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At a time when things could not look much worse economically, there is some good news to accompany the overwhelming bad. First, the bad news. “The economic outlook is a disaster,” said Michael J. Mandel, chief economist for BusinessWeek, during a presentation at the October 2008 McGraw-Hill Construction Outlook 2009 Executive Conference in Washington, D.C. His sentence sums up the economic debacle weighing down all markets in the United States. Some argue about when the economy fell into recession, but it is clear, we are there now. Some have said this is the worst economic crisis since the Great Depression, and there is no sunshine on the short-term horizon.
According to Reed Construction Data’s (RCD) “U.S. Construction Outlook 2009–2010” report, contractors and suppliers must endure a drop in demand for building space and facility capacity and increased commodity prices along with low access to credit, which collectively “suggest that the recovery from the recession will be relatively long and slow,” wrote Jim Haughey, Reed’s chief economist, in the report.
The Reed report indicates that what finally “popped the credit bubble” was the trillion-dollar default on residential mortgages in the United States. When the credit bubble burst in August 2008, businesses also lost out on short-term loans and access to credit. The financial institutions stopped lending money out of fear. That includes contractors from all sectors of the construction market.
“Fixing the credit problem will be a long, ugly and expensive process that will dampen economic growth for several years,” Haughey wrote in the report.
When analyzing the data provided in Reed’s “U.S. Construction Outlook,” the numbers paint a gloomy picture for residential and nonresidential construction alike. Based on U.S. Bureau of Economic Analysis (BEA) at the Department of Commerce, the Reed report indicates that private investment in residential structures dropped 25 percent in the first quarter of 2008, another 13 percent in the second quarter and an additional 19 percent in the third quarter. Nonresidential private investment rose substantially by 18.5 percent in the second quarter but grew by a mere 8 percent in the third quarter. That trend will to continue with the recession hitting the nonresidential market, which had held its own during recent quarters.
Robert Murray, McGraw-Hill Construction’s vice president of economic affairs, indicated that last year’s refuge is no longer a sanctuary for contractors. As single-family housing starts continues to fall, commercial buildings also are heading down. Institutional construction is healthy for now but could trend downward soon. Public works projects also declined by 5 percent in 2008 after growing by 8 percent the previous year. This is likely due to tighter government budgets caused by declining property taxes. Therefore, for electrical contractors who sought refuge in commercial/industrial/institutional (CII) work in the early stages of this economic crisis, there is nowhere to hide in 2009.
According to McGraw-Hill’s statistics, single-family housing starts dropped 36 percent from 2007 to 2008. Commercial building, which had increased by 7 percent from 2006 to 2007, slumped severely in 2008 by 10 percent. This reversal is alarming in terms of square feet, as well. Construction of stores and shopping centers declined by 30 percent in 2008 and should decrease by an additional 15 percent, or 188 million square feet, in 2009. Slowing retail sales have stunted aggressive expansion plans by Wal-Mart, Target, Kohl’s and The Home Depot. When you add the increased amount of store closings and reorganizations of failed retailers, the future for retail construction is especially grim in the short term.
The only sector that showed slight growth was the institutional market, which grew by 7 percent in 2008 after increasing by 5 percent the previous year. Construction projects related to new convention centers, hospitals, schools and churches anchored this uptick.
RCD’s U.S. construction starts information shows a 6.1 percent decline in overall commercial construction, tempered only by a tremendous increase in government office starts of 90.3 percent. There was a 2.1 percent dip in nonresidential construction, but other sectors—especially residential and industrial—felt a harder gut-punch. Residential starts were down 33.4 percent as industrial (manufacturing) starts fell by a whopping 44 percent.
Institutional work was the shining star in the market, posting a 5.6 percent increase from the previous year. Within the institutional market, hospital/clinic starts were up 14 percent, and library/museum starts increased by 32.6 percent.
