Each year, ELECTRICAL CONTRACTOR uses its January issue to focus on the construction market in order to uncover trends that shape the electrical construction business. This annual spotlight synthesizes commentary from leading market experts from a variety of sources to provide an overview of what electrical contractors can expect in 2008 and beyond.
This article draws from comments made at the McGraw-Hill Construction Outlook 2008 Executive Conference held Oct. 25, 2007, in Washington, D.C., as well as Reed Construction Data’s U.S. Construction Outlook 2008–2009 and various other sources.
The 2008 outlook is not pleasant for electrical contractors—or any other contractors—who are married solely to the single-family home market. There’s no doubt the housing market has crashed with a loud thud, much more significantly than even the experts anticipated a year ago. While the single-family home market will not recover any time soon, there still are opportunities for electrical contractors and their building partners to ease the blow.
First, let’s examine what went wrong with the housing market. The last housing recession in the United States occurred in 1991–1992. Experts agree these trends are cyclical, so construction professionals who enjoyed the good times also must endure the bad times. However, this housing recession isn’t like most of its predecessors—it is lasting longer than anyone projected. Why? An alarming “perfect storm” of contributing factors conspired against the market.
“Every time we think we hit the bottom of the housing downturn, the other shoe drops,” said Kermit Baker, Ph.D., Hon. AIA, chief economist for the American Institute of Architects, speaking at McGraw-Hill’s Outlook 2008 Executive Conference. He cautioned that the “housing recession may boil over into a full-blown economic downturn.”
Last year at this time, experts predicted an economic “correction,” or a leveling off, particularly in the residential market. Unfortunately, that downturn in single-family homes collided with a subprime mortgage crisis, prompting a more significant decline.
According to Standard & Poor’s Chief Economist David A. Wyss, who spoke at the McGraw-Hill event, housing is the weak spot right now, and other sectors of the economy are feeling the pull from it. In addition, recovery is going to be slow.
The housing market benefited from the 2004–2005 boom, during which the real problem was pricing, Wyss said. Interest rates were low and housing was affordable; homes were being constructed quickly and selling fast. It was a great time for electrical contractors and their building partners in the residential market, particularly the single-family home market. The lowest interest rates in a generation led to record highs in home appreciations, Baker said.
To get consumers with less-than-perfect credit into new homes, creditors offered subprime, adjustable-rate mortgages (ARMs), which also helped drive housing growth at the time. These types of loans typically have a teaser rate that resets, or “balloons,” after a two-year period. Most people expected to take advantage of low interest rates and higher house values to refinance into fixed-rate loans before their ARMs reset. Traditionally, they had been able to accomplish that. “Seventy percent of all adjustable-rate mortgages used to be refinanced before they reset,” Wyss said. Unfortunately, that’s not happening anymore because homeowners would have to refinance at higher rates and with less equity. Housing prices decreased by nearly 4 percent from 2006–2007, and another 7 percent decline is expected before it bottoms out. That is an 11 percent drop in home values before the trend begins to reverse.
In addition, new loans will require larger down payments, and lenders are tightening restrictions. The stage was set for a record-setting wave of foreclosures.
According to Irvine, Calif.-based RealtyTrac Inc., 446,726 homes nationwide were targeted by some sort of foreclosure activity in the third quarter of 2007 (July to September), marking an increase of more than 100 percent during the same quarter in 2006. There was one foreclosure filing for every 196 U.S. households during the third quarter. In some cases, Wyss said, “mailing in the keys to the bank is not a bad decision.”
Some financial policymakers think this foreclosure trend is the tip of a massive iceberg. In fact, the Bush Administration worked with the Department of Treasury and the financial services industry to develop legislation that would provide some relief to consumers stuck in bad ARMs. In addition, more than 80 percent of respondents to the American Institute of Architects’ Work-on-the-Books Survey (September 2007) indicated that they envision credit market problems to extend into 2008.
