Sidestepping Obstacles and Embracing Opportunities:

Each year ELECTRICAL CONTRACTOR uses its January issue to highlight the construction market for the coming year and discern what market trends mean for electrical contractors; this annual focus analyzes data and commentary from leading construction market experts and economists from McGraw-Hill Construction, Reed Construction Data (RCD) and several other sources to help deliver critical information to electrical contractors about the sectors in which they work. This article will sift through that information to uncover the key obstacles and opportunities, providing readers with the tools to succeed in 2007.

If you examine the total construction picture moving into 2007, it is clear that overall construction will decrease by a modest 1 percent to about $668 billion, according to McGraw-Hill’s construction report. That is not terrible news when you consider the construction boon in recent years. After the increases in 2004–2006, experts expect the economy to correct itself in 2007. Still, the economy is strong and headed upward, they say. That is a sign of a resilient economy in transition.

During the McGraw-Hill Construction-hosted Outlook 2007 Executive Conference held in Washington, D.C., in late October, Nariman Behravesh, executive vice president and chief economist at Global Insight, said, “9/11 did a lot of damage to the New York economy, but it did very little to change the U.S. economy. [Hurricane] Katrina was much more damaging.” He added that after the “dot-bomb” debacle, 9/11, Katrina and other catastrophes, the U.S. economy is still going strong. That resiliency has put the construction market in a relatively good place despite a downturn in the residential sector. “This is a pretty good environment,” he said.

RESIDENTIAL
There is no question that the big construction-related story of 2006–2007 is the softening of the single-family housing market. After five years of single- family housing growth—peaking in 2005 at record levels—a gradual correction took hold in 2006. “We’re looking for a 25 percent reduction in housing starts in 2007 and 2008,” said David A. Wyss, Standard & Poor’s chief economist, speaking at the Outlook 2007 Executive Conference. “It’s been 15 years since we’ve seen a housing recession.”

Soft landing vs. crash
The big difference with this market downturn and the one experienced in the early 1990s is the circumstances that led up to it. The 14 percent decline in 1990 came on the heels of three years of slumping housing starts. The 2006–2007 drop in housing starts follows a record high in 2005.

“We’re still in a low-inflation and low-interest rate environment,” said Global Insight’s Behravesh, “so the housing crash won’t be as bad as in the 1970s and 1980s.” He said the biggest impact would be in large metro markets—New York, Florida, Boston and California, etc.

The inventory of available single-family homes is outpacing the demand, which coupled with the recent hikes in interest rates, has fueled the downturn in the residential market. According to the National Association of Realtors, total housing inventory levels increased 1.9 percent at the end of October 2006 to 3.85 million existing homes available for sale. That represents a 7.4-month supply at the current sales pace.

Reed Construction Data expects total U.S. construction activity to increase by a little more than 5 percent in both 2006 and 2007 versus 10.5 percent in 2005. Residential investment, which includes new construction and improvements, is expected to decline by 0.9 percent in 2006 and by 4 percent in 2007. In addition, housing starts are expected to fall in 2006 and in 2007 by about 10 percent and 5.5 percent respectively.

Residential remodeling
What does this all mean to electrical contractors? If your primary business is in the residential market, you are already feeling the pain and will continue to endure a rough road for another year—at least. However, while new home starts are expected to slow in 2007, residential remodeling is expected to benefit. According to Kermit Baker, Ph.D., Hon. AIA, chief economist at the American Institute of Architects (AIA), the remodeling markets are very strong. The overall remodeling market has almost doubled in size over the last decade, from $153 billion in 1995 to $280 billion in 2005. Baker contends that remodeling will comprise 40 percent of all residential spending in coming years.

Using data from the AIA Home Design Survey, Baker explained at McGraw-Hill’s Outlook 2007 Executive Conference how the remodeling market shaped up in 2006. In the survey, respondents reported that their business is improving in the areas of additions and alterations and in kitchen and bathroom remodeling. The remodeling market for move-up homes, second/vacation homes and other areas were weakening.

