it comes to renting or buying equipment in the current economy, there is not a unilateral answer that works for every business. The pandemic is currently the largest factor affecting spending in every sector, and there are benefits and drawbacks to renting or buying equipment.
Financing remains available for equipment loans, and whether it makes sense to rent or buy depends on the collective and operation strategy businesses intend to implement for the 2021 fiscal year. Many businesses in construction, engineering, and agriculture are taking another look at evaluating whether it is more efficacious to rent or buy new equipment.
Businesses operating in the fossil fuel industry should consider renting equipment, as fuel prices and consumption remain low, compared to the 3rd quarter of 2019.
Benefits and Drawbacks to Renting, Leasing, or Buying Equipment
On the face of it – every business would rather own its fleet outright. Businesses are looking for ways to fortify their business assets, so start by evaluating whether current equipment financing structure produces fiscal resilience or risk in the event of further statewide shutdowns.
Businesses should steer clear of high-debt construction equipment loans, given the market volatility. And, there are several ways in which to improve opportunities to secure the best interest rate, such as improving liquidity and assessing fleet management.
Renting equipment, instead of purchasing, is an effective and simple strategy for managing a fleet's financial risk in times of stagnant economic spending. Renting is an especially attractive option to small agricultural fleets and independent contractors, who have seen the most stagnation of new income since the beginning of the pandemic. In general, equipment rentals are up, and rental fleets are at an all-time high.
Renting a fleet affords access to assets as long as they are deriving income, and the option to simply stop renting if needed. It also gives businesses the latitude to liquidate individual assets, as necessary. In as volatile an economy as exists today, liquidity is a good sign to lenders that a business can ride-out possible economic downturns in the near future. Renting allows businesses to retain more liquidity.
Another option for businesses, to decrease financial obligation and increase liquidity, is to lease equipment, rather than to rent. Renting provides the least financial risk, but it does not produce equity. Leasing is a method of building equity in a fleet while reserving the option to liquidate assets if needed. The benefit of leasing is the decreased long-term financial obligations and possible repercussions of insolvency that equipment purchases present.
Lenders like to see equipment purchases since it guarantees a return on investment. The COVID economy, however, presents a situation where many end-users are more likely to rent than buy, given future pandemic and economic uncertainties. And, the opportunity to convert rentals in the 4th quarter with bonus depreciation, which will hopefully continue through the next year.
What should the industry plan for in 2021?
One of three things can happen in the next six months. In the first scenario, the pandemic will continue to surge in anticipation of widespread vaccine distribution, which carries the potential of causing more shutdowns and economic stagnation. In the middle-of-the-road scenario, things will remain where they stand currently, and further closures will not be necessary. Or, in the best-case scenario, the pandemic will recede and explode into a bull market. Taking a middle of the line approach is the best option of the three that allows for financial certainty in the near future by strategic planning and financial fortification.
The financial forecast for businesses, however, depends on the sector in which the business operates, as well as many other individual factors. Overall, the United States economy feels the sting of the COVID economy in every industry sector, and businesses need to become dynamically prepared for variable scenarios.
Even if the coronavirus pandemic continues to restrict markets into and after the new year, demand for new construction projects and equipment lending is expected to continue at a steady rate. Lenders expect interest rates to remain low and new credit availability to remain normal, making capital accessible for equipment.