While construction businesses may feel like they’re on the verge of their “19th nervous breakdown,” only seven recessions have actually occurred since that Rolling Stones tune hit the charts in 1966. But the song expresses some of the dread brought on by steady deterioration, which is precisely how the nation’s economic performance can be categorized.
A recent Federal Open Market Committee statement betrays a greater level of frustration with the pace of recovery than has been apparent since the recession ended roughly one year ago. Correspondingly, monetary policy is likely to be more accommodating going forward; the only question is the extent to which the money supply will occur.
The Federal Reserve is set to purchase more debt by redirecting funds acquired from the sale of mortgage-backed securities to the purchase of Treasury-issued securities. To help stabilize the housing market, the Fed invested approximately $2 trillion in mortgage-backed securities and other related investments, and it has been remarkably successful in selling off what it purchased. As of October, the goal was to purchase roughly $10 billion in U.S. debt each month for the next several months. While that is not an enormous sum, it is a clear signal to the marketplace that the Fed remains willing to intervene to stave off another recession.
Policy Support May Not Be Enough
In truth, there is little left for the Fed to do without dramatically increasing the risk on the central bank’s balance sheet. The Fed’s shift to purchasing high-quality bonds will reduce associated yield further, but will not solve ongoing issues in high-yield debt markets. Moreover, a variety of key interest rates, including mortgage rates, are already at historic lows. Lowering these rates further probably won’t make much difference to the economy; however, another round of refinancing is anticipated across the United States—largely in healthy housing markets where owners retain some home equity.
For its part, the federal government continues to support economic activity. In certain categories, less than half of the monies associated with the American Recovery and Reinvestment Act of 2009 (ARRA) have been spent. This is particularly true in the infrastructure category, and much of this money will be spent in 2011.
Prior to the mid-term elections, Congress and the president indicated they were willing to step in to provide even more economic assistance. In late July, the U.S. Senate voted 59 to 39 in favor of a bill that retroactively pays for extended federal benefits through November at a cost of about $34 billion. (Approval by the U.S. House of Representatives and President Obama soon followed.) More than two million people had lost their benefits after federal unemployment insurance extensions started to phase out at the end of May, according to the U.S. Department of Labor. Had Congress and the president not intervened, this number would have risen to about 3.23 million by July 31, an indication of just how weak hiring remains.
Efforts to reinvigorate the economy didn’t end there. On Aug. 4, the Senate cleared the way to provide $10 billion to school districts to prevent teacher layoffs and an additional $16 billion in federal aid to cash-strapped state governments.
Policymakers’ recent fiscal actions make a near-term recession less likely, but growing evidence shows the U.S. economic recovery is stalling. In fact, much of the recovery to date has been temporary in nature.
Most companies have not experienced a good year since 2008, when nonresidential construction volumes peaked. Overall payroll employment declined again in September by 95,000 as the ongoing dismissal of census workers, coupled with declines in state and local government employment, contributed to a reduction of 159,000 in government payrolls. Private employment grew by 64,000, less than expected and the lowest total since June. Unemployment remained at 9.6 percent in September.
Optimists can take heart in the continued expansion in private sector employment. Through September, the nation added private jobs for nine consecutive months. Unfortunately, many of the 863,000 jobs added are temporary and fall within the nation’s business services category. During the first nine months of the year, construction shed 92,000 jobs, and the construction unemployment rate stood at 17.2 percent—nearly twice the overall national average. Moreover, at least some of the construction jobs created during this period are attributable to stimulus-related spending, with the implication that many of these jobs will not be permanent.
Data Reflect Emerging Weakness
Altogether, roughly $4 trillion in stimulus funding was thrown at the economy. With much of that spending completed, and with the private sector still hamstrung by tight credit and falling real estate values, the recipe for the next slowdown is being cooked up now.
Whether next year will bring another recession is merely a technical question. The economy will be weak, and recent gross domestic product (GDP) data hint at the levels of debilitation to come. This is bad news for contractors, as the recovery next year will not be rapid enough to restore commercial real estate to health. The level of recovery in nonresidential construction will be modest even under optimistic scenarios.
Recent readings from the Conference Board’s Index of Leading Economic Indicators suggest the broader economic recovery in June 2009 began to lose momentum as early as April 2010.
GDP expanded just 1.7 percent on an annualized basis during the second quarter, and much of that growth occurred early in the quarter. The expectation is that third quarter GDP expanded by roughly the same amount.
That performance foreshadows real growth of around 1.5 percent to 2 percent for the balance of 2010 and into 2011.
Adding to the list of concerns is the fact that nonfarm productivity decreased at a 0.9 percent annual rate during the second quarter. This suggests that employment growth will slow because existing staffing levels can adequately handle present output levels. Should output begin to decline, private employment losses would be significant and would add to anticipated employment reductions in state and local government next year.