Simply put, if consumers cannot afford to buy new homes, they might be more inclined to renovate their existing ones. However, the downturn in the housing market, experts agree, appears to be temporary. Upcoming actions by the Federal Reserve Board of Governors will have an effect.

“Interest rates are slowing the economy down,” said Standard & Poor’s Wyss. “We think the Fed’s done. Cuts are coming by the middle of next year. The Fed has overreacted. They will have to reverse course in the middle of next year. The decision at the Fed affects the economy 18 months out.” Wyss said he expects three rate cuts in the middle of 2007, which will spur growth in the single-family home market.

In fact, the long-term housing outlook, according to the AIA’s Baker, will also grow through some emerging trends. He cited immigration and shifting demographics as factors to consider. According to Census Bureau figures, household growth in the next decade is projected to jump from 12.6 million between 1995 and 2005 to 14.6 million between 2005 and 2015. Interestingly, the 2 million bump is expected to come mostly from a growing minority population.

Other factors, said Baker, are expected to positively affect the remodeling market, including an aging housing stock, rising land and energy prices, and higher home-owner equity levels. Those skyrocketing equity levels during the housing boon of the last five years will enable homeowners to leverage that equity into rehabs and remodeling projects. When you consider the added equity, think about what emerging residential trends will drive those renovations. According to AIA’s Baker, enhanced systems and kitchens and bathroom work will top the list.

Seconds and replacements
While housing growth will continue through the next decade, the National Association of Home Builders (NAHB) and the Joint Center for Housing Studies (JCHS) indicate that second/vacation homes will endure a decline of about 1.3 million units in the coming decade. The NAHB also projects that replacement homes will grow from 2.5 million units in the previous decade to 3.7 million units in the next decade. A substantial amount of the replacement growth, Baker said, will come from hurricane-damaged areas along the Gulf Coast.

Energy management and others
Energy management systems have also increased in popularity. According to data from the AIA Home Design Trends Survey, the greatest increase from 2005 to 2006 came in the area of energy management—an increase of 16 percent. Wireless systems were down by a mere 3 percent and central audio decreased by 10 percent. However, other opportunities emerged for electrical contractors in that survey. For example, security systems construction increased by 9 percent and automated lighting controls work increased by 5 percent. These trends feed into the niche projects and specialties electrical contractors have embraced in recent decades—voice/data/video, home automation, structured wiring, security and life safety, etc.

COMMERCIAL, INDUSTRIAL AND INSTITUTIONAL (CII)
Now that you have a clearer understanding of where the residential obstacles and opportunities lie, let us take a closer look at other construction sectors. If your primary business is commercial, industrial or institutional (CII), you can expect a good year in 2007. According to McGraw-Hill Construction’s Construction Outlook 2007, if you take residential out of the overall construction equation, construction would be up by 12 percent in 2007. The AIA “Work on the Boards” survey, for example, examines billings by architectural firm specialty. That survey suggests that a downturn in residential billings coincided with an upturn in CII billings.

RCD’s U.S. Construction Outlook 2007–2008 also predicts growth in the nonresidential construction sector. According to the report, nonresidential construction spending will increase by 12 percent in 2007 and another 8 percent in 2008.

Commercial
The report suggests that factory construction will nearly double in 2007–2008 from its 2003–2004 level. Spending on commercial buildings (hotel, office, retail and amusement) is expected to grow by 15 percent between 2006 and 2008, but the bulk of that uptrend will come from the 20 percent increase in 2006. According to RCD report, “Hotels are currently the fastest-growing commercial sector, boosted by several large projects in Las Vegas and 8 percent annual gains in revenue per available hotel room (REVPAR).” The report also suggested that hotel spending would grow by 50 percent in 2006, before tailing off to a 16 percent increase in 2007 and enduring a slide in 2008.

McGraw-Hill’s Construction Outlook 2007 reported that hotel construction soared in 2006 by 48 percent based on broad expansion, major Las Vegas projects and new convention center hotels in major metro areas. Baltimore and San Diego, for example, embarked on new convention center hotel projects because of a perception that those cities could not accommodate the largest convention groups. Legalized gambling in other states has prompted new hotel/casino projects, namely in Michigan (Detroit area) and Connecticut. Experts predict more growth in hotel construction in 2007 before a downturn in 2008.

