Swimming pools can be found in most American hotels and have been a mainstay of institutional construction for decades. While more modern and newly built facilities benefit from advanced environmental controls, upgrading indoor pools in older buildings is a unique opportunity for contractors to improve buildings’ air quality and energy consumption.
The New Year has arrived. Goals have been set. Resolutions have been made. 2017 is sure to be full of many wins in life and business. But, the truth is, most contractors will not reach their goals. Most will come out of the gate with fire in their eyes, ready to conquer the world, but will lose steam at some point and settle back into old habits—and the same old results.
The Department of Homeland Security and U.S. Citizenship and Immigration Services (USCIS) has released a revised I-9 Form that employers must use beginning Jan. 22, 2017, to verify all new hires’ employment eligibility, including U.S. citizens and non-citizens. Employers that fail to use the new form on or after Jan. 22 may be subject to penalties.
GDP growth in 2017 is expected to experience a cyclical rebound before returning to a rate more in line with long-term potential, according to economist Bill Conerly. In other words, some experts believe that real GDP growth in 2017 will outpace last year, but will stabilize in the years following. Is this good news for small construction companies?
Industry analysts are optimistic about the construction industry: Nonresidential construction spending is forecast to jump 8.3 percent in 2016 and 6.7 percent in 2017.
Coming into 2016, many economists believed the global economy was poised for a mini-resurgence and that the U.S. economy would approach a 3 percent rate of growth. These same economists predicted the Federal Reserve would increase short-term interest rates three or four times in response to rapidly improving economic conditions.
Wrong on all fronts. The International Monetary Fund (IMF) has repeatedly downgraded its global growth forecasts, most recently in October. According to the IMF and as reported by The Wall Street Journal, the failure of policymakers to successfully address deep-rooted problems in the most important economies (e.g., United States, Europe, Brazil, China and Russia) has thrown the world into its worst slow-growth rut in roughly three decades. According to IMF Managing Director Christine Lagarde, the “political pendulum threatens to swing against economic openness, and without forceful policy actions, the world could suffer from disappointing growth for a long time.”
The IMF forecasts 3.1 percent global economic growth for 2016, well below historic norms. The outlook for growth in developed economies like the United States and Japan is just 1.6 percent compared to 2.1 percent growth last year. The IMF recently slashed its outlook for U.S. economic growth from 2.2 percent, which was the standing forecast in July, to just 1.6 percent.
Though many blame free trade as the core of these emerging challenges, global trade volumes are no longer growing as they once did. The volume of world trade has expanded by about 3 percent a year since 2012, half the growth experienced during the last 30 years.
Indeed, the IMF has been sending out warning signals about the global economy recently. For example, the world is awash in $152 trillion of debt, an all-time high that sits at more than double the amount of debt owed at the turn of the century. As reported by CNBC, a prolonged stretch of low interest rates that persists in much of the world led many corporations to take advantage of favorable terms and to issue aggressive levels of debt. The IMF is working to pinpoint the biggest sources of risk to the global financial system, noting that not only is private debt elevated among advanced economies, but it also is elevated in several systemically important emerging market economies, such as China and Brazil. The IMF has singled out China as a nation at risk of a disorderly wind-down from presently high corporate debt levels.
All of this helps explain the Federal Reserve’s reluctance to raise rates higher. Despite ongoing movement toward full employment and growing evidence of wage inflation, the Federal Reserve refused to raise key interest rates in June and September despite signaling earlier that rate hikes were on their way. The standing presumption is that the Federal Reserve will raise rates in December, an action last taken in December 2015.
Still, the U.S. economy continues to expand. In June, the current economic expansion celebrated its seventh birthday. Many would characterize the recovery from the Great Recession as a 2 percent recovery. That’s largely correct. Since the recession ended, the U.S. economy has expanded 2.1 percent on an annualized basis.
But the pace of growth has fallen short of that in recent quarters. According to the U.S. Bureau of Economic Analysis, national output as measured by gross domestic product (in 2009 dollars) expanded at a 1.4 percent annual rate during the second quarter of 2016. During the first quarter of 2016, the U.S. economy expanded just 0.8 percent on an annualized basis and only 0.9 percent the quarter before that. The upshot is that national output is only up 1.3 percent on a year-over-year basis
Labor, Wages and Profitability
Despite that, the economy has been strong enough to tighten up the labor market. As of mid-November, the national unemployment rate stood at 5 percent. While many economic stakeholders express significant skepticism regarding the interpretation of unemployment rate measures, the fact of the matter is that most construction firms report intense difficulty securing electricians, heating/cooling professionals and carpenters, among others. The construction worker unemployment rate stood at 5.2 percent in September 2016; that’s a far cry from the 13.3 percent unemployment rate that prevailed five years earlier.
