By: Jennifer M. Horn

The Architectural Billings Index (ABI), an important construction indicator, continues to show increased construction activity and economic momentum in a recent 2012 report.  For the fifth straight month, architectural billings increased.  In addition, business conditions improved in all regions of the United States except for the western part of the country.  The general and gradual sustained improvement is in accord with the predictions of leading economists.

For instance, in 2011, Anirban Basu, an economist from the Sage Policy Group, noted that leading economic indicators, including the ABI, had begun to show signs of life and pointed to the Mid-Atlantic region as a top economic performer.

At that time, in terms of U.S. production, the country was more than one and a half years into the economic recovery.  This recovery has also been accompanied by a significant rally in financial markets in America and abroad.  Correspondingly, construction indicators, such as the ABI.

A year later, we see the trend continuing, with firms in the commercial/industrial sector reporting the strongest gains.

Jennifer M. Horn is Senior Counsel at Cohen Seglias and a member of the Construction Group. She concentrates her practice in the areas of construction litigation and real estate.

What do leading economists have to say about an economic recovery for the construction industry? The reviews are mixed, but hopeful. The following three economists recently spoke at an American Institute of Architects (AIA) sponsored webinar in which they outlined and analyzed relevant economic trends.

Kermit Baker

Kermit Baker, Chief Economist for AIA, and the originator of AIA’s Architecture Billings Index and Consensus Construction Forecast Panel, identified a “triple whammy” with regard to the housing and remodeling outlook. Baker said the trifecta of inventory overhang, weak demand and low mobility has continued to hamper home building recovery. He also noted a current upturn in the remodeling market. In sum, housing market conditions remain weak, although it is important to note that existing sales and starts were improving in the recent quarter. Baker’s data comes from the U.S. Department of Commerce and the National Association of Realtors  which tracks new home sales, existing home sales and housing starts. Years of overbuilding has generated significant over supply of vacant homes and during the housing downturn, household growth has been well below levels of the past several decades.

However, residential home builders and construction professionals should be heartened to learn that data from the Joint Center for Housing Studies suggests that leading indicators of remodeling activity point to early stages of an economic recovery. The Mid-Atlantic region, in particular, shows signs of a remodeling rebound.

Baker was careful to point out that housing policy political concerns impact this rebound including:

  • The federal government’s role in housing finance (i.e., Fannie Mae and Freddie Mac)
  • Federal debt reduction initiatives such as the deductibility of home mortgage interest payments, local property taxes, and the exclusion of capital gains from the sale of a home; and
  • The status of incentives to promote home ownership (e.g., Federal Housing Administration).

As referenced by other economists, Baker also noted that the Architecture Billings Index has finally edged into growth territory. In addition, all major non-residential building construction sectors are in or edging into a recovery phase.

Baker also examined the non-residential construction outlook for 2011 through 2012. He concluded that “while most firms are expecting growth in 2011, many are projecting continued decline.” Baker concluded that a construction recovery was expected in the latter half of 2011, and that 2012 should be better.

Jim Haughey

Jim Haughey, Chief Economist for Reed Construction Data, cautioned that a rise in oil prices as well as a threatened federal shutdown jeopardized recovery. Haughey pointed to recent current events since October 2010 including, but not limited to, state budget cuts deepening; President Barack Obama’s roll out agenda halted; and the developing country economic boom, as well as Arab revolutions raising commodity prices. Consumer confidence, however, according to Haughey, is jumping higher. Haughey characterized the construction environment from 2011 through 2012, as one where “private building space and facility capacity” declined from large surpluses to near normal levels. In addition, he predicted that spending confidence would start depressed, but rise rapidly to normal. He also predicted an improvement to credit access. For public construction funds, he predicted a decline deepening in 2011 then recovering partially in 2012. With regard to construction costs, Haughey noted domestic prices moving from zero to one percent inflation; volatile import price inflation averages about five to six percent. Domestic prices move from 0-1% to 1.2%.