After bottoming out in 2002 and 2003, lodging construction has shown increases to about $19.2 billion in 2006. RCD forecasts lodging construction to grow to $22 billion in 2007 and stay about even with that figure in 2008. RCD further forecasts greater growth in office building construction, from about $52 billion in 2006 to a forecasted $61 billion in 2007 and $73.8 billion in 2008.

Office construction increased by 14 percent in 2006, but will slow to a 5 percent increase in 2007, according to McGraw-Hill predictions. There were several major high-rise projects expected in 2006 (e.g., Goldman Sachs headquarters and the Freedom Tower in New York City). In terms of where the office construction work is, we can examine year-to-date increases in major U.S. cities. Seattle was up 301 percent, Minneapolis-St. Paul, Minn., showed a 167 percent increase, and Chicago was up 144 percent. Markets that encountered decreases in office construction included Dallas-Ft. Worth, (25 percent), Miami (19 percent) and Phoenix (17 percent).

RCD forecasts similar upward trends for the commercial retail sector, the healthcare sector and educational construction. Growth for institutional spending (education and hospitals), according to the RCD report, will rise from 9 percent in 2006 to 12 percent in 2007–2008. Hospital starts, for example, were up 28 percent from the previous year, as of July. Starts for educational facilities, through July, were up 19 percent. State budget surpluses helped spark the up-tick in educational spending, several sources said.

Warehouses and manufacturing plants
McGraw-Hill data suggests warehouse construction will be up 2 percent for 2006 and is expected to grow by another 5 percent in 2007. This projected increase is predicated on declining vacancy rates and other factors. One factor that could be an opportunity for electrical contractors and voice/data/video specialists is the need for updated facilities to handle improved inventory management practices.

Manufacturing facility construction went down slightly by 1 percent in 2006, according to McGraw-Hill’s data, but is poised to increase by 11 percent in 2007 to 81 million square feet.

Educating a growing population
“School construction is on an upturn,” said Robert Murray, vice president, economic affairs for McGraw-Hill Construction. “No doubt about it.” Overall, there was a 5 percent increase in educational construction in 2006. That trend is expected to continue in 2007 with a projected 6 percent increase. High school construction is up 16 percent while it is up 18 percent for colleges and universities. And while community colleges and vocational schools represent a relatively small slice of the overall total, those categories showed increases of 43 percent and 22 percent respectively.

Population growth, various states passing school construction measures and universities increasing capital spending fueled the surge in educational spending. There seems to be no downturn in sight, as projections show a steady increase in student enrollments in both K–8 and higher education. There is a slight plateau in grades 9-12 but still more than 16 million students—up from about 12.5 million in 1990. This “suggests ongoing demand for the whole education sector going forward,” Murray said.

Educational construction could be a source of income for electrical contractors seeking to take advantage of a sector that seems to be secure for the near future.

Aging baby boomers’ healthcare
Another opportunity in the institutional sector precipitated from an aging group of baby boomers that will lead to growing healthcare and assisted-living facility construction in coming years. Hospital and nursing home construction is easing back some from the last couple of years, but the growing elderly population is an “underlying base for demand,” said McGraw-Hill’s Murray. According to the Organisation for Economic Co-operation and Development (OECD), the ratio of the over-65 population to the labor force is projected to reach near 30 in the United States by 2020, as compared to about 20 in 2000.

McGraw-Hill’s Murray said several indicators are favorable for nonresidential sectors. Income properties experienced an increase of 14 percent in terms of dollars in 2006 after an 18 percent increase in 2005. He expects some deceleration but for the sector to remain strong above the $125 billion mark. The institutional sector was up 11 percent in 2005 and up 8 percent in 2006. That trend is expected to continue or remain about the same.

However, compared to 1990 when the institutional market sat at about $40 billion, there has been steady growth since, eclipsing $100 billion in 2006. Public works seem to be in a steady incline, heading toward the $125 billion plateau, after bottoming out in 1990 at about $45 billion.

