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2010 Construction Outlook: “Nonresidential Construction Still Mired in a Steep Downturn”

The United States suffered its worst recession in 70 years following the collapse of the housing market. The good news is some economists believe the economy began to recover in Q309 after hitting bottom in the second quarter. The Manufacturers Alliance/MAPI Quarterly Economic Forecast predicts that inflation-adjusted GDP declined in 2.5% in 2009 but is in the process of rebounding to 2.4% growth in 2010 and a robust 3.5% in 2011.

Unfortunately, recovery in the construction market will lag the overall economic recovery, and this recovery is threatened by tight lending conditions and continuing high rates of unemployment. There are two bright spots. First is that the residential single-family construction market is expected to enjoy a mild recovery in 2010 after almost four years of deep declines in spending. Second is the Federal stimulus kicked in during 2009, and while a good portion of the spending focused on infrastructure, a fair portion was also spent on public building construction, resulting in public nonresidential construction enjoying growth in 2009.

The bad news is the private nonresidential construction market is in “freefall,” in the words of one construction economist, with every building market suffering, and with tight credit making conditions worse by causing higher-than-normal delays and cancellations. It is not surprising, therefore, that a number of leading electrical and construction industry economic indicators ended the year on a pessimistic note, signaling a weakening business environment.

Overall, nonresidential spending is expected to decrease by 13.4% in 2010 in inflation-adjusted terms, according to the AIA Consensus Construction Forecast, before recovering with 1.8% growth in 2011. Meanwhile, office vacancy rates are closing in on their highest levels since the dot-com industry’s implosion, and sharp declines in international trade, manufacturing output and wholesale inventories have pushed industrial vacancy rates to new all-time highs, which will both lessen electrical product replacement sales and limit retrofit opportunities.

This construction outlook reviews the year’s topline construction numbers, examines the directions that leading construction and electrical industry indicators are pointing, and provides a summary of the latest AIA Consensus Construction Forecast for 2010.

Total construction

As of November 2009, construction spending was being estimated by the Commerce Department at a seasonally adjusted annual rate of $900.1 billion, 13.2% below the same period in 2008 and a six-year low. During the first 11 months of 2009, construction spending amounted to $868.9 billion, 12.7% below the $994.9 billion for the same period in 2008. (As an informal personal estimate, the value of total U.S. lighting sales has traditionally trended at 1.5-2% of the value of construction, which would put the current value of lighting sales at about $14-18 billion.)

Nonresidential construction

As residential construction spending plummeted in recent years, nonresidential construction surged, acting as an offset. Tight credit and weak demand for new facilities generated by the financial crisis and subsequent recession, however, took their toll on this market in 2009 and continue to dampen its prospects in 2010.

As of November 2009, nonresidential construction was running at a seasonally adjusted annual rate of $641.2 billion, 10.9% below November 2008. Most of these losses were in the private nonresidential construction market, while public nonresidential construction continued to demonstrate some growth. In November 2009, private nonresidential construction was estimated at a seasonally adjusted annual rate of $330.5 billion, 20.6% below the $416.4 billion figure estimated in November 2008. Public nonresidential construction was estimated at $310.7 billion in November 2009, a 2.5% increase over the November 2008 estimate of $303 billion.

“Private nonresidential construction is in freefall, with every category except private power construction down sharply compared to a year ago,” says Ken Simonson, chief economist for the Associated General Contractors of America (AGC). He notes that public construction has benefitted from Federal stimulus funds, but predicted these gains will continue to be tempered by sharp cutbacks in projects funded directly by states, local governments and school systems.

“Tight credit continues to cause cancellations and delays,” notes Heather Jones, construction economist, in FMI Corporation’s Construction Outlook, 4th Quarter 2009 Report. “Project delays continue to be four times the normal rate and are currently at 20% (up from three times in 3Q08). Project cancellations are five times the normal rate and are currently at 10% of backlog (doubled from 3Q08). Credit is expected to remain tight throughout 2010, and delays and cancellations are likely to increase.”

As of November 2009, the nonresidential market’s biggest winners were public office (+9% over November 2008), commercial (+19.8%) and healthcare (+12.2%). The biggest losers were private lodging (-46%), office (-39%) and commercial (-40.5%). Public education construction spending was holding somewhat steady (-2.5%) at $83.5 billion.

“The stimulus is finally beginning to have a measurable, but limited, impact on the construction industry,” says Stephen E. Sandherr, CEO of the AGC.