Robert Murray, vice president of economic affairs at McGraw-Hill Construction, said the credit crunch is the biggest threat to the construction industry.
Period of uncertainty
The country went from record highs in 2004–2005 in appreciation to the bursting of the housing bubble in the following two years. That shift in momentum left too many available homes in the nation’s housing stock. That inventory overhang will level off, construction pundits say, but it will be very slow. Right now, there are between 750,000 and 800,000 excess homes in the nation’s inventory. According to Baker, it is likely that half of those will be absorbed into the market during 2008. The selling off of that inventory is a critical component to the speed with which the nation climbs out of this housing recession. Baker suggests the country could emerge from the housing recession in 2009, barring unforeseen circumstances.
Federal Reserve Chairman Ben Bernanke, in a November 2007 statement before Congress’ Joint Economic Committee (JEC), said, “Growth was seen as remaining sluggish during the first part of , then strengthening as the effects of tighter credit and the housing correction begin to wane.”
Experts think early 2008 is a tipping point. Either the country will crawl out of this downturn, or it will sink into a full recession. Bernanke told the JEC that there are still “a lot of uncertainties.” Those uncertainties, according to Wyss, include potential terror attacks, a trade war, the escalation of oil prices and other variables. “Right now, the economy is vulnerable,” he said.
The Federal Reserve’s rate adjustments keep the overall economy in check, so experts think several more rate cuts will stimulate the housing market, but only incrementally. The Fed cut rates in September, October and December 2007 to help prevent the economy from slipping into a recession.
Reed Construction Data believes these interest rate cuts and an improving U.S. trade balance will stimulate the economy and stave off an economic recession. The Reed Outlook suggests “the economy is headed for a period of growth well below the noninflationary sustainable rate near 3.0 percent.” Also according to the Reed Outlook, the housing market, which is down by 25 percent in terms of starts, has been a drag on the overall economy. However, “If housing grows slightly [in 2008], or even stays flat, this will provide a considerable positive swing in the economic statistics.”
The Reed report forecasts total U.S. construction spending to finish 2007 down 20.4 percent from 2006 (see Figure 1). It also predicts that the U.S. residential building construction market will decrease by 21.2 percent for 2007, increase by 2 percent in 2008, and increase by another 10.2 percent in 2009 (see Figure 2). Total single-family home construction will increase by a minuscule 0.4 percent in 2008 and then skip up by 11.7 percent in 2009, the report predicts. In other words, Reed Construction Data sees light at the end of the residential construction market tunnel. However, “I don’t think anyone is expecting single-family housing to bounce back any time in 2008,” McGraw-Hill Construction’s Murray said.
Remodeling down but OK
When you think of residential construction strictly in terms of single-family homes, the picture is depressing. Perhaps your firm has already felt the brunt of this housing recession, and you have completed your backlog of work—the carryover from when the market was ripe. What now? The remodeling market, which served in 2006 as a refuge for many residential electrical contractors who were stinging from the single--family market, is now feeling the drag of the housing downturn.
According to Murray, “Remodeling had been resilient, but it’s starting to slide back a bit.” In 2006, remodeling was up 8 percent and cushioned the blow. Now, that pent-up demand is leveling off, which is a testament to how the woes in single-family construction are reaching into other sectors.
Reed Construction Data forecasts a modest 1.2 percent increase from 2006–2007 in residential improvements (remodeling, renovation and replacement work), but forecasts a 6.3 percent hike in 2008 and a 7 percent increase in 2009. Remodeling work, therefore, isn’t the sanctuary it once was, but it will be a favorable place to operate until single-family home construction picks up again.
“If you can’t build new houses, the least you can do is remodel a few kitchens and bathrooms,” Standard & Poor’s Wyss said.
AIA’s Baker said, “Remodeling doesn’t get ahead of itself like building does.” He thinks the remodeling market will remain healthy into 2008, but he said it is slowing, as well. Homeowners cashed in on their home equity to fund remodeling projects during growth periods, but that spending is way down, he said.