Amusement purposes
Amusement and recreation spending is another decent bet in the next couple of years. In terms of square footage, convention centers and sports arenas experienced 50 percent and 23 percent growth respectively in 2006. They underscore the 8 percent increase in total amusement and recreation spending in 2006 and another 10 percent increase projected for 2007. Convention centers and sports facilities are not the only government-funded projects that could provide financial windfalls.

Government and transportation
Another opportunity for electrical contractors derives from the multiyear federal transportation bill, which will spark new business in highways, bridges and mass transit. The Safe Accountable, Flexible, Efficient Transportation Equity Act: A Legacy for Users (SAFETEA-LU), enacted in August 2005, pushed highway and bridge construction up by 13 percent in 2006 and is expected to increase by another 9 percent in 2007. There could be increased highway and bridge jobs for electrical contractors as part of the bill, which authorized $286.5 billion in spending on numerous transportation programs for the six-year period that stretches through 2009.

Airport terminal construction has also picked up, suggests the McGraw-Hill outlook. After enjoying a huge uptrend of 52 percent in 2005—on the heels of Congress passing an update to the federal aviation bill—airport terminal construction rose by 20 percent in 2006. The slowing trend is projected to continue into 2007 with a 15 percent increase to $2.3 billion.

Major airport projects in Indianapolis; San Jose, Calif.; Phoenix; Seattle; New York (JFK); Chicago (O’Hare); and Washington, D.C. (Dulles) fueled the growth in 2005. Major 2006 projects in Miami; Raleigh-Durham, N.C.; Detroit; Houston; Boston; and Nashville helped continue the trend.

Utility and energy-efficiency
While highway and bridge projects might be a nice opportunity for electrical contractors, the electric utility work that surged by a monstrous 65 percent in 2006 to $11.7 billion, will decrease by 20 percent in 2007, according to McGraw-Hill Construction predictions. The good news is that transmission line work is still showing strong growth moving forward.

Rising home energy costs, according to the AIA’s Baker, will ignite a shift toward energy-efficient options. He said there would be added investment in the “green sustainable design movement.” That movement could include opportunities for electrical contractors who install photovoltaic systems, control systems and energy-efficient lighting solutions, etc. It could also build the electrical contractor’s ability to work on a design/build basis, providing input at the onset of a major project.

Overall, the next two years look good for nonresidential spending and could look even better. According to the RCD outlook, “If economic growth [real GDP] is higher than the expected 2.5 percent to 3.0 percent pace in the next two years, nonresidential construction spending will be significantly higher than now forecast, especially for commercial projects.”

CONCLUSION
After analyzing the construction data and examining the comments of the industry’s leading experts, we can draw several conclusions about the outlook for 2007. First, we know the residential market is in a state of transition from its boom years to a softening trend. That transitional period should begin to change in the middle of this year when the Federal Reserve Board of Governors is expected to lower interest rates again. If you are an electrical contractor who works primarily in the single-family home market, that is good and bad news.

Second, if you work in the residential market, you can find refuge in remodeling and renovation work until business returns on the home construction front. There are plenty of opportunities in the remodeling arena to sustain your business in the interim. Third, for those contractors entrenched in the CII sectors, it is your turn to enjoy the good times. With the fastest growth coming from CII work—particularly in educational and healthcare facilities—it is increasingly important to bid the more secure project types. By following the trends and seeing where growth lies, you can better tailor your business to capitalize on those opportunities.

It is true that the housing crash was an inevitable construction market correction, and it has affected many contractors; however, in a time of global volatility, higher oil prices and natural disasters, it could be a whole lot worse. As Standard & Poor’s Wyss concluded, “During the ’70s and ’80s you would have killed to have an economy like this.” Therefore, enjoy the good times, because they tend not to last forever. It’s a cyclical thing.EC

KELLY, a former ELECTRICAL CONTRACTOR editor, is a Baltimore-based freelancer. Reach him at writerjmk44@comcast.net.