In addition, Associated Builders and Contractors (ABC) reports that its latest Construction Backlog Indicator (CBI) is sliding backward as the nation’s construction contract activity declined 3.3 percent in September to 6.7 months after falling more than 5 percent in August to 6.9 months.
Ten Headwinds Likely to Impact Next Year’s Economy
1. Consumers tap their brakes. Though recent data indicate that consumer spending has accelerated, the pace of spending may not persist. Much of this spending is attributable to higher stock prices in 2010 and the satisfaction of pent-up demand. The impact of these factors may weaken next year, and with income growth slow and unemployment rates still high, there is reason to believe consumers could pull back some time next year.
2. The housing market recovery has slowed down. The fear that the housing market would begin to swoon once the first-time and move-up buyer tax credits expired is being realized. In fact, existing home sales slipped 2.3 percent from September to October, and new housing activity stumbled even more.
3. Federal tax increases could further diminish momentum. A significant number of the Bush tax cuts will expire at the end of the year. Congress essentially can raise taxes by doing nothing. Capital gains taxes would rise from 15 percent to 20 percent, taxes on dividends would more than double, and the estate tax would rise from 0 percent to 55 percent. Marginal income tax rates also are headed higher.
4. State and local tax increases represent a source of slippage. At least 46 states struggled with fiscal shortfalls when adopting budgets for the current fiscal year, which began July 1 in most states. The combined gaps for 2011 and 2012 are $260 billion.
5. The stimulus eventually will wear off. Though much of the $787 billion ARRA has yet to be spent, by some point in 2011, the federal stimulus driver will begin to wind down—another sign that phase two of the economic downturn is headed this way.
6. European debt crisis is no formula for success. Greece, Portugal and Spain all have experienced debt downgrades. Though members of the European Union have established a $1 billion bailout fund, there is still the possibility of a sovereign default going forward. Nearly 100 European banks are being stress-tested.
7. State and local government spending will further deflate aggregate demand. Despite ongoing assistance from the federal government, most state and local governments have begun to decelerate spending. While it’s good to temper spending levels, the short-term impact on contractors is negative. As of mid-October, spending on construction related to education was down 14 percent on a year-over-year basis, a reflection of the fact that state and local governments are beginning to shrink both operating and capital budgets.
8. Government spending cuts in other parts of the world could put the global expansion into neutral. At the recent G-20 summit, nations from around the world agreed to slash their deficits over time. A number of countries in Europe, including Greece and Spain, have initiated austerity programs through a combination of tax increases and spending adjustments. Not surprisingly, the most recent data indicate the global economic expansion is beginning to soften.
9. Small business confidence is fading. The National Federation of Independent Business’ Index of Small Business Optimism lost 0.9 points in July following a sharp decline in June. The persistence of index readings below 90 is unprecedented in the survey’s history. Moreover, according to recent data from ADP, small businesses in the aggregate shed more jobs than they added in September for the first time since January.
10. Unemployment remains high and private job growth has not picked up sufficiently. The key to sustained economic momentum is income growth. With employment growth still lagging and with the public sector now retrenching, the prospects for a significant acceleration in income growth next year are weak. Correspondingly, the expectation is for sluggish consumption growth in 2011.
Looking Ahead
ABC anticipates total nonresidential construction spending will decline 14.7 percent in 2010. Next year will see a transition with certain key economic fundamentals stabilizing, but not improving enough to rescue the year.
Much of the construction activity will continue to be concentrated in federally financed segments, including conservation and development, water and sewer, and highway and street.
The fact that many of the nation’s energy producers deferred a substantial amount of maintenance in 2010 also is likely to translate into opportunities in 2011, but not enough to offset the deep and ongoing weakness in privately financed construction.
Price Volatility Appears Under the Surface
If media and other reports are to be believed, contractors have no reason to fret over inflation. After all, much of the discussion recently has been focused on the Federal Reserve’s preoccupation with deflationary pressures in the United States.
The consumer price index increased just 0.1 percent on a seasonally adjusted basis, and rose just 1.1 percent during the past 12 months. After eliminating the volatile food and energy categories, consumer inflation is up 0.8 percent, the lowest 12-month increase since March 1961.
But a careful analysis of the producer price index suggests contractors are facing input price volatility and should work to avoid contracts that restrict escalation clauses. (However, many contractors report this is often not an option given intense price competition and the take-it-or-leave-it attitude of many construction service purchasers.)
In October, the producer price index for inputs to construction, a weighted average of materials utilized in every field of construction, rose 4.8 percent on a year-over-year basis. Iron and steel prices increased 14 percent during the past year. Crude energy prices rose 8.2 percent during the past year as well.
Meanwhile, the corresponding index for finished nonresidential buildings and subcontractor work has either declined or not risen as rapidly, which means profit margins continue to be under pressure.