Ken Simonson

Finally, Ken Simonson, Chief Economist for the Associated General Contractors of America examined current economical influences on construction. He identified the following:

  • Growth Domestic Product, personal income: Gradual acceleration;
  • Continuing problems for office, retail, warehouses;
  • Loans for developers remain tight – to – unavailable;
  • State/local spending infrastructure not a priority;
  • Federal spending helped but may decline soon; and
  • Price spikes for diesel, copper, and possibly steel.

Simonson acknowledged that federal funding sources play a major role in the construction market. For example, he noted that federal stimulus programming was at its peak currently, totaling $135 billion. The base realignment work, currently at its peak, is due to end September 30, 2011. In addition, Gulf Coast Hurricane work, also currently at its peak, is due to end June 1, 2011.

Critically, Simonson also analyzed the current economic outlook for materials, noting that the construction industry depends on specific materials that are:

  • In demand worldwide;
  • Have erratic supply growth; and
  • Are heavy, bulky or hard to transport.

Construction, which obviously requires the physical delivery of heavy materials, is subject consequently, to price spurts, transport bottlenecks, and fuel price swings. Happily, Simonson also noted that a slight upturn has begun in the housing outlook. In particular, the rental demand should rise as more people get jobs or move to military base realignment sites. According to Simonson, the condo market continues to have large overhang. In this regard, demand for completed condominium units remains weak and, as a consequence, economic pressures on existing owners is increased when problems occur in buildings with low or partial occupancy. Additionally, financing challenges are exacerbated by low condominium occupancy. Compounding the issue, banks remain unwilling to lend to developers.

Conclusion

All in all, a mixed economic bag for the remainder of 2011, with good reason to hope for recovery in 2012. Of course, there are no guarantees when reading economic tea leaves. Even Baker, Haughey, and Simonson can not immediately predict the global impact of political and international issues – for example, the economic fallout from the recent earthquake, tsunami and nuclear tragedy in Japan (that occurred after the above referenced webinar was presented). Based upon the recent and past economic data; however, take heart that the construction recovery is real; albeit moving at a painfully slow pace.

I recently had the opportunity to sit down with Ms. Anne Klein, SenioAK-photo 6-9-05.jpgr Vice President of the Office Services Group of Grubb & Ellis’ Southern New Jersey Office, where she serves as a senior broker. With 26 years of experience in the industry, Ms. Klein’s successes include leasing over 6,500,000 square feet of build-to-suit space, and she has completed investment sales of over 1.5 million square feet of office space. During her 13 years with Grubb & Ellis, she has been retained as leasing agent for over 4,000,000 square feet including Teacher’s Insurance Annuity Association’s premier Class A, 170,000 square foot office building and Goldman Sachs real estate arm’s one-story office complex comprised of over 500,000 square feet, both of which she subsequently sold. Ms. Klein’s tenant representation extends across the country, working with local brokers in each market, while exclusively representing each tenant’s specific office leasing and sale requirements.

Most recently lecturing to real estate, construction, and design professionals from throughout the Mid-Atlantic region at a Commercial Real Estate Women (CREW), Philadelphia Chapter event, I asked Ms. Klein to summarize her commercial real estate industry predictions for the remainder of 2011, and in 2012 for New Jersey and beyond:

Jennifer Horn: What is the current state of the real estate industry today?

Anne Klein: I think we have hit close to bottom. Although vacancy increased last year, we are starting to see increased leasing activity, successful subleasing, and even building sales as lenders loosen requirements a bit.

Horn: In terms of economic recovery for the real estate market, what positive indicators are you seeing in the construction industry for the remainder of 2011 and into 2012?

Klein: We need residential sales to stabilize before residential construction will increase. As for commercial construction, architects are getting busier, which should trickle down to contractors later this year.

Horn: What challenges does your industry still face?

Klein: Rents and rent concessions; these are all over the board right now. This, in turn, affects the building values for future sales. Once landlords get more confidence in the increased activity, things should settle down and price wars should temper.