Wages are rising more rapidly in many industries despite the fact that the typical American worker has become less Productive.
Data from the Bureau of Labor Statistics’ (BLS) Job Openings and Labor Turnover Survey indicate that construction job openings stand at a 10-year high. The Christian Science Monitor recently reported that demand for construction workers is so strong in Portland, Maine, that the Southern Maine Community College has had to suspend its construction technology program because too many students were leaving school to accept employment offers. During the course of the past year, average hourly earnings for construction workers rose above $28 per hour.
Wages are rising more rapidly in many industries despite the fact that the typical American worker has become less productive. According to BLS, non-farm business sector labor productivity fell 0.6 percent on an annualized basis during the second quarter of 2016. Meanwhile, unit labor costs rose 4.3 percent. Data indicate that the typical American worker is less productive now than a year ago.
That’s not good for profitability. In fact, American corporate profits have been shrinking due to a combination of a weak global economy, sagging exports, diminished commodity prices and low productivity. According to FactSet, the estimated earnings decline for the S&P 500 during the third quarter of 2016 is -2.1 percent. If earnings dip for the third quarter, it will mark the first time that the S&P has recorded six consecutive quarters of year-over-year declines in earnings.
Impact on Construction Spending
This has major economic repercussions for construction firms. Weaker earnings eventually translate into weaker construction, with firms often seeking to control costs rather than embrace risk and invest aggressively. According to the U.S. Census Bureau, a significant number of key construction categories have experienced reduced construction spending during the past year, including manufacturing (-7.2 percent), power (-3.8 percent) and health care (-3.1 percent).
Overall nonresidential construction spending actually declined 1.3 percent between August 2015 and August 2016. Much of the weakness can be found in the public sector.
Many Americans may have thought spending in the water supply category would be booming given the recent crisis in Flint, Mich., or that highway and street-related construction would be trending higher given the passage of the FAST Act last year. But despite the nation’s growing infrastructure deficits, available data indicate that, if anything, American spending on infrastructure is in decline. Between August 2015 and August 2016, construction spending fell in the following public sector-oriented categories: public safety, conservation/development, transportation, sewage/waste disposal, water supply and highway/street.
Many factors are at work. The federal government is sitting on a $19 trillion national debt and facing both Medicare and Social Security insolvencies within the next two decades. Plus, there is conflict in many state capitals around the nation. Many governors are unnerved by rising Medicaid expenditures and underfunded pensions, and many local governments continue to feel the impacts of the Great Recession in the form of slowing expanding property and income tax revenues.
Despite these headwinds, many construction firms continue to report that they remain busy, and that their most significant challenge is to find workers and subcontractors that can complete work satisfactorily and on time. Associated Builders and Contractors’ (ABC) most recent Construction Confidence Index revealed that while construction firm leaders are not quite as confident as they were in prior quarters, most continue to expect growth in sales, margins and staffing levels.
Additionally, ABC’s Construction Backlog Indicator shows the typical construction firm remains busy. However, the average contractor is no longer “getting busier,” with average backlog being stuck between eight and nine months during the past several quarters.
One of the likely reasons for higher levels of confidence among construction executives is their collective awareness that American enterprises will need to replace much of their capital stock in future years. When people talk about America getting older, they typically are speaking about its population. But that’s hardly the only thing in the United States that’s aging.
According to the Bureau of Economic Analysis, the average age of all fixed assets, including structures such as factories and hospitals, stands at 23 years—the oldest on record tracing back to 1925. The average age of these assets has been rising because companies and governments have been reluctant or unable to spend money to replace older assets with newer ones. That’s bad news for American living standards. It suggests that Americans are working at less modern factories and using computers that are not nearly as powerful as they could be. Doctors are practicing medicine in hospitals that are in disrepair and not ready to handle the demands of newer equipment. The average age of medical instruments is now approaching five years (the oldest on record since 1945), and the average age of the nation’s highways and streets is more than 28 years (also the oldest on record).
For years, engineers have spotlighted America’s lagging investment in broadband speeds, leak-proof water systems, and roads and bridges. In 2013, America’s infrastructure investment gap totaled $1.4 trillion. The bulk of that total, $1.1 trillion, pertained to a lack of adequate investment in the nation’s surface transportation network, which includes roads, bridges and mass transit.
The level of underinvestment in electricity infrastructure approaches $200 billion, while the level of neglect in the water and wastewater infrastructure category exceeds $100 billion. Airports require about $42 billion in additional investment to meet demand, while America’s inland waterways and ports require an additional $15 billion. Ongoing underinvestment has earned U.S. infrastructure a D+ grade from the American Society of Civil Engineers.
