There is a lot of uncertainty and politics around President Donald Trump’s new tariffs. This article is meant to cut through the politics and show contractors how the tariffs may affect their bond programs.
First, let’s explore what a common construction project looks like. This breakdown can vary greatly depending on the type of project. For example, a manufacturing facility may be significantly more equipment and material intensive than a speculative warehouse. Additionally, a subcontractor’ contract may have a larger percentage of material than the general contractor’s contract. In general, most construction contracts are 30% – 50% material.
Let’s assume that we have a general contractor with $50 million in signed construction contracts. The contractor estimates projects with 10% gross profit, 10% equipment costs, 40% labor and 40% material. In dollar amounts, the backlog would look like this:
Total Cost = $50,000,000
Labor = $20,000,000
Material = $20,000,000
Equipment = $5,000,000
Gross Profit = $5,000,000
When looking at backlog, surety bond companies remove Gross Profit and only look at actual costs. From a bond standpoint, this contractor has $45,000,000 in Cost to Complete. Assuming the bond company wants them to have a 5% working capital case, the contractor will need $2,250,000 in working capital to be able to bond this work before tariffs.
Should the contractor’s material prices increase by the tariff amount (25%), the material will now cost $25,000,000 instead of $20,000,000. This will increase the total cost to $55,000,000 and the bonded cost to complete to $50,000,000. This means under the same bond program; a contractor will need an additional $250,000 in working capital to bond the same work.
Keep in mind that these tariffs may have a more profound impact on subcontractors who use materials as a percentage of their contracts. Certain trades such as mechanical contractors, carpenters and drywall hangers, may be affected the most.
There are a number of ways that these tariffs could affect contractors. Based on the numbers above, contractors will need to hold more liquidity to bond the same amount of work. However, if contractors can pass the increased cost to project owners AND keep their margins (10%), it could be a net gain for contractors.
In the example above, the gross profits from the same work would increase from $5,000,000 to $5,500,000 without obtaining any new projects. This is a bold assumption, however. When price escalations were common after the COVID-19 pandemic, owners were very slow to accept the changes and contractors often funded the increases from their own profits for a while.
Another indirect impact that contractors could face is supply chain disruption. While material manufacturers and suppliers figure out the new tariffs, it may create shortages and delays in getting building materials. These delays could not only create contract defaults and liquidated damages, but they may also lead to material pricing increasing far more than the actual tariffs to meet rising demand.
There are some steps that contractors can take to protect themselves and their bonding.
First negotiate price escalations and delay provisions with the project owner. While owners will be reluctant to accept such language, they will likely need to face the new reality. After the pandemic, smart contractors were able to get such concessions while those that didn’t often faced steep project losses.
While this is always a good strategy, add extra dollars or contingencies to project your company. This may be especially important for “hard bid” contractors. We often get pushback from contractors saying they will be uncompetitive. However, it’s always better to not get a project that is going to generate little profit or a loss.
While long term relationships are important, you need to communicate with your suppliers on expectations, costs and timelines. Contractors may have to seek out new relationships that can substitute local materials or obtain them faster.
While they may be reluctant to provide them, consider asking for supply bonds from key suppliers. This can protect against escalations and delays for a low cost.
Tariffs will certainly impact contractors and their ability to bond projects. Hopefully, these tariffs will be short term in nature. In the meantime, contractors should take important steps to minimize the impacts on their business and bonding.
Axcess Surety is the premier provider of surety bonds nationally. We work individuals and businesses across the country to provide the best surety bond programs at the best price.
