Construction Fraud or Dissatisfaction?

KPMP found, in it 2007 survey of the global construction industry, that twenty percent of respondents were aware of fraud in recent projects.

Richard Whittington, head of the firm’s construction practice was taken aback by the scale and the potential risks to the global economy and to the companies defrauded.

This link references the actual KPMG press release on the subject and provides a fuller description of the issues: http://www.kpmg.co.uk/news/detail.cfm?pr=2823

The article itself is most concerned with the availability of qualified contractors, not fraud. The survey itself was based responses of senior executives, at large and frequent procurers of construction services, including REITs, resource exploitation companies, utilities and governments. These individuals were queried on the current state of the industry, levels of satisfaction, project planning and contractor selection.

Forty two percent of the survey said that they were concerned with availability of qualified contractors, 75% saw a growth in demand for construction services and 39% anticipated a growth in construction expenditures.

Lastly and most interestingly, on-time delivery increased to 84% for the last project done, but over-budget projects increased to 35%.

In the study 80% of the surveyed were satisfied with their contractors, 20% claimed fraud. I would be interested to know the overlap between those claiming fraud and the merely dissatisfied. It must be noted that the respondents said they were aware of fraudulent activity but not whether they took action or more importantly on what facts and circumstances they based their judgment.

Comparable analysis doesn’t help much, but an audit of expenditures could provide adequate proof, if people were willing to pursue remedies. There are reasons why companies are not more concerned.:

-A building has intrinsic value associated with a well developed market. Except for truly bad projects or times of over-supply, a new building can be resold more than it cost to build.

-Construction is by definition is a sunk, controllable cost. Even if one over-pays, the only book expense is depreciation, and with current conventions, any excess expense is spread over a long period of time.

-In the US, tax benefits can help recoup any excess very quickly, and cynically, the higher the cost, the lower the tax bill. The exposure is low to cost over-runs.

The next issue was on-time delivery and cost over-runs, and it is encouraging that the percent of cost over-runs is much lower than the improved on-time performance level. If cost over-runs hurt, having a busted occupancy schedule can be ruinous.

I think the on-time performance is the most important measure in the study. Only when supply chains work and people are available can construction get gone on time. This fact bodes very well for the future with increased estimates for construction demand in coming years.

Contractors have to be careful about being over-extended. The problem is not equipment, but rather people. Running a large construction project well is a true gift, and any contractor is very concerned about keeping good teams in bad times. It appears that the better contractors will be able to grow very effectively building on present capability.

One question still open is the scope of the study. It included large procurers of construction services, but mentioned no banks and including them would add perspective on the whole industry, not just the top-tier. Since the lending is secured, the developer can finance conservatively 80% of the construction cost. Both parties, hopefully, will monitor these expenditures. After completion, a take-out loan is arranged to pay the construction loan with permanent financing.

It would be during construction that fraud would be detected. In practice, many lenders will not monitor the expenditures, an area of expected expertise, either from over-extension, or to solicit business. That is why the claimed incidences of fraud are so interesting: were they corrected or not. Claiming fraud looks better than admitting inattention, so fraud might not actually be fraud at all, but customer dissatisfaction, which would fit with the statistics.

Fraud is important, but was not really the most interesting part of the study. What is important is that the industry is growing and service quality high. Even cost over-runs can be seen as the result of on-time performance, which as we have seen is quite valuable. It seems the sector will provide many solid investment opportunities in the near term.