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New Report Sees Market Conditions Improving

The construction industry’s outlook is blossoming with the April daffodils, according to the Gilbane Building Co.’s Spring 2013 Construction Economics Report. Signals are strong for residential buildings and margins, and total construction spending is on a roll. The executive summary follows.

Construction Growth is Looking Up

  • ††Construction spending in 2012 finished 10 percent above 2011, with +6 percent for nonresidential building and +15 percent for residential, marking the first year of growth after five years of decline.
  • ††The monthly rate of spending is up 20 percent in 24 months, rising 18 of the last 24 months.
  • ††Architecture Billings Index (ABI) went up from May 2012 to January 2013 with only December decreasing slightly (see figure B below). This is a very good leading indicator for new construction work starting in Q3-Q4 of 2013.
  • ††The backlog of construction starts from the last two years indicates an upturn in nonresidential spending starting in May 2013.
  • ††Contractors’ building costs that were “charged” in 2012 were above labor and material cost increases, signaling a movement towards recovery to more normalized margins.
  • ††Construction spending for 2013 should increase +7 percent, but driven almost entirely by a 20 percent increase in residential spending.
  • ††Construction gained 150,000 new jobs in the last five months through February 2013, rivaling the all-time highest jobs growth rate. Although most of those jobs support residential construction, recent months show an equal number added to nonresidential construction.

Figure A


Gilbane Construction-Economics-Executive-Summary Spring2013Total spending of all types of construction will
grow just over 7 percent year over year from 2012 to
2013. We will start the year at an annual rate of
spending near $890 billion and grow to a rate of
$940 billion by year end. The ABI indicates a Q1-
Q2 2013 slowdown, followed by future growth. The
Dodge Momentum Index, although down recently,
is still well up since the mid-2011 bottom, indicating
growth in 2013.

 


 

Impact of Recent Events

  • ††FMI’s first quarter 2013 Nonresidential Construction Index Report executive summary states hiring expectations for full-time employees are the best since 2009, and very few panelists said new health care legislation would affect their hiring plans.
  • ††Sequestration or any future compromises will reduce funds available for federal and public projects. Federal highway funding is exempt. Public construction declined in 2012 and is expected to continue to drop in 2013 for the fourth consecutive year.

Some Economic Factors Remain Negative

  • ††The ABI, McGraw Hill Dodge new starts and the Dodge Momentum Index (DMI) indicate a dip in nonresidential spending potentially from February through May 2013.
  • ††The construction workforce has shrunk by 2.25 million workers (29 percent). It will be many years before the entire workforce grows back to its previous level. As the workload increases in the next few years, a shortage of available skilled workers may have a detrimental effect on cost, productivity and the ability to readily increase construction volume.
  • ††Since the end of 2008, the Producer Price Index (PPI) data shows material price inputs to construction increased by 12 percent. During that same period, contractor’s margins decreased by 6 percent.
  • The PPI for construction materials rose 0.6 percent in January, a big one-month increase, followed by a 1.3 percent increase in February, the largest increase in nearly two years. Historically, the largest increases in this index occur in the first quarter.

Figure B


figure2The Architectural Billings Index (ABI) has
proven to be a reliable indicator. The ABI predicts
nonresidential activity nine to 12 months in the future
and correctly indicated the downturn and upturn
in 2012. Another downturn is indicated that gives
caution for Q1 through Q2 2013. Indexes above
50 indicate increasing billings. Spending generally
follows a similar pattern nine to 12 months later.

 

 

The Effects of Growth

  • ††Construction spending in the fourth quarter 2012 grew at a rate of 30 percent per year, an unsustainable rate of growth. If that growth rate continues, 1.6 million construction jobs would need to be added within one year, four times faster than has ever occurred. Spending in January 2013 simply returned to a normal growth trend line (see figure A). There was no big surprise in this data.
  • ††As spending continues to increase, contractors gain more ability to pass along costs and increase margins. However, contractors almost always are playing catch-up. In the most recent three-month period, contractors’ costs began to climb faster than whole building costs increased due to increasing material costs and declining productivity.
  • ††FMI’s first quarter 2013 Nonresidential Construction Index Report executive summary states most contractors surveyed expect growth in 2013 and hiring expectations for full-time employees are the best since 2009. Companies report the rate of productivity has dropped and the cost of labor continues to increase.

Figure C


figure3To capture increasing margins, future
escalation will be higher than normal labor/material
cost growth. Lagging regions will take longer to
experience high escalation. Expect residential
escalation near the upper end of the range.

We advise a range of
4 percent to 6 percent for 2013
5 percent to 7 percent for 2014


Outlook for 2013

Supported by overall positive growth trends for 2013, margins and overall escalation will rise more rapidly than in the last five years.

The decline of work from 2006 to 2010 brought the largest decline of margins in recent history. In 2011, that trend began to reverse, although 2011 still saw margins lower for the year. Margins regained a positive footing in 2012.

For the last three months, significant material cost increases have not yet passed along resulted in margin reductions. A dip in nonresidential spending may occur during the first two quarters of 2013, and with that a further dip in margins. Work activity in nonresidential construction will pick up again in the second half of 2013. Residential work will remain extremely active. Once growth in nonresidential picks up and both residential and nonresidential are active, apparent labor shortages and productivity losses can be expected. As it did in 2012, even moderate growth in activity will allow contractors to pass along more material costs and increase margins. When activity picks up in all sectors, escalation will begin to advance rapidly.

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