2011 Construction Outlook: Delayed Recovery for Nonresidential Market

This construction outlook reviews the year’s top line construction numbers, shows where leading construction and electrical industry indicators are trending, and provides a summary of the latest AIA Consensus Construction Forecast for 2011.

The 2011 American Institute of Architects (AIA) semi-annual Consensus Construction Forecast, published in mid 2010, predicted a marginal increase of 3.1% in inflation-adjusted terms in nonresidential construction spending in 2011.

At the end of 2010, the Forecast Panel revised its predictions, predicting a slower rate of recovery, with 2011 spending levels not anticipated to be enough to show growth over 2010, despite modest improvements in the overall economy.

Even though the national economic recovery is now a year and a half old, it has not gained much traction. The housing and employment markets remain weak. There are some positive signs, however; the fall of 2010 saw healthy growth in manufacturing and consumer spending, and bank lending restrictions appear to be easing. ScotiaBank Group predicts a healthy growth rate of 2.7% in 2011 and 2.9% in 2012 for U.S. gross domestic output (GDP).

The nonresidential construction market was mired in a steep downturn in 2010 due to an oversupply of facilities in most construction categories, weak demand for space, continuing declines in commercial property values and reluctance among real estate lenders to provide credit.

“The key factors that have prevented an accelerated recovery include historically low lending rates for real estate projects, the lingering effects of general overbuilding and an unfavorable bond market that has hampered the ability for municipalities to get the requisite funding to build new schools and hospitals,” says AIA Chief Economist Kermit Baker, PhD, Hon. AIA. “Conditions should improve later this year and gain momentum as we move into 2012, particularly for hotel, retail and office building projects.”

The semi-annual Consensus Construction 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.

While activity for institutional projects should hover near 2010 levels, there is likely to be a modest decline in commercial construction in 2011, according to the Panel. Overall nonresidential construction spending is expected to decrease by 2% for the year.

“The nonresidential construction market is expected to recover this year, but late enough in the year that spending levels are unlikely to see any growth over 2010 levels,” Baker points out. “A consensus 2% construction spending decline in 2011 will hopefully indicate the bottom of the recession trough and set the stage for a recovery in 2012.”

“Most market drivers are now neutral or positive,” writes Jim Haughey, RCD Chief Economist at www.reedconstructiondata.com. “Commercial construction starts have stabilized well above the cyclical low point in June 2009. The starts trend was clearly upward from the beginning to the end of 2010. Starts are refilling the pipeline and will lead to slow growth in spending at commercial jobsites beginning around yearend.”

In the institutional market, Haughey says market drivers are weakening due to government funding for construction coming down after remaining strong during the early part of the recession. “But the spending decline for institutional projects will be moderate because emergency Federal funds, while no longer growing, remain substantial,” he points out.

The Forecast Panel believes 2012 will produce stronger gains.

“Overall building construction should rise around 5%, with growth twice that rate for the more cyclical commercial sector,” Baker adds.

Market Segment Consensus Growth Forecast	2011	2012
Overall Nonresidential	-2.0%	5.0%
Commercial/Industrial	-4.2%	10.9%
Hotels	-6.2%	15.6%
Office	-7.9%	7.1%
Retail	-1.0%	10.9%
Industrial	-11.8%	5.8%
Institutional	-0.2%	1.6%
Amusement/Recreation	1.4%	1.2%
Education	-3.1%	1.7%
Religious	1.3%	3.4%
Public safety	-6.7%	-2.3%
Healthcare	1.1%	5.5%

Construction spending trends
As of November 2010, U.S. put-in-place construction spending, estimated by the Commerce Department, was headed toward a total projected value of about $822 billion for 2010, 9.4% below 2010 and 30% off its most recent peak of $1.17 trillion in 2006. (As December and full year numbers were not available at the time of writing—having a two-month lag—all projections for December and subsequently full year 2010 is based on some simple math by the author, providing a rough estimate.)

