2008 Outlook

Commercial jobs continue to carry construction numbers

by Clair D. Urbain

The strong commercial construction market promises to carry through 2008; inflationary pressures remain on construction materials.

The sustained strength in the commercial construction market should continue through the long term, surmise U.S. construction economists. However, tighter supplies, increased transportation fees and higher prices for raw materials will keep driving up building costs.

“Construction tends to follow a 20-year cycle, but in most cases, commercial/non-residential construction doesn’t boom and bust at the same time as residential. Residential has slowed in 2006 and in 2007, but housing should begin a rebound,” predicts Jeff Taylor, economist at Associated Builders and Contractors (ABC).

“Commercial construction will begin to slow after 2008, but won’t be as dramatic as residential because the market isn’t nearly as speculative as residential, which tends to get ahead of itself. There will be a slowdown in some areas, but unless consumer spending and the business sector fall hard, we won’t see a meltdown in commercial construction,” he says.

An exclusive survey of Contractor Tools and Supplies readers reflects continued optimism in the commercial construction market. While not as fantastic as readers’ 2006 business projections for 2007, nearly all readers believe business will be as good as 2007 or even better in 2008 (Table 1).

World economy
The world economy affects U.S. construction more than ever before.

“The U.S. economy growth rate is 2.5 to 3 percent; world GDP is 4.3 percent in 2007 and vs. 5.4 percent in 2006. The numbers in 2008 should be stronger than 2007 and that trend should continue,” says Jason Schenker, chief economist at Wachovia. “China is above the world GDP growth but the trend is slowing. We expect China’s GDP growth to cool from 10.7 percent in 2006 to 9.6 percent in 2008. It is trying to slow its economy to improve its currency value.”

The developing countries of Brazil, Russia, India and China (BRIC) are rapidly expanding their industrial bases and creating strong demand on the world’s supply of energy and raw materials. The BRIC countries have an appetite for energy and materials that will sustain high, and even higher prices.

“Most raw materials are coming from emerging markets except materials coming from Canada and Australia. The emerging markets are more volatile. In the BRIC countries, their increased demand has put the worldwide supply and demand out of sync. The outlook will be better when the world demand slows, but even when that happens, prices will never fall to the levels in the past,” says Taylor.

That’s why prices for building materials have increased dramatically, and the economists predict that price escalations will slow, but will continue in 2008 and beyond.

Residential, non-commercial outlook
Although the popular press has heralded the collapse of the residential market, Put-in-Place numbers from the U.S. Census Bureau suggest that while there has been a drop in residential construction, 2007 still posts the fourth highest year of activity.

“We are predicting a recovery for residential construction in 2008, but it could be as late as 2009. We believe 2008 will bring residential a 3 percent growth rate, which played against inflation, is flat or no growth. In fact, in 2007, nonresidential and non-building construction was slightly larger than residential construction. Residential volume will take the lead again after 2009,” predicts Heather Jones, construction economist at FMI.

Table 3 charts the anticipated growth of Put-in-Place construction by sector. Clearly, the economists at FMI believe that residential will recover and that nonresidential work will continue to march to new, higher numbers.

“The outlook for the construction market is optimistic,” says Ken Simonson, chief economist at Associated General Contractors (AGC). “We touched the bottom of economic growth and it should be upward from here. We should have several quarters of two and three percent growth, which is much better than .66 percent growth charted in the first quarter of 2007.

“In 2006, we saw nonresidential public and private spending reach 13.6 percent growth and, in the first four months of 2007, that growth continued, posting as much as 17 percent growth for private and 9 percent for public construction spending,” says Simonson, “But governmental bodies are getting more cautious, especially when it comes to property tax receipts. School construction and other projects that rely on this type of money will be carefully evaluated,” Simonson says.

“In private construction, there is a shifting mix. There is good growth in big box stores and commercial properties, but those segments are vulnerable to what’s happening in the housing market. Anecdotally, Wal-Mart recently reduced its projection of new stores in 2008.

“Overall, I think construction of stores that serve homes or residential areas will slow and small suburban office construction will dwindle with lower residential sales. However, Class A office space will increase due to buyouts and mergers,” reports Simonson.

The economic experts predict that health care, lodging, transportation and public safety will be especially hot markets in 2008 and beyond.

