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Nonresidential Construction Market Musings
By: Andy Nag


2011 Outlook

7:14AM on Tue 08 Mar 2011
In 2011, the outlook for commercial construction looks decidedly better than it did during the early days of 2010. Manufacturing activity, consumer spending and corporate profits have experienced some growth. And despite the lingering effect of the sovereign debt crises in Europe, the high unemployment rate and an uncertain housing market, the nonresidential construction market is expected to grow towards the end of 2011.

All major markets in the commercial sector, retail buildings, office buildings and hotels are forecasted to decline in 2011. The retail sector is expected to recover during the second half of 2011, but the inability of the residential construction market, a primary driver of retail construction, to decisively emerge from its extended slump might delay the recovery or moderate the rate of growth.

Office Sector-2011 outlook The office sector will continue to languish due to high unemployment rates, an uncertain regulatory environment and fluctuations in office vacancy rates. The large amount of unoccupied office space is expected to be a significant drag on new construction in the office market as tenants upgrade to existing high-quality space and refrain from developing new facilities.

The hotel sector is expected to be adversely impacted by the soft business and leisure travel markets. Most construction in this sector is likely to be renovations of existing facilities in the upscale segment. New construction will also likely be impeded by financing issues, with banks reluctant to underwrite projects while hotel occupancy rates are still falling.   

The multifamily residential sector, comprising condominiums and rental units, will likely continue to decline during the first half of 2011, but is forecasted to bottom-out this year, after declining for the previous four years.

Public Sector-2011 outlook The manufacturing sector will continue to fall with another double-digit decline expected in 2011. Modest capacity utilization rates are restraining new construction in this sector and until capacity utilization rates top eighty percent, expansion in manufacturing construction is unlikely.

The education sector is expected to be relatively stable in 2011. However, weak state and local government revenues, the primary drivers of educational building construction, will continue to impact school construction and stagnant endowments will affect college and university spending.

The healthcare sector is also forecasted to be relatively stable in 2011. Higher borrowing costs and escalating healthcare costs are expected to dampen investments in new healthcare facilities. However, given the aging population and medical facilities, the medium- and long-term prospects in this sector remain positive.

The public building sector is most likely to experience a high single-digit decline in 2011. With the impact of the government stimulus funds waning, new spending in this sector faces an uncertain future in the short-run. 

Best,
Andy Nag

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Lessons Learned and Emerging Opportunities

3:05PM on Wed 16 Feb 2011
As economic recovery progressively gains traction, now is as good a time as any to take stock of the commercial construction market. The extended down-cycle in commercial construction imposed several constraints on the industry and exposed latent inefficiencies in its activities. A synopsis of a few emerging trends that emanated or accelerated during the prolonged downturn could be instructive.

Primary among these is the industry’s relationship with its workforce. Influenced by dire market conditions, most organizations in the industry restructured during the downturn and experienced extensive productivity gains that continue to yield results.  However, an impending challenge for these organizations would be to adequately cater to their customers as the market gradually returns to relative normalcy.

A second issue concerns commercial construction credit. The tight project financing scenario and anemic public finances that accompanied the credit crisis compelled developers and owners to ascertain and avail alternate methods of obtaining financing.  The situation allowed for a steady growth of hitherto under-appreciated funding techniques like public-private partnerships and private equity. But despite a surge in such novel financing practices, commercial construction projects continue to get deferred at atypical rates.

Another industry trend accelerated by the rambling recession is modular construction. In an effort to maintain margins under increasing pricing pressure, organizations adopted technological solutions to streamline activities across the supply-chain. The potential decline in profitability was accentuated by rising material costs, especially during the latter part of the down-cycle. Consequently, several organizations had recourse to technology platforms like Building Information Modeling (BIM). The uncertain market environment necessitated predictable outcomes and dictated closer collaboration among stakeholders within the project cycle, and technologies like BIM enabled such interaction.