Horn: Is the residential and commercial real estate foreclosure crisis over?

Klein: No. Residential foreclosure is still climbing at alarming rates, and the stories are so sad. Commercial lenders with buildings underwater are selling notes or taking back the deeds. For the market, it’s still marketable space and the buildings will either be filled and sold, or just sold at discounted rates to buyers who might reposition the buildings and then fill them up in time.

Horn: What advice do you have for clients frustrated by tight restrictions on financing?

Klein: Hang in there. As we are seeing recovery, banks are slowly but surely going to get back into the lending game. Hopefully at responsible levels!

Horn: How has New Jersey fared as a whole compared with the rest of the nation?

Klein: New Jersey is having a tough time encouraging new businesses to join the state. Governor Christie seems to understand that and is trying to make New Jersey a much friendlier state to do business in, which should only help our ability to draw new companies, resulting in a stronger real estate market.

Horn: Where is the work now?

Klein: It has been a year of renewals for tenants who want to stay put until they know what their longer term space needs will be. With little or no tenant improvements, landlords are happy to offer better rent deals for tenants to stay put. As for the companies that know their future needs, they are taking advantage of the market and we are seeing a flight to quality with those companies.

Horn: What continued economic precautions should the industry be taking in the current environment?

Klein: Don’t build any speculative construction!

Horn: Do you see green building playing a large role in the remainder of 2011/begining of 2012?

Klein: Not like you might think in today’s day and age. Thanks to the current administration, there are more incentives than ever, so hopefully that will help encourage more green initiatives by both developers and users.

Horn: What two pieces of advice would you give to the average real estate investor struggling to survive and, in the current environment, may not believe pundits who contend that the recession is over?

Klein: Do every deal you can, within reason, and retain every tenant until we see the light!

Horn: Why should the industry be optimistic about the remainder of 2011 and beyond?

Klein: We ARE in the beginning of a slow recovery. As long as we work hard and smart and have patience, we will be able to head back up the bell curve.

Anne Klein can be reached at 856-334-2110 or anne.klein@grubb-ellis.com. For more information about Grubb & Ellis, please visit www.grubb-ellis.com.

Economic Forecast for the 2011 Construction Industry: Outlook Good?

Basu.BMP
I recently had the pleasure to chat with
Mr. Anirban Basu, Chief Economist for the Associated Builders and Contractors, Inc. (ABC) and Chairman & CEO of the economic and policy consulting firm, Sage Policy Group, Inc. Voted one of the region’s 20 most powerful business leaders in 2010 by The Baltimore Business Journal, Mr. Basu is a frequent contributor to many different media outlets, including writing a monthly article for Construction Executive magazine and producing the economic news report, Construction Economic Update. Most recently lecturing to construction professionals from throughout the Mid-Atlantic region at the ABC – Eastern Pennsylvania Chapter’s 2011 Construction Industry Symposium, I asked Mr. Basu to summarize his construction industry predictions for 2011 and beyond:

Jennifer Horn: First, some good news, please. Where are we now in terms of economic recovery, and what positive indicators are you seeing in the construction industry for 2011?

Anirban Basu: In terms of U.S. production, we are now more than one and a half years into the current economic recovery. This recovery has also been accompanied by a significant rally in financial markets in America and abroad. Correspondingly, some construction indicators, such as the architecture billings index, have begun to show signs of life.

Horn: If the recession is over, why aren’t things improving faster for the construction industry as a whole?

Basu: Construction tends to lag the U.S. economy in terms of recovery even under normal circumstances. But these are not normal circumstances since such a high proportion of the excessive investment and speculative activity during the previous growth cycle related to real estate. This in turn triggered a financial crisis of epic proportions, leaving construction vulnerable to a massive and in many cases ongoing downturn. For construction recovery to begin in earnest, the nation will need to add millions of additional jobs to bring down vacancy rates, spur demand and create greater confidence among prospective financiers.