Given a weak U.S. dollar, there is reason to believe 2011 could be a year of substantial commodity price speculation, which suggests construction materials prices could be volatile going forward. This will make an already challenging construction environment even more difficult to manage.
According to the National Bureau of Economic Research’s Business Cycle Dating Committee, the recession that began in December 2007 ended in June 2009. But that opinion reflects national information, not regional data. Overall, regional performance remains disparate.
The economy is strongest in the nation’s heartland, with North Dakota and South Dakota logging the two lowest state unemployment rates. Other states with low unemployment include Montana, Arkansas, Oklahoma, Minnesota, Alaska and Texas. Each of these states is natural resource intensive, and commodity-based activities are expanding rapidly in America. Thus, these states are experiencing the greatest increase in investment and demand for labor.
Technology-centric communities—such as Silicon Valley, Boston and the Washington, D.C.-Baltimore, corridor—also are rallying. The pace of innovation in information technology helps explain observed job growth in computer-related industries. Moreover, the Departments of Defense and Homeland Security are spending substantial resources, helping produce income for government contractors from Northern Virginia to the northern Baltimore suburbs. Not surprisingly, among the 20 largest metropolitan areas in the nation, Washington, D.C., boasts the lowest unemployment rate, and Baltimore has the fourth lowest.
The impact of broader economic performance on construction is obvious. Boston, for example, has emerged as one of the nation’s stronger regional markets, and is now associated with the third lowest unemployment rate among the nation’s 20 largest metropolitan areas. Through August, future nonresidential construction contracts rose 6 percent from 2009 levels.
By contrast, in Atlanta—which continues to be weighed down by one of the nation’s weakest residential and commercial real estate markets—contracts for future nonresidential construction were down 15 percent year to date.
Economic weakness continues to be concentrated in portions of the industrial Midwest, in the southwestern United States and in portions of the Southeast. The highest unemployment rate among the nation’s major metropolitan areas is in Riverside, Calif. High unemployment rates also characterize the economic realities of Detroit, Miami and Tampa, Fla., each of which is associated with the nation’s weakest housing markets.
Successful construction executives stay on top of industry trends, readily adapt to changes in the marketplace and pay close attention to the owner community’s wish list. The green building market serves as a perfect example. Contractors that saw the tide turning green a few years ago better positioned their companies to withstand the downturn in construction. Now, what lies ahead for the future of green building?
According to McGraw-Hill Construction, the pace of green building growth has been nothing less than dramatic. Up to 35 percent of new nonresidential construction in 2010 will be green, creating $55 billion to $71 billion in market opportunity. In five years, McGraw-Hill expects the market for new nonresidential green buildings to jump to nearly $145 billion, with green retrofit and renovation projects adding another $14 billion to $18 billion.
The factors influencing the growth in green building include government mandates and public policy; demands from owners of larger construction projects and general public awareness; and a better understanding of the benefits and long-term cost savings. To date, 12 federal agencies, 33 states and 384 local government programs have green building legislation and initiatives in place. More than 70 percent of projects valued at $50 million or higher include LEED in their specifications.
Construction segments leading the way in green building in 2010 include:
- Education: Projects totaled $13 billion to $16 billion, representing 36 percent of the market;
- Health care: Projects totaled $8 billion to $9 billion, representing 40 percent of the market; and
- Office: Projects totaled $7 billion to $8 billion, representing 50 percent of the market.
On the jobs front, green building stands to generate nearly 8 million U.S. jobs and $554 billion for the American economy over a four-year period from 2009 to 2013, according to the U.S. Green Building Council and Booz Allen Hamilton.
In addition, green building can be good for a company’s bottom line, according to McGraw-Hill’s reports. Between 2008 and 2009, for firms performing green building projects:
- design firm revenues increased 16.8 percent; and
- contractor revenues increased 11.3 percent.
Also of note, the industry will see an upsurge in the use of building information modeling (BIM) for energy performance simulations on green building projects.
Between 2006 and 2010, the U.S. volume of construction put in place dropped by about a third, according to the U.S. Census Bureau. This decline in activity profoundly impacted the construction materials marketplace, keeping demands—and prices—relatively low throughout the recession and today’s slow recovery.
Although materials prices are generally higher now than during their low point in 2009, prices in most segments showed modest month-to-month declines or were flat heading into the last quarter of 2010.
However, contractors should anticipate unpredictability in construction materials prices in 2011, as U.S. monetary and fiscal policies remain unsettled and investors seek to avoid assets that would fluctuate due to the value of the dollar, according to Associated Builders and Contractors’ Chief Economist Anirban Basu.
The relatively low price of materials will not be sustained, agrees Julian A.J. Anderson, president of global property and construction consulting firm Rider Levett Bucknall. The permanent decrease in materials capacity will sow the seeds of future upward price pressure, and commodities will face ongoing price increases driven by global demand and scarcity, he says.
