SECOND QUARTER CONSTRUCTION OUTLOOK 2010

General  

After two years in the depths of one of the worst recessions in living memory, there are still very few signs of a recovery. The limited signs of some recovery over the past quarter are now in a pause mode. In the construction industry demand remains weak because of continued oversupply, developers are reluctant to commit to new projects and those prepared to take the risks are experiencing difficulty in obtaining financing.

The U.S. Department of Commerce in June, 2010 estimated an overall construction (private and public combined) “Seasonally Adjusted Annual Rate” of $836.01 billion which represents a decline of 7.9% from June 2009. Even more discouraging, the value of construction put in place for the first six months of 2010 is $389.60 billion and is 11.2% less than the same period a year ago.  

Last quarter’s relatively positive outlook for residential construction is looking less rosy with the expiration of federal tax credits for first-time homeowners. Through the first five months of this year the increase in residential construction was only 4.7% above the same period last year. Last quarter a 7% increase was forecasted for 2010 after a 25% drop in 2010.

Non-residential construction continues to languish in the doldrums. Office construction for the first six months of 2010 was down 31.9% from the same period last year; commercial construction down 31.4%; manufacturing down 31.1% and lodging a massive 58.5% less than the same period of 2009.    

In public funded construction, the dollar value of construction for the first six months of 2010 was $136.94 billion compared to $144.37 billion for the same period in 2009 which represents a 5.1% decrease. A breakout of these numbers shows a 21.6% increase in public residential construction but a 5.8% decrease in public non-residential construction. These figures indicate that stimulus funds only reduced the depth of the decrease in construction activity rather than creating an increase.

According to the Bureau of Labor Statistics, the June 2010 the construction industry unemployment rate was 20.1%. Overall, there has been little change over the past four months. 

On a somewhat more positive front, the American Institute of Architects’ Architecture Billings Index for April was flat for the first time since early 2008 when billing levels started dropping. Moreover new project inquiries are somewhat on the rise. However any increase in architectural workload will only translate into an increase in construction activity in 2011. 

A further small positive sign of improving conditions is the ENR Construction Industry Confidence Index for the second quarter of 2010, which rose 7 points from the first quarter of 2010. 

Construction Cost

The July 15 Producer Price Index Report of the U.S. Labor Department shows that after three months of construction material cost increases, it fell by 1.9 % in June 2010. Overall, prices are still up 0.8 % for the second quarter of the year and 4.2% higher than a year ago.

Concrete products fell 0.2% in June but were unchanged for the second quarter and 2% from the same time a year ago. Lumber prices, which had been rising monthly since October 2009, showed a 9% decrease last month but an overall 1.3% decrease for the quarter and a 21.9 % increase from June 2009.  Structural metal fabricated goods are slightly up for June, up 1.6% for the quarter and 1.3 % higher on a year on year basis.

Increases in construction labor rates are much lower than in the past. The Bureau of Labor Statistics’ latest release shows a 2.48% increase in average hourly rates between June 2009 and June 2010.

From an overall construction cost viewpoint, greatly increased competition between suppliers, sub-contractors and contractors over the past two years have resulted in each party reducing overhead and profit margins thus reducing bid prices and leading to moderate to strong construction price deflation. During the past quarter residential cost started to inch up from historical lows but that has been stalled with the expiration of federal tax credits for first-time home buyers. Costs for non-residential construction markets have bottomed out and there are no signs of upward movement because of the very low demand.

Because of the lack of new projects, competitive bidding remains the most cost efficient procurement method. However, the risks in terms of quality and increased change orders must be managed. In addition there will be risks of contractor/subcontractor insolvency.

Overall Construction Escalation Outlook

The slight improvement in the overall economy in the second quarter of 2010 has stalled, appearing to be on pause and the future is still uncertain. The large reduction in overall construction activity continues to greatly increase competition between bidders and put pricing pressure on projects. Costs have generally bottomed out and are 8% to 10% below their peak in 2008.

The somewhat more optimistic outlook from the construction design professionals is encouraging but projects on the drawing boards will only translate to construction activities in 2011. 

