Where does opportunity lie?

January 2008 » Exclusive
Although there is no arrow on a wall pointing to where opportunities lie, ZweigWhite’s 2008 AEC Industry Outlook offers some insights.
Shanon Fauerbach, P.E.

Insight for civil engineers

Unfortunately, there is no arrow on a wall telling us where opportunity lies. Firm leaders are required to interpret data, information, and experience to determine which markets to focus on, which services to provide, where to open new branch offices, and which business management techniques to implement. It’s a difficult proposition, especially since the implications of the residential market decline are uncertain and we’re facing a presidential election year.

But we’re here to help. The following sections of this article are excerpts from a valuable, annual report published by ZweigWhite: 2008 AEC Industry Outlook: Strategy and Insight for Design & Construction. As stated in the report’s introduction, it will tell you what opportunities and obstacles you can expect to face in the coming year so you can make informed and accurate decisions about the future of your design or construction firm. Although not as quick to interpret as a sign, this article—and especially the complete report—provides data and the information that hopefully will yield insight for you to keep your firm on course.

2008 Outlook
What is the overall outlook for 2008? It appears that both the downturn in residential construction and the growth in nonresidential construction will moderate. It’s unlikely, though, that the strength of nonresidential construction can continue to offset residential construction weakness for much longer. In addition, a weaker economy, coupled with a down housing market, would reduce state and local tax revenue and begin to constrain public construction markets in 2008.

There’s a very real chance that the credit crunch that has hampered the residential construction market and weak economic growth will constrain commercial construction projects. The decline in the AIA’s Architecture Billings Index in the fall of 2007 may signal a slowdown in commercial construction spending by mid-2008. The Wall Street Journal reported in October 2007 that the pace of U.S. commercial construction activity is showing signs of slowing and could drop in 2008 for the first time in years.

According to the Journal, "The strength in the commercial sector until now had been offsetting the decline in the housing market. That appears to be changing, though continued growth in institutional construction, such as universities and hospitals, and road construction will provide somewhat of a balance."

However, if the residential construction market starts to recover by the second half of 2008 and the credit crunch doesn’t spread throughout commercial construction markets, there is a good chance that 2008 could see a return to growth (albeit slow to moderate growth) in total construction spending.

Despite the residential construction slide and the talk about the economy possibly dipping into recession in 2008, AEC firm leaders are pretty bullish on their outlooks for 2008—at least when it comes to their own firms. The 2008 AEC Business Trends Survey (conducted in September and October 2007) asked respondents what they expected their business to be in 2008. As Figure 1 shows, 5 percent of respondents expect business to be "outstanding" in 2008, while 46 percent expect business to be "excellent." (The 51 percent of respondents who expect business in 2008 to be "outstanding" or "excellent" is down slightly from the 57 percent of respondents who classified their businesses in 2007 as "outstanding" or "excellent.") Only 10 percent of respondents expect business to be "satisfactory" or "poor."

Figure 1: Forecast for Business Performance in 2008

In 2008, what do you expect your firm’s business to be?
 

2008

2007

Outstanding

5%

11%

Excellent

46%

46%

Good

41%

37%

Satisfactory

5%

6%

Poor

5%

1%

Source: ZweigWhite

 

 

 

 

 

 

Reflecting the tepid expectations that they have for the U.S. economy in 2008 (only 35 percent of the respondents feel the economy will strengthen in 2008), it’s perhaps not surprising that respondents to the 2008 AEC Business Trends Survey are more bullish on the prospects for the AEC industry in 2008 than they are for the U.S. economy.

As Figure 2 shows, 50 percent of respondents expect the AEC business to outperform the U.S. economy again in 2008, while only 16 percent believe the U.S. economy will outperform the AEC business. However, the percentage of firm leaders expecting the AEC business to outperform the U.S. economy dropped from 73 percent going into 2006 to 55 percent going into 2007 to 50 percent going into 2008.

Figure 2: Performance of AEC Business versus U.S. Economy

Will the AEC business outperform the U.S. economy in the next 12 months?