“Americans used homes as an ATM,” Wyss said.
Homeowners, Baker said, are returning to basics, being careful not to “over-improve” their properties. With fewer dollars to spend, they are becoming more conservative and cognizant of which projects deliver the best return on investment (ROI). He said midrange projects have outperformed upscale projects in terms of their ROI.
According to the AIA Home Design Trends Surveys (2006–2007), new construction in the third quarter weakened significantly, while remodeling kitchens and baths was considered improving by 35 percent of respondents. That’s down about 10 percent from 2006, but it shows there are still opportunities for remodeling. Likewise, 34 percent of respondents indicated improvments in the additions and alterations remodeling category. Again, that is down about 10 percent from 2006, but it shows some refuge from the new homes construction market.
It is important to maintain a sense of historical perspective when examining the remodeling market. Despite recent downward trends, remodeling has been strengthening since 1995. According to the American Housing Survey, which is tabulated by the Joint Center for Housing Studies (JCHS) and the U.S. Department of Commerce, the market doubled from $149 billion in 1995 to $298 billion in 2006. It is expected to slip back to $291 billion for 2007 but remains strong overall.
Remodeling also will be more important, moving into the next decade, Baker said. Based on JCHS and National Association of Home Builders (NAHB) research, Baker expects remodeling to approach a 50 percent share of residential expenditures by 2015.
According to McGraw-Hill data, multifamily housing should decline by 18 percent for 2007 and decline another 11 percent in 2008. That trend went from stable in 2006 to a sharp decline in 2007 and a projected softer decline in 2008. If this trend continues, there should be growth in the multifamily sector during the latter part of this decade.
Recent large projects, such as the 1,200-unit Chicago Spire Condominium Tower and the Planet Hollywood Condominium Hotel in Las Vegas, have helped sustain the multifamily housing market in this slump. Those, and other major projects, began in 2007 and will take years to complete. There’s a lot of electrical construction and systems work to be done on those and similar projects.
Reed Construction Data’s Outlook forecasts a stronger multifamily construction market than does McGraw-Hill. Reed predicts a 7.9 percent increase in multifamily construction in 2008 and a slightly smaller increase of 5.2 percent in 2009. Regardless of which report is most accurate, the market for multifamily construction is improving. That’s good news for electrical contractors.
While single-family housing starts declined by 25 percent in 2007, commercial building was up by 7 percent. That is far shy of the 2006 increase of 27 percent, but it remains a viable opportunity for electrical construction.
Murray sees opportunity for contractors in the commercial stores sector. Store and shopping center construction bottomed out in 1992 and climbed significantly through 2006 to the 300 million-square-feet mark. In addition, while a 10 percent decline is anticipated for 2008, there is plenty of work to be done. Five major retailers—Wal-Mart, The Home Depot, Lowe’s, Target and Kohl’s—have implemented aggressive store-expansion plans in recent years. Only Wal-Mart scaled back those plans. Reed Construction Data forecasts commercial construction (mostly retail stores) to grow by 14 percent for 2007 (see Figure 3). The forecast for 2008 and 2009 in retail construction is much more modest at increases of 6.1 percent and 2.2 percent, respectively.
According to the Reed Outlook, “Construction spending will expand fastest in 2008 for hotels and healthcare and slowest for retail and education” (see Figures 3, 5, 6 and 7). Reed projects U.S. put-in-place lodging construction to grow from $28.7 billion in 2007 to $34.4 billion in 2008 and $42.5 billion in 2009. Healthcare forecasts indicate growth from $45.9 billion in 2007 to $53.7 billion in 2008 and a jump to nearly $60 billion in 2009.
According to Murray, the institutional market might be the key to success because of increased investments in schools, prisons, convention centers and churches. California voters approved a proposition that earmarks more than $10 billion for school construction. Texas voters approved nine local school bond issues of more than $2 billion, and North Carolina voters approved $970 million for school projects.