While military construction starts increased by almost 15 percent, we must examine that number in context. The previous year, military starts rose by an astonishing 123 percent. The latest numbers indicate a major slowdown in military construction projects. Despite the expected decline, contractors close to government military base realignment areas can benefit from an influx of funding. According to McGraw-Hill, federal spending for fiscal year 2008 increased in the Department of Defense’s base realignment plans by 29 percent. That number will increase by another 18 percent in fiscal year 2009.
The main point to take from construction starts data is that residential and manufacturing have taken the largest hits. Closed plants and factories leading to defaults on mortgages and lost homes are fueling this downward spiral. Overall, construction starts declined by 15.5 percent from 2007 to 2008. These figures are enough to send most electrical contractors to the psychiatrist for antidepressants, but there is a thin silver lining.
We have touched on the bad news, but there is a modicum of positive news in this downtrodden economy. While this may be the worst economic climate since the 1930s, things will not deteriorate to that level.
“We are living in a very different place than the U.S. economy was in the 1930s,” said James Poterba, president of the National Bureau of Economic Research (NBER), speaking at the Reuters Investment Outlook 2009 Summit held in New York on Dec. 8, 2008. “It is possible to have the worst postwar recession without getting anywhere close to what it was in the 1930s.”
He added, though, that this recession will likely last longer than the average recession. The NBER, which marked the beginning of the recession at December 2007, believes this downturn will last well into 2009 and be the most severe slump since the 1981–1982 recession.
“A year ago, no one would have predicted where we are today,” BusinessWeek’s Mandel said at the McGraw-Hill conference. “Few predicted this direness.”
Mandel said this is the slowest growth rate in the U.S. economy in 50 years. He said the combination of overbuilding of homes and excessive lending sparked this crisis. Mandel—a self-described optimist—spoke in frank gloom-and-doom terms about the economic outlook, and he was not alone.
Kermit Baker, Ph.D., chief economist for the American Institute of Architects (AIA) in Washington, D.C., said the housing boom that homebuilders and other trades enjoyed over the last several years was cyclical.
“It will correct itself eventually,” he said. However, he warns that we have not yet hit bottom in the housing market. “We haven’t been able to work off the excess inventory [of houses],” which is the only way to crawl out of this crisis, he said.
Homebuilders have cut production, but the excess housing stock is still sitting on the market. As home prices continue to fall at historic rates, consumer spending goes down as well. Baker is confident that it will rebound because slumps historically have. Agreeing with Poterba, Baker said the recovery time for this recession could be longer than most. An overall weak economy delays the housing recovery, but when the recovery begins, production of new homes rebounds quickly, he said.
“We knew this was coming, but we didn’t know the extent,” McGraw-Hill’s Murray said. “This is a recession … . It’s looking pretty dark.”
Reed Construction Data expects construction spending to decrease by 5.8 percent in 2008 and an additional 2.2 percent in 2009. However, RCD predicts a reversal in 2010 with a 7.9 percent increase in construction spending. Then, in the first quarter of 2011, construction spending will again reach its 2006 peak, the RCD report indicated.
According to Hanley-Wood’s Key Indicator Alert, new home sales fell again in October 2008 by 5.3 percent to a seasonally adjusted pace of 433,000 units. New home inventory declined to 385,000, which is the lowest figure since June 2004, but the housing market is not out of the woods yet. The existing home inventory will take quite some time to sell off. More foreclosures are on the way, as other adjustable rate mortgages reset at higher rates in 2009.
However, if remodeling of existing homes is part of your repertoire, there are opportunities for you. Unfortunately, those opportunities are starting to feel some negative effects from a tighter economy and limited consumer spending, not to mention increased unemployment. Reed’s seasonally adjusted data shows that construction employment is down by more than 6 percent since January 2007. That is starting to plateau off, but it is indicative of what is happening in all economic sectors. If people are not working, they are not improving their homes. Multifamily housing might offer some refuge for the time being.