Residential construction

As of November 2009, private residential construction was estimated at a seasonally adjusted annual rate of $250.7 billion, a 19.2% decline from November 2008—and 62% below the 2005 high of $664.2 billion and its lowest point since 1995.

“The residential construction market has been decimated,” writes FMI’s Jones. “For housing starts, 2009 was the worst year since we began keeping records in 1959.”

She adds that this market is expected to begin a recovery in 2010, noting in FMI’s Construction Outlook, 4th Quarter 2009 Report:

• Single-family put in place construction will recover more slowly than single-family starts, the reason being the average size and cost per new home is declining under pressure from tight credit conditions and of course the recession.

• Multifamily construction will continue to fare poorly due to tight credit conditions.

• Residential improvements will increase in 2010 as homeowners make necessary repairs due to building age and invest in improvements over moving up.

“From an affordability standpoint, rarely has there been a better time in history to purchase a home, thanks to record low interest rates, attractive prices and of course the recent extension and expansion of the home buyer tax credit,” says Joe Robson, chairman of the National Association of Homebuilders (NAHB) and a homebuilder from Tulsa, OK. “However, builders are not seeing the full impact of these conditions on buyer demand, partly because awareness of the latest incentives is still building, and partly because of concerns about job security and other economic woes.”

“This is shaping up to be a bumpy recovery period for the housing market,” says NAHB Chief Economic David Crowe. “While some families may be just starting to factor the expanded tax credit into their potential home buying plans, many are hesitating because of the poor economy. At the same time, tight lending conditions for both consumers and homebuilders continue to pose considerable obstacles on the road to a sustained housing and economic recovery.”

AIA Architecture Billings Index

To find out more about what is likely to happen in the nonresidential construction market in 2009, we can ask architects—or rather, the American Institute of Architects (AIA) can.

Architects’ billings are a good indicator of future construction activity, expressed via the Architecture Billings Index produced by the AIA. The ABI is derived from a monthly “work on the boards” survey and produced by the AIA Economics & Market Research Group. As a leading economic indicator of construction activity, the ABI reflects the approximate 9- to 12- month lag time between architecture billings and construction spending.

In December 2009, the ABI ended the year with a score of 43.4. While 2009 ended better than it started (with a 33.3 ABI score), indicating a higher degree of optimism in the $20 billion architectural community, it still ended in negative territory; a score above 50 indicates an increase in demand for design services (billings), and the ABI has not reached or exceed a 50 score since January 2008. The new projects inquiry score, however, was 55.3.

“The main impediment to an economic turnaround for the design and construction industry remains frozen credit markets. We continue to hear that there are numerous viable projects out there awaiting financing,” says AIA Chief Economist Kermit Baker, PhD. “And the longer this situation persists, the more dire the news for the architecture profession which is struggling at unprecedented proportions.”

NEMA Electroindustry Business Confidence Index

Another forward-looking index is the Electroindustry Business Confidence Index (EBCI) for current North American conditions, produced by NEMA. This economic indicator gauges the business confidence of the electrical industry in Asia, Europe, North America and Latin America, and is based on the results of a monthly survey of senior managers at NEMA member companies, which represent more than 80% of the electrical industry.

The EBCI began 2009 with a score of 20, but optimism improved most of the year, signaling a steady strengthening of the business environment facing the electrical manufacturing industry. The EBCI topped 50 in August and stayed above 50 until dipping 5.7 points to 48.2 in December, indicating modest deterioration in the business environment at the end of the year.

On the other hand, the EBCI for future North American conditions rebounded in December following declines in each of the two previous months. At 64.3, the index posted its tenth straight reading above 50, with a 6.3 point gain relative to November suggesting the degree of anticipated improvement in conditions over the next half year increased in the latest month.

NEMA Lighting Systems Index

Looking at the lighting segment, NEMA tracks the industry’s health using a metric called the Lighting Systems Index (LSI), a composite measure of NEMA member companies’ U.S. shipments of lighting products such as lamps, ballasts, fixtures and emergency lighting and exit signs. Product shipments data are drawn from statistical surveys conducted regularly by NEMA and are adjusted for inflation and regularly recurring seasonal fluctuations.

The LSI increased 3.3% in the third quarter of 2009 compared to the second quarter—its first increase in nine quarters. Nonetheless, the LSI was only one quarter removed from its lowest reading on record and declined 19.3% on a year-over-year basis.