Another factor is that certain key construction segments are experiencing significant spending growth. As an example, the spread of e-commerce helped produce a 6.4 percent increase in commercial construction between August 2015 and August 2016. Two segments are growing even faster: office and lodging.
Despite high vacancy rates in a number of major U.S. markets, office-related construction spending rose by nearly 24 percent between August 2015 and August 2016, a staggering figure given the broader economy’s sub-2 percent rate of growth. Lodging-related construction, which pertains primarily to hotel room construction, rose by nearly 16 percent during this period.
Much of this is attributable to the global search for investment yield. With bonds yielding low or sometimes negative interest rates, investors have been scrambling for opportunities to generate income. U.S. equity prices have represented a primary beneficiary, but so too has America’s commercial real estate. According to Jones Lang LaSalle, foreign investment in U.S. commercial real estate rose a staggering 153.4 percent in 2015 to $71.7 billion. This has helped trigger new construction in certain instances, even in the absence of adequate levels of demand. According to Jones Lang LaSalle , office space supply is soon expected to exceed demand in New York, Dallas and Houston.
The growing consensus that some real estate markets may not be overpriced and overbuilt may help explain evidence suggesting that lending standards for commercial real estate loans are now tightening. Some banks and their regulators appear to be concluding that growing exposure to real estate may not be as advantageous as it was earlier in the cycle.
Buyer’s or Seller’s Market?
Some construction firm leaders point out that purchasers of construction services continue to respond as if this remains a buyer’s market. That attitude can limit pricing, revenue growth and profitability. With many firms busy and labor in short supply, costs are behaving as if this is a seller’s market. The result is a squeeze on profit margins.
Plus, construction materials prices are no longer falling. Copper prices have stabilized. Natural gas recently bounced back above $3 per million Btu and oil remained around $50 per barrel (as of mid-November). Earlier in 2016, oil was trading below $30 per barrel. If commodity prices continue to firm up, this can drive up the cost of delivering construction services. Purchasers of such services may not be prepared for cost increases and may resist them. That could translate into further stagnation in construction spending volumes, particularly if interest rates begin to rise in earnest in 2017, which could cause a growing number of proposed projects to become impracticable.
For more than two years, the Federal Reserve has been able to focus heavily on stimulating economic growth and moving the nation toward full employment. Precipitous declines in energy prices soaked much of the inflation out of the economy.
That is changing. Energy prices are firming and labor costs are marching higher. The Federal Reserve will need to be more concerned about rising inflation expectations going forward. Associated increases in interest rates could have significantly negative impacts on certain asset prices, including stocks, bonds, commercial real estate and apartment buildings. That would not be good for construction.
There is a bullish scenario, however. For much of the past two years, declines in investment and corporate earnings have been driven largely by the U.S. energy sector. With energy prices no longer falling, this could produce more investment and rising earnings—potentially translating into better support for asset prices, ongoing hiring and consumer spending.
For now, it’s tempting to maintain a somewhat pessimistic outlook. A combination of debt accumulation and low interest rates appears to have taken asset prices above levels supported by economic fundamentals. This renders the macro-economy and that of the nation’s nonresidential construction sector somewhat vulnerable to asset price adjustments.
One of retirement plan sponsor’s most important duties is to ensure the plan is in compliance with legal requirements. This is no easy task, especially for construction firms with high employee turnover. The Employee Retirement Income Security Act (ERISA) and the Internal Revenue Code (IRC) have specific requirements that plan sponsors must follow, and the current regulatory environment has led to increased scrutiny of plan practices.
The construction industry is in a hot cycle right now. The economy is growing and a steady stream of new projects are keeping construction professionals busy across the United States.
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A U.S. Bureau of Labor Statistics report revealed nearly half of all small businesses fail in the first four years of their existence. While there are many proven causes, including owner incompetence, inexperience, fraud and neglect, one killer culprit often flies under the radar: stagnation.
The bounce back from the Great Recession, which ended in June 2009, has been notably weaker than typical post-recession recovery periods. The economy appeared to be picking up steam in 2013 and 2014. The first half of 2016 was disappointingly slow, but signs of improvement for the second half have appeared.
Employment continues to grow at a slow, but steady, pace. The overall outlook is for continued, albeit slow, expansion in the economy and the construction industry.
Starting in 2012, the construction sector has turned in stronger growth than the general economy. However, that growth has not been evenly distributed. Residential construction has had the strongest rebound, but with notable differences. Multifamily construction has fully recovered, while single-family construction struggles with starts still well below the long-term needs of the nation.