The recession also required companies to focus on customer initiatives. As the reserve of profitable projects in commercial construction dwindled, companies revived their focus on customers to win business. Several organizations implemented customer engagement and acquisition programs to retain strategic customers and acquire potential customers. In an effort to cost-effectively publicize differentiated, augmented service offerings to their customers, several companies in the industry tentatively espoused a variety of social media tools.

With the downturn in commercial construction slated to bottom-out in 2011, it is imperative that the industry retains the improved practices that emerged out of arguably one of the worst circumstances for the construction industry. In the event of a protracted incline, as many economists predict, to a more sustainable future, the industry will likely have ample opportunity to assimilate the lessons learned from the recession.

I’m interested to hear what lessons you have learned during this recession. Please share with me in the comments section.

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Where do we go from here?

3:01PM on Thu 22 Jul 2010

In this blog I will attempt to address the second question posed in my previous blog - When will the nonresidential construction market be back on the growth track again?


And it will be an attempt only because as the Danish physicist Niels Bohr supposedly once quipped, “Prediction is very difficult, especially if it is about the future.” To complicate the situation, this time around the nonresidential construction market recovery might lack any historical precedence.


The problem starts with the multi-faceted nature of the nonresidential construction market. It is massive in size and comprises an array of building types that have specific, even exclusive, drivers. Turnaround in a colossal, dynamic market with multiple moving parts is rarely a harmonized maneuver.  


As I previously mentioned; the market seems to be stabilizing. Productivity in the industry continues to improve. Project financing has eased a bit recently, and owners and developers are tapping into new sources of funding like private-public partnerships and private equity.  


The retail sector will likely be the first nonresidential sector to show some sustainable growth, possibly commencing during the second half of 2011.
The office sector will continue to suffer from an uncertain economic recovery due to the easing of corporate profits and rising office vacancy rate, which is forecasted to peak in 2011. Any significant growth in this sector is unlikely until 2012. Additionally, the hotel sector is expected to be shackled by a lackluster travel and tourism industry until 2012.


On the institutional side of the market, state and local governments,
the primary drivers of educational building construction, will be troubled by the tough financing environment and lower tax receipts. This year, many states are facing large budget deficits including California, New York, Illinois, New Jersey and Florida. It is still uncertain as to when the state and local governments will be able to repair their balance sheets and start to infuse substantial amount of funds into public projects.


In the healthcare sector
, the potential of diminished profits due to higher borrowing costs and escalating healthcare costs is expected to reduce healthcare facility construction. Although the long-term impact of the new healthcare legislation remains unclear, especially for facilities construction, the rise in the number of people with insurance coverage is expected to increase the demand for healthcare services and consequently for healthcare facilities. This sector is likely to show some growth during the second half of 2011.


Most indicators seem to predict that the market will not experience any broad, significant growth until 2012,
which is unlike what we have experienced in many of the past nonresidential construction cycles.


Have you seen any indication that we may be back on track sooner than later?


Best regards,
Andy Nag

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Are we there yet?

9:16AM on Wed 07 Jul 2010
Or to frame it in the context of the nonresidential construction market, are we at the bottom of the cycle yet?

Well, not quite yet.

By common consensus, the steepest economic recession since the Great Depression is over. But does it imply that the nonresidential construction market will inevitably follow suit? And more importantly, when will the market be back on the growth track again?

Let us address the first question above. A cursory glance at the past five cycles in nonresidential construction, stretching back to 1970s, shows that the market rebounds rather quickly (with a customary lag) following the general economic recovery after a recession. But this time around could be different. And the difference could be partially attributed to the nature of the current economic recovery.   

The overall economic recovery ambles along without much conviction. The growth in output we cheered along during the fourth quarter of 2009 and the first half of 2010 seems to be running out of steam. The primary drivers of this growth were inventory restocking and the stimulus programs launched over the past year and a half. Now that the inventories have been replenished and the stimulus programs are winding down, other drivers need to come into play to maintain the momentum.

With foreclosure rates forecasted to be greater in 2010 than in 2009, the housing market recovery is anything but stable. