Overview of the Economy
Our 2013 outlook publication observed that the economic indicators at the end of 2012 were not particularly promising for strong growth in 2013. The conclusion was that the obstacles to overcome would inhibit solid economic growth in 2013. The economy shows signs of improvement, but economic data leaves room for some caution amid the optimism. Economic recovery has been unsteady and slow since the recession officially ended in June 2009. It appears that 2014 will improve upon the 2013 performance.
Real GDP Growth
Gross domestic product (GDP) is a key measure of economic health. GDP growth for 2012 was 2.8 percent after a mid-2013 adjustment of the initial 2.2 percent. By most forecasts, GDP will be below this mark in 2013, although third quarter results were a surprisingly strong annualized 3.6 percent. Our 2013 forecast reflect this third quarter release. Forecasters generally expect GDP in 2014 may approach 3 percent. This rebound would be very welcome news for the construction sector.
The economic indicators below are encouraging for the most part, but support the projections that slow growth will continue in 2014.
|Unemployment Rate, November||At 6.6 percent the year-over-year unemployment rate is lower. Jobs are being added each month, but not always at the pace expected. Unemployment rate for the previous November was 7.4 percent. However, total unemployed plus marginally employed (U6) rate is 13.2 percent. Troubling questions remain concerning underemployed and discouraged workers.|
|Construction Unemployment Rate, November||The 8.6 percent reported is significantly lower than the 12.2 percent of the previous November. Significant improvement in this lagging economic indicator is a hopeful sign for the industry.|
|Consumer confidence or sentiment, November||Continues to fall by several measures. According to one measure it is at the lowest level in a year. By one measure it rose sharply in November.|
|Debt, 3rd Quarter||Overall, the economy continues deleveraging. Total debt as a ratio of GDP will be down if projections for 2013 are correct. However, debt now exceeds GDP based on projections. The very high level of public debt remains a concern.|
|Consumer spending, October||Largely in a holding pattern. Pent-up demand is a factor for spending in some high-end items. Perhaps, the general uncertainty about state of the economy continues to hold back this critical part of the economy. As 2013 ends, retailers are hopeful of a better year-over-year growth.|
|Leading Economic Index® (LEI), October||The Conference Board LEI increased slightly for a fourth month of small increases. The past year shows an upward trend despite a couple of setbacks. This would indicate a modest expansion despite falling consumer confidence and anemic consumer demand.|
|The Institute for Supply Management (ISM) Manufacturing and Non-Manufacturing Indices, November||Both indices are above 50, indicating economic expansion. After showing some weakness mid-year Manufacturing Index is showing some strong mid-50s values trending toward upper 50 values. The Non-Manufacturing Index does not show such strong growth.|
|Inflation rate, October||Remains under 2 percent as measured by the Consumer Price Index (CPI).|
|Stock market averages, November||The good news is that averages are up and markets reached record territory in 2013. The cautionary news is the continued growth is tainted by the Federal Reserve (Fed) quantitative easing (QE) policy and warnings that stocks are overvalued.|
The economic effects of October's political showdown and the rollout of the Affordable Care Act are still to be measured. The budget deal recently reached in Congress will help avoid any uncertainty about continuing government operations for a couple of years, though the debt ceiling remains an issue of debate
The tapering of the QE bond buying program announced by the Fed will be watched carefully as there may be some significant changes. Stock markets, interest rates and inflation will likely face negative impacts. Will the Fed be able to manage this with minimal disruptions to the economy?
On the positive side, State tax revenues are improving. As a whole they are up on a year-over-year basis. October construction put in place showed increases in public sector spending, following a drop in September.
GDP growth by state for 2012 was positive for all states except Connecticut (-0.1%). The recovery has been stronger in some states than others. The energy sector has been a significant contributor with North Dakota (13.4%), Texas (4.8%) and California (3.5%) as the top performing states. Three states at the bottom of growth shared a 0.2 percent growth; Delaware, New Mexico, South Dakota and Wyoming.
Risks to the recovery remain. A few uncertain issues are:
What will be the level of federal and state government spending? Federal budget uncertainty appears to be resolved with the recent budget agreement.
Beginning to taper the Fed QE program which will tighten credit and raise interest rates.
Energy prices, though falling recently, if rising can slow recovery.
Consideration of energy prices introduces the aspect of global economic performance. With the greater interdependence among the world economies brought about by globalization, it is difficult to consider the U.S. economy without some brief discussion of worldwide economy. The risks to the U.S. recovery poised by global economics and politics should not be overlooked.
|Global GDP Growth Projections|
- Eurozone and European Union growth was in neutral for the third quarter of 2013.
- GDP grew at 0.1 and 0.2 percent respectively. With the region’s fragile economy, the question is whether this is a stall of the recovery. The OECD is projecting only a 1 percent growth for the Eurozone in 2014.
- China expects their economy to expand about 7.5 percent for 2014. This is moderate growth for China's past decades, but a very dynamic pace compared to the rest of the world. There will still be strong demand exerting a great pull on global commodity resources. There is a government commitment to continue the focus on infrastructure improvements, so this sector of the construction market should do well. The larger question is whether there will be any meaningful restructuring during this slowdown?
- India GDP growth should be about 3 percent for 2013, below growth rates experienced for many years. There should be a rebound in 2014 as there are forecasts for the FY 2013-2014 GDP to grow about 5.5 percent. There are currency depreciation and inflation issues to resolve.
- Brazil is seeking consistency in its economic growth. Over the past several years economic growth has been up and down. Annual GDP
- Growth beginning in 2008 was 5.2, -0.3, 7.5, 2.7, 0.9. The economic outlook for Brazil is not strong for this year and next, between 2 and 3 percent, but at least there may be some steady growth.
With the economy having difficulty staying out of first gear, the construction market continues struggling to find traction for growth. While low economic growth will not power the demand engine for construction, there are signs that GDP may be poised for a consistent period of growth. Construction Put in Place. Data by the Bureau of the Census shows the residential sector, which typically leads the nonresidential sector in recovery, grew 13 percent in 2012. It accounted for about one-third of all construction put in place. Residential construction put in place exceeded 50 percent of total construction from 2003 through 2006. This extended period over 50 percent during the housing bubble was a rare event.
Residential sector recovery continued in 2013 with solid multi-family sector growth, which should moderate soon, and strong single family sector growth, which should continue to strengthen. Residential sector growth may approach 20 percent in 2013.
Interest rates are beginning to rise. This may well be the trend into 2014 if the Fed eases its bond buying program. Rising home prices and the higher interest rates are narrowing the pool of homebuyers. Despite this obstacle, the residential market growth should continue in 2014.
The nonresidential sector continues to struggle for traction. After construction put in place posted a 6 percent growth in 2012 it is likely to grow less than 2 percent this year. In constant dollar terms, no real growth is expected for 2013 when the final numbers are compiled in 2014 by the Bureau of the Census. While many factors contributed to the minimal growth, lackluster GDP growth is perhaps a primary consideration. Sustained GDP growth predictably leads to increasing construction volume. It remains below levels to fuel construction growth. Construction put-in-place will be a little less than 6 percent of GDP for 2013.
Another factor is lending standards which remain restrictive. Indications are they may be easing a bit. Also, the demand for loans is strengthening. If interest rates rise in 2014, this may dampen improving demand. Government spending on construction remains low. In current dollars, total public sector construction dropped 13 percent since 2009. Public sector construction spending fell about 2 percent in 2013. Federal spending is below 2008 levels, State and local level spending has shown slight decreases since 2011. It may increase next year and the rate of federal spending decline will improve.
The continued demands for infrastructure improvements and tight public sector budgets will only strengthen the Public Private Partnership (PPP) marketplace in the U.S. PPP may be the only way for capital and/or credit starved entities to be able to build major projects. Nonresidential construction may be stuck in first gear, but at least it is not stalling. Our forecast for 2014 has the nonresidential market at over 5 percent. Some industry indicators point to increased optimism for 2014.
- The Architectural Billings Index (ABI) produced by the American Institute of Architects (AIA) is a measure of current design activity. It is a construction activity leading indicator. A score above 50, indicating an increase in billings, forecasts growth. The Index for October 2013 was 51.6. The past 15 months were above 50 except for April 2013. The residential sector has been the strength of on-going run. The index values for the west and south regions are a bit more encouraging than the mid-west and northeast regions.
- The Associated Builders Contractors (ABC) surveys months of backlog among members. The Construction Backlog Indicator for nonresidential construction provides a coincident economic indicator. The indicator is higher year-over-year for all quarters of 2013. However, first quarter of 2013 fell from fourth quarter of 2012 and the second and third quarter values of 2013 are steady. Reading some of the sub-index values leads to a conclusion that the softness may be in the government funded projects winding down.
- Industry confidence indexes, such as the ENR Industry Confidence Index and the CFMA Confindex have year-over-year improved values, but the 2013 values have not changed much during the year. These leading indicators indicate some modest improvement is expected in 2014.
Working with the Census Bureau Construction Put in Place data, it appears that the largest year-over-year percentage increases occurred in the Lodging (31%), Transportation (17%) and Commercial (9%) nonresidential sub-markets. The size of the sub-markets is a factor. Lodging is relatively small so the volume increase was only about $4 billion. The three sub-markets provided about a $14 billion increase in construction put in place.