In the short term, bid prices are likely to remain low due to the very weak demand and lower input costs. In the longer term, it is likely the construction market will have a slow recovery only from the second half of 2011.

The most likely escalation scenario is an uneven slow recovery over the next three or four years.  We predict a slightly negative to static second half of 2010, a static 2011, a 1% – 1.5% escalation in 2012 and a return to a manageable 2% – 3% per annum thereafter.

FIRST QUARTER CONSTRUCTION OUTLOOK 2010

While there are signs that the broader economy appears to be emerging from the depths of recession, there is little sign that there is any momentum towards a recovery for the construction industry.  The U.S. Department of Commerce in November estimated an overall construction “put-in-place” decline of 10% for 2009 and forecasted a further decline of 2% for 2010.

The federal figures indicate a somewhat more positive outlook for residential construction with a forecasted 7% increase in 2010 after a 25% drop in 2009.  On the opposite side of the spectrum, commercial construction shows a forecasted 25% decrease in 2010 after a 32% decrease in 2009.  Office construction is forecasted to decrease 22% in 2010 after a 20% decrease in 2009.

Over 1.7 million construction jobs have been lost since the peak monthly employment in the summer of 2006.

In public funded construction there is a 6.1 percent increase over the past year.  Given the depth of the recession in the construction industry, stimulus funds may only be sufficient to reduce the depth of the cuts in employment rather than creating an increase.

The demands for “private sector, small firms” in qualifying for federal, state or city projects is extremely onerous and subsequently stimulus funds will tend to feed the larger companies with previous public sector experience.

Demand for new construction in the commercial sector is very low – many areas remain overbuilt, and it will be some time before the excess is absorbed.

New commercial development is further hampered by non availability of financing for new developments.  In a survey conducted by ENR involving 941 construction firms, the single biggest complaint is the lack of bank financing for projects no matter how investment-worthy the projects.

Construction Cost

The cost of construction materials has seen significant fluctuation over the past two years. The major indexes all show a peak in 2008 followed by a 5.6% decline in 2009.  ENR is projecting a further 1.9% decline in 2010.

Looking at individual materials, however, there are a wide variety of profiles.  Steel has shown a sharp decline of some 30% from its peak and ENR expects it to decline another 4.8% in 2010.  Lumber has fallen steadily from a peak in 2004 and will get an initial boost in the first half of 2010 as the housing market improves and is forecasted to end 2010 at 5.2% higher.  Cement prices have fallen steadily in 2008 and 2009 and is likely to fall further as consumption is forecasted by the Portland Cement Association to slip another 0.7% after plunging 50.3% in 2009.

Labor costs are showing no significant reductions but rather the rate of increase are much lower than in the past.  The Construction Labor Research Council, Washington, DC reports that the average negotiated increase for 2010 is 3.6% which is well below the average of 4.6% in 2008.

From an overall construction cost viewpoint, greatly increased competition between suppliers, sub-contractors and contractors have resulted in each party reducing overhead and profit margins thus reducing bid prices and leading to moderate to strong construction price deflation. Overall construction cost indexes reflect that selling cost of construction on year to year basis declined between 7% and 10% and are at 2006 levels.

The most cost efficient procurement method would be to introduce some form of competitive bidding.  However, this comes with risks in terms of quality and increased change orders and the possibility of contractor/subcontractor insolvency.

Overall Construction Escalation Outlook

The large reduction in overall construction activity is leading to greatly increased competition between bidders and putting downward pricing pressure on projects.  In most areas cost trends continue to be sharply negative, leading to moderate to strong construction price deflation.

In the short term, bid prices are likely to remain low due to the very weak demand and lower input costs.  In the longer term, the outlook is less clear.  It is likely the construction market will have a slow recovery over many years as it will take time for investment to return to the construction sector.

The most likely escalation scenario is an uneven slow recovery over the next three or four years.  We see 1% – 1.5% de-escalation in 2010, a static 2011, a 1% – 1.5% escalation in 2012 and a return to a manageable 2% – 3% per annum thereafter.