Meanwhile, nonresidential building construction has done fairly well. But again, there are differences within this category. For lease properties (lodging, office and retail) generally have shown solid growth. Institutional construction faltered, only showing some minimal growth in 2015. Going forward, for-lease construction will grow, but at a much slower pace. Office construction is likely to be the best performer in this category, mainly benefiting large and medium urban areas. Institutional construction activity will advance, mainly due to more health care construction activity and a slight pickup in education construction activity. Urban areas across the United States will benefit from this activity the most.
From 2012 through 2015, manufacturing construction had healthy growth. Most of that strength derived from energy-related investment in chemical plants due to the sharp increase in U.S. energy production. With the reductions in production due to lower prices, construction in energy-related investment slowed considerably in late 2015 and into 2016. In 2017, manufacturing construction will improve slightly. The South and Midwest will be the primary beneficiaries of this construction activity, while the Northeast and West will benefit from high-tech manufacturing construction.
Infrastructure and Energy
Nonresidential, non-building construction (infrastructure) has only had two good post-recession years: 2012 and 2014. Construction on power projects was the prime source of growth in those years, with a minor assist from transportation projects. In 2017, construction activity for this area is likely to be flat. Even if politicians deliver on their promises of increased infrastructure spending, most of it will occur in 2018 and beyond.
Several states have stepped into the breach, many experimenting with new sources of funding, such as public-private partnerships (P3s). Look for P3 projects to support infrastructure projects in 2017 and beyond.
The economy has adjusted to lower energy prices. Some of the positives from the drop in prices are still filtering through the economy. Meanwhile, most of the negatives have played out. Energy companies have adapted remarkably well to the lower price environment. As a result, production has held up better than expected. The current price structure is likely to continue for at least another year and possibly longer barring a major supply disruption. Relatively “minor” disruptions like the Colonial Pipeline leak that resulted in a temporary shutdown will lead to price spikes—in this case for gasoline on the East Coast.
The boom in the energy sector gave a boost to states such as Montana, North Dakota, Pennsylvania, Texas and Wyoming. This spilled over to the construction sector in those states. The turnaround in the energy sector has been a drag on construction, putting downward pressure on construction employment in Montana, North Dakota and Wyoming. Nonetheless, construction employment makes up a relatively large share of total non-farm employment in those states. Construction activity in those states will continue at a slow pace in 2017.
With its dependence on coal, West Virginia has been hard hit by lower natural gas prices (a direct competitor to coal for use in power plants) and environmental regulations. Montana had the double whammy of a hit on its coal industry and its oil and gas industry. Given their more diverse economies, employment in the construction industry in Pennsylvania and Texas grew (0.3 percent and 1.5 percent, respectively, as of August 2016) in spite of the downturn in the energy sector.
Pennsylvania will experience some improvement, mainly concentrated in its urban areas and largely due to construction for office and health care. Texas will continue to benefit from its diverse economy, with Dallas showing the most growth. Despite the hit from the slowdown in the energy sector, Houston is doing relatively well and can expect slow growth.
Health Care, Lodging, Manufacturing and Residential
Construction activity in the Gulf Coast states of Alabama, Louisiana and Mississippi will be concentrated in manufacturing and residential construction. Much of Louisiana’s construction resources will be devoted to rebuilding following the recent devastating floods.
The same will be true for many southern Atlantic coastal areas. Overall, the southern states will experience healthy residential construction activity. Manufacturing construction will be important to much of the area. The urban areas will benefit from office and some retail construction.
Lower energy prices have helped, and will continue to help, states as diverse as Indiana, Kansas, Michigan, New Hampshire, New York, Pennsylvania and Tennessee. They also will benefit from manufacturing and health care construction.
Investment in lodging will continue in locations that thrive on business and leisure travel. These include large cities such as Atlanta, Chicago, Las Vegas, Los Angeles, Miami, San Francisco and Seattle. Even as investment in lodging proceeds at a slower pace in 2017, lodging construction activity will spread out to smaller resort areas.
Most areas of the country will see further increases in residential construction as employment continues to rise, spurring household formation and demand for single-family and multifamily units. Most of the larger multifamily projects will be in major metro areas such as Boston, Los Angeles, Miami, New York City, Philadelphia, San Francisco and Washington, D.C., but also will begin to expand to some urban areas in the next tier—mainly in the South and West.
Multifamily construction activity has slowed in some of these areas, notably New York City, Philadelphia, San Francisco and Washington, D.C., as new products have come onto the market—slowing or stabilizing rent increases. As the new product is absorbed and vacancy rates fall, construction will rebound in the second half of 2017.
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