However, in 2011, the continued upward trend in labor and materials prices will be buffered by ongoing competitiveness among contractors, resulting in continued suppression of prices at bid, Anderson says.
TRENDS BY SEGMENT
In October, construction materials prices rose 0.6 percent and were up 4.8 percent compared to the same time last year, according to the U.S. Department of Labor’s producer price index.
Asphalt
Prices for prepared asphalt, tar roofing and siding fell 1.2 percent in October—the third monthly decrease—but were up 0.8 percent for the year.
Drywall
According to U.S. Gypsum, drywall prices are affected mostly by consumption in new residential construction, which accounts for half of all consumption. New commercial construction has less of an impact on drywall prices, as it only accounts for 15 percent of consumption. Residential repairs and commercial repairs each account for 17.5 percent of drywall consumption.
In 2006, drywall demand stood at 35 billion square feet, but dropped to 18.5 billion by 2009, according to the U.S. Geological Survey.
The producer price for gypsum, the main component in drywall board, rose slightly during 2010 but is starting to decline heading into 2011, as residential demand remains low.
Concrete and Cement
Concrete product prices remained flat in the third quarter of 2010 and were down 0.5 percent from 2009.
The recession had a profound impact on cement prices, as well. By the end of 2009, 14 cement plants had closed and only three new plants opened. In addition, several planned expansions of existing plants were suspended.
While the producer price index of cement declined throughout 2010, some demand due to federally funded infrastructure projects has prevented steeper price declines from occurring. The majority of cement is consumed by streets and highways (27 percent), followed by residential buildings (25 percent), then water and waste management projects (11 percent), according to the Portland Cement Association (PCA). Commercial buildings only account for 8 percent of cement use, and public buildings only account for 4 percent of use.
PCA anticipates flat growth in consumption by the end of 2010. This will be followed by small increases of 1.4 percent in 2011 and 4 percent in 2012. Sustained growth is forecasted for 2013 and beyond.
Copper
The construction industry significantly impacts copper prices, as 48 percent of copper consumption occurs in building construction, according to the U.S. Geological Survey. Remaining uses for copper include electrical and electronic products, consumer products, transportation equipment and industrial machinery.
Copper is in far less demand today than during the construction boom of 2006, when copper was valued at $8,150 per ton in the United States. Base case mine production is forecast to decline by 1.8 percent in 2011, with mine output falling to approximately 17.6 million tons, according to Brooke Hunt. However, demand for additional mine production is anticipated in 2012, when copper shortfalls could return.
The United States relies significantly on imports for copper, with Chile producing the highest percentage of global product (33.7 percent), followed by Peru (8 percent). Copper is a unique material because it has very few substitutes, and the demand is not as sensitive to price changes as other materials.
Crude Energy
Crude energy prices climbed 5.4 percent in October due to an 8.7 percent increase in natural gas prices. Crude energy prices were 8.2 percent higher than in October 2009.
Lumber
Softwood lumber prices decreased 1.1 percent in October, but were up 4.9 percent on a year-over-year basis.
Lumber demand will remain low next year, correlating with the depressed market for new residential construction. However, some lumber demand still exists for residential upkeep and new non-residential construction, although less than 10 percent of U.S. lumber demand comes from non-residential construction, according to the U.S. Forest Bureau.
Metal, Wire and Cable
Prices for fabricated structural metal products edged down 0.4 percent in October and were down 2.2 percent compared to last year.
Nonferrous wire and cable prices increased 4.3 percent in October and were 10.9 percent higher than in October 2009.
Steel and Iron
The steel price index peaked in late 2008, with prices dropping sharply in 2009. This year, iron and steel prices slipped 0.8 percent in October but were 14 percent higher than they were last year. Steel mill product prices were up 1.4 percent for the month and up 12 percent year-over-year.
Global demand for steel is quickly outpacing U.S. demand. For example, in 2006, the United States accounted for 11 percent of the world’s consumption; today, that numbers stands at 7 percent.
U.S. steel usage is dwarfed by China’s. According to the World Steel Association, China experienced a 24.8 percent growth rate in steel use in 2009, which was 10 times that of the United States. In 2010, the United States showed an improved demand for steel, with a steel use growth rate of 26.7 percent, compared to China’s at 6.7 percent. In 2011, the World Steel Association predicts the two countries’ steel usage will start to converge, with the U.S. rate predicted at 7.4 percent and China’s rate predicted at 3.5 percent.
Because the current domestic supply of structural steel still far exceeds the current demand, structural steel prices will remain relatively stable, barring a significant spike in scrap prices resulting from foreign demand, according to the American Institute for Steel Construction (AISC).
However, reinforcing steel (rebar) will have a different supply/demand curve because it is more heavily impacted by infrastructure projects, AISC notes.