Health care hot
FMI economists currently expect health care to lead in construction growth, achieving double-digit growth rates through 2011. “Health care is growing strong. Hospital construction makes up 66 percent of this market and medical offices make up 26 percent. Special care, which includes nursing homes, makes up 8 percent,” says Jones.

“Most of the hospital improvements are at established city hospitals that are upgrading facilities. There is a growing trend toward private rooms and hospitals are building facilities in suburbs to leverage their name and personnel into areas that need hospital coverage,” says Jones.

“Nursing home construction is a small piece of the pie and the forecasters predict it’s a longer-term market, and should become a bigger piece of the pie in 10 or 15 years.”

There will be a special care construction explosion, but it won’t eat much market share from other healthcare segments. “That whole pie will continue to grow,” says Jones.

Transportation is another double-digit construction category through 2011. The Aviation Bill will supply money for some significant improvements in primary and secondary airports. Presently, the Transportation Bill for funding highway and bridge construction hasn’t passed, but it will. And, public safety projects will continue strong, says Jones.

“There are many state and federal prisons being built in the west, southwest, south and mid-south of the country where population continues to grow. Border Patrol construction is very active. Locally, communities are adding fire and police stations in new residential areas. Our population is mobile, but our facilities are not. As the population moves, facilities need to be built in areas gaining population from net migration,” says Jones.

Lodging continues to grow but will level off in 2008 and beyond. Much of this construction is development in Las Vegas, but there is a considerable amount of rebuilding casinos and hotels in hurricane-ravaged New Orleans and Gulfport, Mississippi. “For example, the $500 million Beau Rivage project in Biloxi was just completed,” says Jones.

Highway hotels are also expanding. “This is part of the growing suburb phenomenon of the past few years. Residents there are older and have more disposable income. There is a demand for overnight lodging near these new suburbs,” says Jones.

Manufacturing construction is also seeing a rebound. Spending for manufacturing construction improved in 2007 and hasn’t been this high since 1998. “But that is comparing 1998 dollars vs. 2007, so in real terms, it probably has yet to surpass it. All sectors have been very active,” says Jones.

Energy-related construction, while relatively quiet, will gather steam, says Simonson. “There are projections that as many as 100 conventional power plants are on drawing boards. Plus, there is more environmental retrofitting going on at plants to reduce emissions.”

Jones concurs. “Power generation and distribution will remain flat at 5 to 7 percent growth until 2011 when power plants will take off. Most will be coal plants that use cleaner technology and will tend to be smaller than some of the mega plants that are being built today.

“Nuclear plants are a big ‘if.’ Exellon Corp. is filing nuclear plant construction permits for a unit in Texas costing $4 billion. This will be the first nuclear power plant built in the United States to come online since 1996. We won’t know if these permits will go through until 2009 or 2010,” says Jones.

Geographically, construction continues where there is population growth. “It seems hottest in the Mid-Atlantic area of Virginia, South Carolina, North Carolina and Florida. Demand is solid,” says Taylor.

The industrial Midwest continues to be weak, but there are some bright spots as ethanol plants and biodiesel plants are being built, bringing good-paying jobs to rural areas.

The excesses of residential construction and sub-prime lending problems in California are catching up with them and hurting that market. “They overbuilt the residential market and there are now indications that Nevada may even be overdeveloped,” says Taylor. “The Northwest looks good and, in my opinion, the Mid-Atlantic area looks the best.”

Supply surprises
The strong demand in construction worldwide has put some strain on building supplies. Experts predict that while prices for many commodities have or will soon stabilize, none will retreat significantly. Prices for products containing nickel, copper or PVC will likely continue to escalate at double-digit rates.

Construction distributors and contractors concur. Respondents to a recent Contractor Tools and Supplies survey suggests that building steel, PVC/petroleum-based products, plumbing products and fuel will continue to have upward price pressure in 2006 (Table 2 below).

Industry watchers agree with contractors and distributors. “Construction supplies will be costing more. We won’t see anything come down except maybe lumber. Copper, steel, asphalt and diesel fuel will come off of highs but will remain high. Oil, scrap steel and transportation costs will continue to drive prices. I fully expect greater volatility and higher prices, so it’s wise to use some sort of escalation clause in contracts for supplies. Often, suppliers will talk with developers to lock in a price for a set time and then revisit the price. It is tougher to get long-term commitments,” says Taylor.