After adjusting for seasonal influences and inflation, emergency lighting equipment was the only index component to see shipments weaken compared to the second quarter of 2009; however, every category experienced a decline in shipments on a year-over-year basis, with light fixtures suffering the biggest drop-off compared to Q32008.

Associated General Contractors

The Associated General Contractors of America (AGC)’s business outlook forecast, based on survey responses from nearly 700 construction firms, found that 88% of contractors believe there will be no recovery for the construction industry in 2010.

“They aren’t predicting a turn-around because few contractors expect privately funded construction projects, which typically account for the bulk of annual construction activity, to improve,” says Sandherr of AGC.

Sixty-four percent (64%) expect demand for new manufacturing facilities will decline, while 71% expect demand for new retail, warehouse and lodging facilities to drop. As a result, the number of firms expecting to buy new equipment is down to 46% this year from 61% in 2009. Meanwhile, 81% report already having to cut profit margins in their bids just to stay competitive and another 10% say they are now submitting bids so low they will actually lose money on the projects. Nearly three out of four (73%) firms said they laid off employees in 2009, average 39 layoffs per firm, while 60% are currently unsure whether they will be able to add new staff or be forced to make further cuts, signaling a great deal of uncertainty.

“Construction spending declined last year by $137 billion, and is now at the lowest level in six years,” Sandherr points out. “And while only 5% of the U.S. workforce, construction workers shouldered 20% of non-farm layoffs last year. As the latest federal employment figures make clear, the depression-like conditions in the construction industry are one of the main factors dragging on overall employment.”

One relatively bright spot is the Federal stimulus. Thirty-one percent (31%) of contractors say they were awarded stimulus-funded projects. Of these, 46% say the stimulus helped them retain an average of 24 employees each. Another 15% say the stimulus helped them to add an average of 10 new employees per company while 12% cite the stimulus as driving new equipment purchases. Fifty-five percent (55%) say work on public buildings will improve or remain stable in 2010. Additionally, 57% expect growth or stability in demand for hospital and higher education construction.

“Unfortunately for the industry and for our economy, this year’s construction outlook is far from positive,” says Sandherr. “As long as the construction industry remains mired in its own depression, broader economic and employment growth will continue to lag.”

NAHB/Wells Fargo Housing Market Index

Builder confidence in the market for newly built, single-family homes improved in 2009 compared to 2008’s record lows caused by recession and ongoing flow of foreclosed homes onto the market, but remained pessimistic, according to the National Association of Home Builders/Wells Fargo Housing Market Index (HMI).

Derived from a monthly survey that NAHB has been conducting for more than two decades, the HMI gauges builder perceptions of current single-family home sales and sales expectations for the next six months as “good,” “fair” or “poor.”

Throughout the 2009, the HMI remained well below the 50-point threshold suggesting business conditions favorable to positive sales growth, and ended the year with a score of 16, its lowest point since June.

“Home buying conditions have rarely been as good as they are right now, but consumers are still waiting to see significant positive signs of improvement in employment and confidence, and this is slowing buyers’ return to the market,” says NAHB’s David Crowe. “Meanwhile, competition from foreclosed homes is also severely impacting new-home sales. That said, expected improvement in the job market this spring will help propel the housing recovery as we head into the prime home buying season.”

The AIA Consensus Construction Forecast

As the overall economy continues to struggle, nonresidential construction spending is expected to decrease by 13.4% in 2010 in inflation-adjusted terms, according to the AIA Consensus Construction Forecast, before recovering with 1.8% growth in 2011.

This semi-annual forecast is based on a survey of the nation’s top construction forecasters, including McGraw Hill Construction, Global Insight, Moody’s Economy.com, Reed Business Information and FMI.

The purpose of the Forecast Panel is to project business conditions in the construction industry over the coming 12-18 months. Interestingly, the Panel forecasted a 11% decline in nonresidential construction spending in 2009, and as of November 2009, was spot on.

The 2010 outlook is fairly bleak across the entire nonresidential market, with no winners. Industrial/commercial projects, including office, industrial and retail projects, however, will see the most significant decreases in activity.

AIA Forecast

Table 1. AIA Consensus Construction Forecast for the 2010 Nonresidential Market

“The long-awaited economic recovery seems to be well underway, and even the residential construction sector looks like it has hit bottom and is moving back up after almost four years of deep declines,” writes the AIA’s Kermit Baker. “Nonresidential construction, unfortunately, is still mired in a steep downturn.”

Click here to see the complete report from AIA.

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