The Reed Outlook also purports prosperity in education construction. The report shows a 13.6 percent increase in spending for education construction in 2007, while forecasting 8 percent and 4.1 percent increases in 2008 and 2009, respectively (see Figure 7). McGraw-Hill’s Murray said colleges and universities also have increased capital budgets for construction.
Another safe bet in 2008 is public works projects, Murray said. Federal spending for fiscal year 2007 increased by 10 percent for federal-aid highway projects. Mass transit spending jumped by 6 percent. Airport improvement grants remained flat, but other opportunities lie in the highway and bridge infrastructures. Because of the I-35 West bridge collapse in Minneapolis, highway officials are clamoring to fortify critical infrastructure components.
In addition, the Reed Outlook has good news for electrical contractors’ bread-and-butter businesses. Reed estimates that U.S. put-in-place construction in communication work will expand from $26 billion in 2007 to $28.7 billion in 2008 and to almost $30 billion in 2009. Even more encouraging is the put-in-place electric power market, which Reed Construction Data forecasts will grow from $47.8 billion in 2007 to a staggering $65.8 billion by the end of 2009—a 38 percent increase during that two-year window (see Figure 11).
Emerging green trend
Also picking up serious steam in construction is the green movement. Speaking at the McGraw-Hill Outlook Conference, Rick Fedrizzi, president, CEO and founding chairman of the U.S. Green Building Council (USGBC), said environmentally responsible (green) building has changed dramatically in recent years. “Fourteen years ago, it cost more to build green,” he said. “Today, that’s not the case.” He said you must have a solid business case for green building before you can make the environmental agenda stick. “Traction is happening because you can help the environment and still make a solid profit.”
Dr. Chris Luebkeman, one of the world’s leading futurists, who spoke at the McGraw-Hill 2008 Construction Outlook Executive Conference, said he thinks electrical efficiency is one of the top environmental elements that can make a big difference in the green building movement. Other energy-efficient systems have taken hold and led to a proliferation of the Leadership in Energy and Environmental Design (LEED) certification program. This program has had particular traction in government construction. There’s a lot of coordination to get a building LEED-certified, but the certification is coveted.
On a panel during the McGraw-Hill conference, Brad Haeberle, vice president of marketing at Siemens Building Technologies Inc., said there is a lot of activity in intelligent design, specifically in Asia. He expects many of those trends to transfer to the United States. He made particular note of tiny wireless sensors that can be placed anywhere in a building to sense many different functions. This could have ramifications in the electrical and systems arena. He thinks there is a lot of opportunity to retrofit existing buildings in the green movement.
Green building is a topic electrical contractors may be forced to embrace, if they haven’t already done so. Its popularity is growing, and its affordability isn’t as prohibitive as it once was.
Now that we’ve broken down where the work might be and might not be for electrical contractors, it’s also important to know about alarming trends that should be on your radar as you move forward. Experts agree that an aging work force is a crisis waiting to happen.
According to futurist Luebkeman, the work force is getting older, and mass retirement of aging baby boomers will cause a crisis. We’re “losing thousands of years of experience every year,” he said. In the next 5 to ten years, the aging baby boomers will be retiring in record number, taking their experience with them. Said Siemens’ Haeberle, 80 to 90 percent of the work force will be turning over in the next 10 years. He added that shift represents a “significant brain drain and removal of a skill set from the marketplace.”
Training and education will be the keys to getting the next generation of workers and managers up to speed before the mass exodus of experienced electricians and systems technicians takes hold. “Skilled labor is a problem,” Haeberle said. “Finding those people and in a fast enough way is ... our most significant problem.”
The housing recession is draining the entire market. Persevering through this cycle will be tougher for those electrical contractors dependent on single-family homes than their counterparts who are anchored in the growth areas. Overall, though, there still is a lot of electrical and systems construction work that needs to be completed. Are you prepared to answer the RFP? EC
KELLY, a former ELECTRICAL CONTRACTOR editor, is a Baltimore-based freelancer. Reach him at email@example.com.