Bob Garino, economist at the Institute of Scrap Recycling industries, predicts that various types of building supplies will be in high demand in 2008. He offers his insight on several key markets:

Steel: Prices seem to be firming up as added capacity comes online. There were 1.3 billion short tons of steel produced in the world in 2007 and production should increase 5 percent (70 million tons). China produces 318 million metric tons, a 10 percent increase from 2006.

“China will produce more than 400 million tons and it can’t consume all of that. There is a new 5 percent duty on short steel products and 10 percent on long steel products. China exports to the U.S. are lower this year than last year. U.S. prices are lower this year, so imports have moderated, but we still need to import steel. We can’t make all that we need, but our steel industry reacts quickly to dumping,” says Garino.

Aluminum: Prices have marked time over the last six months. There is a balance in the market, so it is stable. The domestic market could have limited price pressure throughout the rest of the year.

Copper: Uncertainty and pessimism in the first quarter reduced copper prices to $2.70 per lb., but a tightening market has taken copper trading between $3.35 to $3.40 per lb. “We are seeing heavy Chinese copper imports and we are trending toward surplus. Some experts still predict $4 per lb. for copper, but I see an average of $3.70 per lb. in 2008,” says Garino.

Nickel: It’s at all-time highs due to strong stainless steel demand. Nickel will drive the steel prices; Garino predicts $19 per lb. for nickel.

Gypsum: Used heavily in residential and non-residential construction, the residential downturn will help weaken gypsum prices, reports Garino.

“Gypsum is weak and will be down more in 2008,” says Simonson. “However, there is some rally in lumber futures, but with home building in doldrums for at least another eight to 12 months, there will be reduced demand.”

Cement: Shortages in 2004 and 2005 ended in 2006, thanks to eliminating the anti-dumping duty from Mexico, says Simonson. “The fee was reduced from $26 to $3 per metric ton and will completely go away in 2009. China has also opened up world-scale cement plants and is shipping to the United States. Concrete prices are lower, but still very sensitive to energy costs. We will still see increases in concrete prices.”

Asphalt: Shortages that showed up in 2006 have not showed up in 2007. “Paving season is a bit delayed and there were some one-time refinery problems with low-sulfur retrofits. We hope to see less volatility this year, but still be high due to $65-plus per barrel oil,” he says.

For estimators, projecting costs will get even more difficult.

“The trends shaping construction costs in the last three years aren’t an anomaly. There has been a shift. The BRIC nations will permanently affect the world market. The trend will continue for at least 10 years. Getting the BRIC nations developed is good for all of us because by raising their standards of living, they become better customers,” says Simonson.

Other trends
Industry experts say contractors are slowly working to incorporate better information management systems to improve productivity. “Construction still lags in this area. Building Information Modeling (BIM) is gaining interest and so are Lean activities. Green construction is also here to stay,” reports Jones.

Taylor says for contractors to be more competitive, they must increase productivity. “Contractor firms tend to be smaller businesses and there are few checks and balances. There are not many metrics built in. Just how do you document productivity? This is becoming an increasing issue in the market, and bigger contractors are already effectively addressing it.”

Green construction practices are also here to stay. Green construction will hit $20 billion by 2015 through tax incentives and regulations being made in state and local codes. “We are seeing it in schools and office buildings. Proponents claim green buildings have more productive employees because the buildings are healthier and more efficient.

“Green construction may not hit every sector, but be aware of it and look for ways you can apply some of the concepts in what you do. More construction companies and their workers are LEED (Leadership in Energy and Environmental Design) certified. Big construction companies are already well into this concept. It is even bigger globally,” says Taylor.

BIM will change how buildings are designed and built. It integrates the design and building process for increased efficiency and to meet regulations facing new buildings.

“The architect normally makes sure all the regulations and codes are met in the design process, but when it becomes more of a collaborative process with the builder or contractor, it means the legal and contractual process must change. It changes how architects and builders do business and it can help them do it faster and better. Its adoption has been slow due to the smaller size of construction firms,” says Taylor.

Published in the September/October 2007 issue of Contractor Tools and Supplies magazine.

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