Horn: Is the residential and commercial real estate foreclosure crisis over?

Basu: Neither the residential nor commercial real estate foreclosure crisis is over. There are still plenty of distressed properties and owners who are unable to make their payments. This year may be the peak year for residential foreclosures and commercial real estate weakness is likely to impact U.S. economic performance for several years to come.

Horn: When will banks open the spigot on financing?

Basu: Banks continue to make loans to people and organizations with high credit scores and demonstrated reliability. However, many financiers remain quite cautious with respect to people and organizations with checkered credit histories and/or with short credit histories. One suspects that this will change over time as certain bankers become increasingly aggressive in the search for financial market share, but for now lenders remain rather disciplined and that is unlikely to change substantially in 2011.

Horn: How has the Mid-Atlantic region fared as a whole compared with the rest of the nation?

Basu: In general, the Mid-Atlantic region has been a top performer. New York has bounced back nicely thanks to the performance of financial markets and growing profitability among many prominent banks. The Washington-Baltimore Corridor has also been a top performer, thanks largely to the ongoing expansion of federally-financed activities and the presence of a massive medical research sector. Philadelphia’s impressively diversified economy has also begun to rebound and Delaware’s business friendly environment continues to yield economic development dividends.

Horn: How do issues like Base Realignment and Closure (BRAC) and Cybersecurity in Maryland and Marcellus Shale in Pennsylvania shape their respective economic stories?

Basu: The most successful regions of the nation typically can point to a few sectors of the economy in which they are leaders. Maryland, for instance, is a leader in medical research, defense technologies, cybersecurity, government contracting, biotechnology and a handful of other sectors. The growing federal presence in cybersecurity and homeland security via BRAC simply bolsters Maryland’s already strong position, creating jobs, innovation and income in the process.

Pennsylvania, among other things, has been known since the nation’s early history as rich in natural resources, including agricultural products and coal. The latest gold rush relates to Marcellus Shale and the search for natural gas, which stands to impact the states economy for several decades to come.

Horn: Where is the work now? Also, what happened to all of the federal money that was supposed to stimulate the industry?

Basu: Much of the construction work today is in publicly-financed activities, including in the highway and street and conservation and development categories. Much of this work relates to the federal stimulus package passed in February 2009. However, much of that work is now ending and privately-financed activities do not yet appear set to recovery. An exception to this is the power industry, which appears increasingly well positioned to create new opportunities for contractors.

Horn: What continued economic precautions should the industry be taking in the current environment? In particular, what two pieces of advice would you give to the average supplier, subcontractor, or general contractor struggling to survive and, in the current environment, may not believe pundits who contend that the recession is over?

Basu: Industry leaders must continue to work relentlessly to contain costs. In most construction segments, there is still too much productive capacity, which means that there are too many bidders and that profit margins remain small. Therefore, those firms that fail to adequately contain costs will not be in a position to secure bids, which will eventually lead to exhausted backlog and potential failure. The fact that construction materials prices have been rising recently does not help in this regard. This means that construction firms must be particularly sensitive with respect to containing labor costs.

There are also plenty of opportunities to be proactive. One way is to take the time to understand public policy, as government seeks to alter the way in which construction services are delivered and the content of those services. This is particularly true with respect to green processes, technologies and materials – which government continues to support. Those contractors with demonstrated expertise in green construction stand to gain disproportionately in terms of market share going forward. This also stands for the general proposition that all construction firms should view themselves as technology companies, which implies a continuous appreciation for what it means to be at the cutting edge.

Horn: Why should the industry be optimistic about 2011 and beyond?

Basu: The industry should be optimistic because the market equilibrium is approaching. Many construction firms will falter in 2011, which means that survivors will be better able to secure market share and gain pricing power over time. Moreover, broader U.S. economic momentum has picked up substantially in recent months.

Anirban Basu can be reached at (410) 522-7234 or abasu@sagepolicy.com. For more information about Sage Policy Group, Inc., please visit www.sagepolicy.com.