The sub-markets with the largest year-over-year percentage decreases in 2013 were Communication (-20%), Religious (-12%) and Power (-10%). They accounted for about a $13 billion decrease in construction put in place. Power went from one of the top growth segments in 2012 to one of the bottom in 2013. It remains one of the larger sub-markets of nonresidential construction.
An overview of six sub-markets, which account for just less than half of the nonresidential volume, digs deeper into what to expect in 2014.
The Hospitality market has rebounded strongly since 2012 averaging over 25 percent growth each year. The bounce back continues building on gains in occupancy rates and higher levels of travel and tourist activity. Construction activity may moderate slightly going forward.
The Office market grew slowly in 2013. A lot of available space remains, the vacancy rates are improving. The industry faces challenges from trends toward smaller footprint, agile work spaces. The pace of growth will pick up, but the focus will be on upgrades to existing buildings.
The Commercial market has rebounded, mostly with small projects in support of residential growth. Continued improvement in employment numbers will assist help improve the market. The reappearance of some big projects and rebranding / renovations will keep growth modest for 2014.
The Health Care market should be ramping for growth considering demographics, but the implementation of the Affordable Care Act presents too many unknowns so little growth is forecast for 2014. Health care projects will continue to reflect a shift toward ambulatory care, remote outpatient facilities, and medical office buildings.
The Education market has the potential for modest growth. As state and local government financial outlook strengthens look for stronger growth in 2014.
The Manufacturing market grew modestly in 2013 and should show even stronger growth in 2014. This revitalization may only be cyclical while economic conditions support it, but a mix of some operations returning to the U.S. and improving domestic demand for durable goods will support short term growth.
Inflation is an increasing concern as the construction demand appears poised to rev up. Escalation at a particular location will be very different from the national escalation discussed. Market conditions will strongly influence the variations. The U.S. construction indices are typically input based so they do not capture the affects of market competition like an output (tender) based index.
|Cost Growth Comparison|
|Period (Quarter-Year)||Turner||RS Means|
|3rd Q 2008 – 3rd Q 2010||-15%||+1%|
|3rd Q 2010 – 3rd Q 2013||+9%||+10%|
|3rd Q 2008 – 3rd Q 2013||-6%||+11%|
The Turner Building Cost Index is one the few indexes that attempt to measure selling price. The accompanying table attempts to show the difference that is possible between indexes measuring input versus output prices. The RS Means City Cost Index provides the input based index for comparison. The RS Means index allows a rough deletion of the labor and material escalation to ascertain some magnitude of market influence on prices. From the highest index related to the boom (third quarter 2008) to the lowest value (third quarter 2010) the Turner index lost 15 percent while the Means index gained one percent. This difference reflects the widening gap between the two indexes during the market over-heating period leading up to the recession.
The Turner index began increasing again in 2010 indicating that construction demand began reversing the market "discount" of the recession as contractors sought to improve their profitability as competition eased. However, Turner Index price growth since the third quarter 2010 trends well with the Means and ENR indices.
Construction demand in local markets will dictate escalation levels. As a national average, construction prices increased about 3 percent, perhaps as much as 4 percent according to the Turner Building Cost Index, in 2013. The loss of suppliers and trade contractors from the recession will reduce competition and increase prices as construction volume builds. Combined with potential labor and material price increases, escalation for 2014 could be 5 to 7 percent should demand increase as projected. The price spike expected at the end of a recession when demand accelerates appears to be arriving. Another risk for inflation in 2014 is Fed eventually ending the QE program.
The recession seriously curtailed the construction industry, which was over-heated. Unemployment measures for the industry remain worse than the general economy measures – 9 percent versus 7 percent. Construction employment levels remain below the pre-recession peak by over 20 percent. As construction demand increases, expect a shortage of workers, especially skilled workers. The industry looses part of the workforce during recessions as workers leave for other industries where employment is available. In this recovery the problem is compounded by the baby boomers that left the workforce.
The same observations apply to the architecture and engineering community as well. Bureau of Labor Statistics indicate 1.5 percent year-over-year increase in AE services pricing. Labor rate increases should be between 2.5 and 4 percent in 2014. Markets with high demand levels may see premiums paid for skilled trades.
On average, material prices increased between 1 and 2 percent in 2012 and between 2 and 5 percent in 2013. Producer Price Index for New Construction Materials produced by the Bureau of Labor Statistics shows material prices increasing 1.5 percent in 2012 and about 2 percent in 2013.
It is unlikely that domestic demand will cause much upward pressure on prices in 2014, except for some residential materials, such as lumber and gypsum wallboard. Three external factors to consider are global demand for key construction commodities, oil prices and exchange rate fluctuations for materials where large quantities are imported. China and India will continue to utilize key commodities, just at slightly lower rates. Materials price escalation should be in the 3 to 5 percent range. Materials showing more price volatility, such as steel and copper, may be double the average material price escalation.