AEC business will outperform U.S. economy . . . . . . . . . . . . . . . . . .50%
U.S. economy will outperform AEC business . . . . . . . . . . . . . . . . . .16%
Both will perform the same . . . . . . . . . . . . . . . . . . . . . . . . . . . . 34%
Source: ZweigWhite


 

 

Respondents to ZweigWhite’s 2007 Financial Performance Survey of A/E/P & Environmental Consulting Firms project their firms’ revenue to grow a median of 32.0 percent during the next three years. That is a healthy median average yearly revenue growth rate of 9.7 percent. That is a full percentage point higher than the growth rate forecast by respondents to the 2006 edition of the survey, and it’s another indication of the relatively positive view of design firm leaders about near-term business prospects.

McGraw-Hill Construction is forecasting a 2-percent drop in the value of new construction starts in 2008 to $614.1 billion. The drop, fueled by tighter lending conditions and weaker job growth, would not be as steep as the 8-percent fall projected by McGraw-Hill Construction for 2007, however. "The credit crunch that emerged at mid-2007 continues to be a major concern for construction and the overall economy," said Robert A. Murray, vice president of economic affairs for McGraw-Hill Construction. "As a result, we’re now predicting downturns in the previously resilient multi-family and commercial segments, as well as continued weakness in single-family home construction."

McGraw-Hill Construction forecasts that single-family housing will weaken further in 2008 with a 3-percent drop in dollar volume (following a 14 percent drop in 2006 and a 25 percent decline in 2007) and a 6-percent decline in the number of units. It projects multi-family housing will see an 8-percent drop in dollar volume and an 11 percent decline in units. It reports that condominium development is being dampened by greater scrutiny from lenders and reduced homebuyer demand.

McGraw-Hill Construction’s 2008 forecast also calls for a 6-percent decline in the dollar volume of commercial buildings while the dollar volume of institutional buildings will rise 4 percent and public works construction will move up 3 percent. If McGraw-Hill Construction’s projections of an overall drop in 2008 come to fruition, it would mark the first time since the recession of the early 1990s that construction spending would have fallen two years in a row.

The Portland Cement Association (PCA) is forecasting a decline in overall nonresidential construction as the economy weakens due in large part to the subprime crisis and increased energy costs. PCA is not forecasting the housing market to rebound until the middle of 2009. PCA believes the possibility of a recession materializing by the end of the first quarter of 2008 is 40 percent. If a recession occurs, PCA projects construction spending will decline nearly 13 percent in 2008.

Economic forecasting firm Global Insight is projecting total construction spending will drop even more sharply in 2008 than in 2007. Global Insight is forecasting total U.S. construction spending to decline by 8.0 percent in 2008, on top of a 7.3-percent drop in 2007.

Reed Construction Data has a much more optimistic forecast for construction activity in 2008 than McGraw-Hill Construction, PCA, and Global Insight. Based on U.S. Census Bureau data, Reed Construction Data projects total U.S. construction activity will increase by 5.7 percent in 2008, starting with small gains early in the year that progress increasingly throughout the year.

Reed Construction Data forecasts that the housing recovery will occur sequentially, market by market, rather than uniformly across the country. As of October 2007, Reed Construction Data was reporting that the negative impact on nonresidential construction spilling over from residential mortgage problems appeared to be small. It also forecasts that four years of accelerating growth in public construction spending will not continue in 2008 as state and local governments become more cautious in their budgets. As of November 2007, Reed Construction Data projects new residential construction spending will drop again in 2008, but only by 2.8 percent. It forecasts nonresidential building construction spending would increase 11.1 percent in 2008, while heavy engineering spending would increase by 11.7 percent.

Ken Simonson, chief economist for the Associated General Contractors of America, said in October 2007 that the 3.7-percent increase in architectural and engineering employment in the prior 12 months would result in construction jobs in the ensuing months, particularly in energy, power, and hospital projects. "Over the next several months, I expect investment to slow in income-producing properties such as office, hotel, and retail structures," Simonson stated. "But accelerating investment in energy and power projects, plus continued strength in hospital and educational construction, should keep the nonresidential totals up.