Residential put-in-place construction was headed towards a projected value of about $246 billion, about the same as 2009, suggesting the market has bottomed out after losing 60% of its value from its most recent peak of $613.7 billion in 2006.

Nonresidential construction increased from 2005 to 2008 but began a steep decline, ending 2010 at a projected $566.6 billion, 13% lower than 2009 and 20% off its peak of $709.8 billion in 2008. The damage would have been much worse in this market if not for the Federal Stimulus, which boosted public spending. The traditionally more volatile private nonresidential building construction market was headed towards a projected value of $264.8 billion, 23.6% below the $346.7 billion spent in 2009 in this market, and 35% off its most recent peak of $408.6 billion in 2008. Bolstered by American Recovery and Reinvestment Act of 2009 funds, the traditionally more stable public nonresidential building construction market was headed to projected total spending of $301.7 billion in 2010, 2% below 2009’s $307.5 billion.

Looking at the top five nonresidential markets, all were projected to suffer steep declines in put-in-place construction spending in 2010, based on Commerce data, as private construction spending continued to collapse and public construction spending began to soften as Stimulus funding was used up:

• office spending: projected $38 billion, 28% below 2009’s $52.7 billion
• commercial spending: projected $41.5 billion, 25% below 2009’s $55 billion
• healthcare spending: projected $40 billion, 11% below 2009’s $45 billion
• education spending: projected $89.7 billion, 13% below 2009’s $102.9 billion
• manufacturing spending: projected $39.5 billion, 33% below 2009’s $58.5 billion

AIA Architecture Billings Index
The American Institute of Architects’ (AIA) Architecture Billings Index (ABI) is a leading economic indicator that provides an approximately nine- to 12-month glimpse into the future of nonresidential construction spending activity.

The ABI is derived from a monthly “work on the boards” survey and produced by the AIA Economics & Market Research Group. Hundreds of firms are surveyed and the percent reporting a significant increase in billings during the previous month is added to half the percent of those reporting no change, resulting in a score. A score of 50 means an equal percentage of firms are reporting an increase as a decrease. A score above 50 indicates that firms overall are reporting an increase in billing activity, which is suggestive of market expansion.

In December 2010, the ABI jumped more than two points to 54.2, reflecting an increase in demand for design services, after being stuck near the 50 level for the previous six months. While December is historically the most unpredictable month from a business standpoint—and therefore the most difficult from which to interpret a trend—the $20 billion architecture community has not been this optimistic since December 2007. The new projects inquiry index, meanwhile, was 62.6, up slightly from a mark of 61.4 in November.

“This is more promising news that the design and construction industry is continuing to move toward a recovery,” said AIA Chief Economist Kermit Baker, PhD, Hon. AIA. “The coming quarter will give us a much better sense of the strength of the apparent upturn in design activity.”

That recovery, however, again is not expected by Baker until at least the second half of 2011.

“Architecture firms are not expecting such an upturn to be very strong,” he adds. “A December 2010 survey of architecture firms found that expected growth in billings for 2011 is quite low. Overall, firms are expecting revenue gains of just 1% for the year.”

NAHB/Wells Fargo Housing Market Index
Builder confidence in the market for newly built, single-family homes remained in contractionary territory throughout 2010, 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 2010, 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.

“The steady but low level of the HMI reflects the fact that builders and consumers have yet to see consistent signs that the economy is improving,” says NAHB Chief Economist David Crowe. “The good news is that the index and its subcompartments remain above recent lows from the earl fall. NAHB expects an improving job market this spring will help prospective buyers feel more confident and propel more sales activity in 2011. However, the continued problems that builders are facing in obtaining construction credit and accurate appraisal values could significantly slow the onset of the housing recovery.”

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 climbed for a second consecutive month in December 2010, rising 5.5 points to 68, its highest level since June. A reading above 50 indicates more panelists than not reported conditions improved during the month. Forty percent of survey panelists reported improved conditions in December, while only 4% reported deteriorating conditions. The intensity of change in current North American conditions also edged higher in December increasing to +0.4 from +0.3 the previous month. Panelists were asked to report intensity of change on a scale ranging from –5 (deteriorated significantly) through 0 (unchanged) to +5 (improved significantly).

The EBCI for future North American conditions, meanwhile, rose for a fourth straight month in December. The index reached 78, its highest mark since well before the severe recession of 2008-09, and was up a cumulative 24 points since August 2010.

NEMA Lighting Systems Index
Looking specifically 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 Q32010 LSI, released in November 2010, increased 0.9% in the third quarter of 2010 compared to the second quarter and increased 5.6% on a year-over-year basis. The LSI trended has trended higher since hitting a cyclical (and all-time) low during the second quarter of 2009, but aggregate lighting equipment demand remains at a low level.

In terms of the underlying mix of lighting systems products, growth was scattered across all five covered lighting product groups, according to NEMA, but only fluorescent ballast shipments registered anything resembling an appreciable increase in demand from a year earlier.

“Significant weakness in both the residential and commercial markets continues to hamper demand for lighting equipment,” Brian Lego, director of economic analysis for NEMA, wrote on the association’s website in November 2010. “Until construction begins to rebound, replacement demand will likely account for the vast majority of sales of nonresidential lighting equipment over the near term; in addition, retrofits will constitute a sizable share of demand as companies switch out non-compliant or higher-cost lighting systems. Consequently, the LSI will likely see modest gains through 2011.”

Bright spot in down times: The green construction market
The down nonresidential market may have a bright spot: demand for sustainable design. According to McGraw-Hill Construction’s Green Outlook 2011: Green Trends Driving Growth, the U.S. green building market is accelerating at a dramatic rate. The value of green building construction starts was up 50% from 2008 to 2010—from $42 billion to $55-71 billion—and represented 25% of all new construction activity in 2010. According to projections, the green building market size is expected to reach $135 billion by 2015.

In nonresidential building, the green building market share is even higher than the overall market. Today, a third of all new nonresidential construction is green—a $54 billion market opportunity, according to McGraw-Hill. In five years, nonresidential green building activity is expected to triple, representing $120 billion to $145 billion in new construction (40%-48% of the nonresidential market) and $14-18 billion in major retrofit and renovation projects.

To break it down further, health care construction this year is expected to grow its green share to as much as 40% (valued at $8-9 billion in 2010)—phenomenal growth in just two years. Education (valued at $13-16 billion in 2010) and office green construction (valued at $7-8 billion in 2010) also remain strong sectors, showing high increases in market share, due in part to the fact that bigger projects are the most likely to “go green.” This year, the U.S. Green Building Council’s LEED specification is mentioned in 71% of all projects valued at over $50 million.

Green building is the bright spot in an otherwise tough economy, and in some sectors, that rate of growth has been remarkable. “It’s an amazing area of opportunity at a time when the construction market is extremely challenged,” says Harvey M. Bernstein, vice president, Global Thought Leadership and Business Development, McGraw-Hill Construction. “In today’s economy, firms that specialize in green or serve this market are seeing a tremendous advantage— and they’re doing good at the same time. Green building leads to healthier places for us to live and work in, lower energy and water use, and better profitability.”

According to the Green Outlook 2011 report, building owners cited three business benefits as the main drivers for building green:

• Reduction in operating costs of 13.6% on average for new buildings and 8.5% for retrofits;
• Increase in building values of 10.9% for new buildings and 6.8% for retrofits; and
• Increase in return on investment (ROI) of 9.9% for new buildings and 19.2% for retrofits.

Beyond these bottom-line advantages, McGraw-Hill Construction attributes green building’s rapid expansion to owners’ desire for market differentiation, growing public awareness, and an increase in local and federal government regulations. As of September 2010, green building legislation and initiatives were present in 12 federal agencies and 33 states, and the proliferation of local government initiatives have increased at an especially impressive pace—from 156 localities in 2008 to 384 localities in 2010.