Multifamily housing, Baker contends, remains the strongest sector of the construction market. He also sees some strength in remodeling and repair work. According to Baker, in 2007, $335 billion was spent on remodeling, accounting for 3 percent of all activity in the U.S. economy and 70 percent of home improvement dollars. There is room for more concern, though.
“Early in the housing downturn, remodeling held strong, but now remodeling is getting caught in the housing crossfire,” he said.
Baker predicts that green building initiatives and the aging housing stock will spur increases in home improvements. The older stock needs fixing and replacement parts, such as new roofs; heating, ventilating and air conditioning (HVAC); and other upgrades. According to Harvard University’s Joint Center for Housing Studies, homeowners spend an average of about $2,500 annually on improvements if a house is 54 years old or older. Conversely, if a home is six to 11 years old, the average spending per year dips to $1,750 per unit. Expenditures slide to about $1,300 per unit on houses less than six years old. There still is opportunity in home retrofits, but there will be a slowdown in growth in this sector.
Green collar jobs
There is a lot of potential, Baker said, in sustainability (green) projects, which could pose vast opportunities. Green retrofits will lead the wave of innovation that increasingly will penetrate the remodeling market. Rick Fedrizzi, president, CEO and founding chairman of the U.S. Green Building Council (USGBC), agreed.
“The green revolution will be a big part of the solution,” he said at the Outlook 2009 Executive Conference.
He recommends contractors working in environmentally friendly projects—particularly Leadership in Energy and Environmental Design (LEED) projects—stay the course. LEED is a certification for projects that comply with strict environmentally friendly criteria.
“LEED is one of the reasons this green movement is taking off,” Fedrizzi said. He added that the return on investment is making green projects more attractive to mainstream contractors.
He said the USGBC is prepared to make LEED a big part of future growth in “green collar” jobs. Solar installations and wind generation will anchor a movement that could create 40 million new green collar jobs by 2030, Fedrizzi said. He said energy-efficient lighting alternatives and improved building performance will catapult this green market. He also said there will be greater investment in building systems and controls, which is an indicator to electrical contractors that LEED projects can be launching pads for success.
That success can come from the existing building stock, Fedrizzi said. He said 86 percent of existing buildings need retrofits and updates to systems to make them more energy efficient.
Fedrizzi said the focal point should be schools. For 55 million students, older buildings in which they learn are in dire need of repair. Green building concepts help in the learning process. He said there are reports of 20 percent better test scores in green schools, with less asthma and overall better health. Environments with more natural light and better air quality are more conducive to learning.
The changing demographics also indicate that school construction is a ripe sector for electrical contractors. Right now, school budgets are tight, as indicated by a modest 2.6 percent increase in construction starts in the school/college sector, according to RCD’s “U.S. Construction Outlook 2009–2010” report. McGraw-Hill data show that recent state legislation will fuel school projects in certain states. For example, California passed a referendum in 2006 to earmark $10.4 billion for school facilities. In the November 2007 elections, Texas voters approved a school construction measure.
According to McGraw-Hill Construction, school construction is still strong but losing some momentum. In terms of square feet, 223 million square feet of educational buildings accounted for a mere 1 percent increase over 2006. McGraw-Hill predicts a decline of 7 percent in 2009. Some areas of education are stronger than others. Laboratory spending decreased by 41 percent in 2008. Major increases in construction came from vocational schools (27 percent), community colleges (21 percent) and high schools (13 percent).
Changing demographics are fueling this sector. As the economy improves over the next few years, investment will increase for schools because of the growing younger population. According to Reed’s report, property taxes drive kindergarten through grade 12 construction spending. Taxes are down right now due to the economic situation, particularly with record levels of foreclosures and homes for sale. However, expect modest-but-steady growth in this area after a single-digit decline in the near-term.