"My biggest concern is higher costs," Simonson concluded. "Diesel prices, which affect contractors through use of offroad equipment, construction trucks, and fuel surcharges on delivery of materials, are 25 percent higher than a year ago and seem poised to rise further. Other materials, especially imports, are likely to accelerate as well. And construction wage rates are going up faster than for the economy as a whole. But public agencies, from transportation departments to county councils, have failed to budget enough for construction cost escalation, and instead are trimming projects."

Hot markets
Which markets are going to provide the best opportunities for design and construction firms in 2008? As part of the 2008 AEC Business Trends Survey, ZweigWhite asked respondents in an open-ended question to name the three markets that they anticipate will be the "hottest" in 2008. For the fifth year in a row, survey respondents ranked health care as the most promising market in the coming year. Higher education was the next most common response from participants, as Figure 3 shows.

Figure 3: AEC Firm Leaders’ Ranking of "Hot" Markets in 2008

1) Health care (hospitals, clinics, assisted living facilities)
2) Higher education
3) Highways and bridges
4) K-12 schools
5) Office

Source: ZweigWhite

Based on ZweigWhite’s analysis of the markets, following are the ones that should provide the best growth opportunities for AEC firms in 2008. Note that some of the markets differ from the survey respondents’ opinions on the top markets in 2008.

1) Health care—The needs are high, and the money is there. The increases in health insurance costs that are bad news for AEC firm leaders trying to control costs are good news for firms working in the health care market. The increases in health care expenditures will result in additional capital available for health care projects. In addition, an aging population and advancements in technology are increasing the demand for new health care facilities.

2) Higher education—Higher education construction is at record levels, and colleges and universities are still upgrading and expanding residence halls and educational facilities to deal with increasing enrollments. The competition for new students is further driving the growth of the market.

3) Power and energy—The sharp increase in energy prices in 2007 has provided energy companies with soaring revenue and profits to invest in capital in major infrastructure projects, making up for a few years of underinvestment. In addition, it has pushed public support and improved the financial viability of the development of alternative energy sources. The federal Energy Policy Act of 2005 will continue to drive new projects in 2008 and beyond.

4) K-12 Schools—The K-12 market has flattened somewhat, but it is still a large and solid market for design and construction firms. Enrollment in K-12 schools in the U.S. is going to begin to grow again. The West and South are primed to lead the way for K-12 construction in the next few years because of a sharp increase in student populations. The one down side in 2008 is a projected decline in property tax revenue.

5) Telecommunications—The telecommunications market has shown significant growth since the beginning of 2004, and it is poised to grow again in 2008. Telecommunications companies are making record investments in their infrastructures as they compete for customers with wireless, broadband, and VoIP services.

A word of caution about chasing "hot" markets—design and construction firms should move prudently when considering whether to invest in or target any market based on its current status. Market potentials change fast. And for firms working in down markets, that is sometimes the best opportunity to gain a foothold that will put you in position to succeed when the market bounces back.

Regional summaries
Where are the geographic hot spots in the AEC industry expected to be in 2008 and beyond? It appears again that design and construction opportunities in the United States will be stronger in the South and the West compared with the Northeast and Midwest, driven in large part by demographic migration to those areas of the country. However, the downturn in residential construction in numerous Sun Belt states will mean some areas of the South and West, such as Florida and California, will likely not be as strong as in previous years. States in the Mountain region and Texas should be particularly strong for design and construction firms in 2008.

Conclusion
For a more in-depth outlook for 2008, including business trends to watch, market sector outlooks (commercial and residential real estate, environment, power and energy, transportation, and more), an industry-wide forecast (including regional and international summaries), and the results of the ZweigWhite 2008 AEC Business Trends Survey, order the 173-page, 2008 AEC Industry Outlook at www.zweigwhite.com/store, or call 508-651-1559.


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