Growing immigrant population
If you drill down into the demographic changes, AIA’s Baker said immigration data point to a robust housing market in the coming decade. According to American Community Survey and the U.S. Census Bureau projections, the average annual growth in the foreign-born population will jump to 1.51 million between 2020 and 2025. That is a 300,000-person boost, which could be a great opportunity for the construction industry. Foreign-born citizens comprise a growing percentage of the overall U.S. population, as well. In 1970, the foreign-born population made up a mere 4 percent of the total U.S. population. In 2005, that percentage tripled to more than 12 percent. Once concentrated in the biggest states of California, New York, Florida and Texas, the immigrant population is becoming more far-flung, creating opportunities to deliver electrical construction and voice/data/video work to serve this growing group.
The demographics, Baker said, also favor remodeling opportunities. Immigrants and their children account for a larger share of the population in critical home buying and remodeling years. Immigrants dominate the key age groups of 25 to 29, 30 to 34, and 35 to 39. These ages are the most likely ages for people to purchase and remodel homes. Remodeling—still weaker than in previous years—is holding its own with slight-but-steady growth. The tight housing market, coupled with a tight credit market, is reducing the availability of funds for home-owners to make improvements to their homes. When the economy rebounds, this immigrant population may be a key driver for the construction market.
Making matters worse for electrical contractors in today’s tight economy is the drastic changes in commodities prices. According to McGraw-Hill Construction, between December 2007 and September 2008, key commodities to the electrical sector were up, forcing higher materials costs and tighter margins. Iron and steel increased by 36 percent, while copper wire jumped by 13 percent. The 36 percent increase in iron and steel comes after single-digit increases since 2005. The 13 percent increase in copper wire comes on the heels of a 1 percent decrease in 2007. However, 2005 through 2006 saw increases in copper wire of 18 percent, 26 percent and an astounding 61 percent, respectively. These core materials in electrical construction have hampered contractors’ ability to keep pricing down, which affects their bids and competitiveness.
Bailouts and stimulus packages
Few have escaped the economy’s grasp, and some are begging for help from the government. The federal government has already doled out billions of dollars in relief to various sectors. We also know President Barack Obama supports a stimulus package for individual taxpayers, in addition to the Bush stimulus package.
Whether these influxes in cash will fuel economic growth and help Americans navigate through this crisis is unclear. We know that this nation and its construction trades have endured difficult times in the past. Of course, there will be some contraction. For some electrical contractors, this was the environment that caused them to think about retirement. For others, it meant bankruptcy or selling to a competitor. Overall, the electrical construction industry has weathered past storms and remained a viable and important trade.
The recommendation from Wall Street and the government is the same: Stay the course. Wait out the storm, and things will slowly improve. It will not be easy, and it will not come fast. But times of prosperity follow times of economic crisis. If history is our guide, a rebound is coming.
The key for electrical contractors is to prepare for opportunities when the market turns. Now is the time for self-assessment. If you can get through this mess and remain competitive, prosperity awaits on the horizon. Green buildings, school construction, institutional work and multifamily housing are nice places to start. That is what the experts say, and the numbers confirm. Looking at the overall economic picture, Baker summed up the direction of the construction market: “Cycles correct themselves, so you’ll just have to hold your breath.”
KELLY, a former editor at ELECTRICAL CONTRACTOR, is a Baltimore-based freelance writer. Reach him at [email protected].
About The Author
Joe Kelly, is currently senior editor in the Periodicals Group at the American Bankers Association, has been a magazine editor and writer for the bulk of his career. In 1998, Kelly became associate editor of ELECTRICAL CONTRACTOR magazine and was named editor in January 2000, a position he held until May 2003. He was instrumental in the 2002 ELECTRICAL CONTRACTOR magazine redesign and the 2003 ECmag.com Web site redesign. In addition, he helped launch Security + Life Safety Systems, in March 2003.
Kelly currently lives in Baltimore with his wife and two children and frequently contributes to ELECTRICAL CONTRACTOR.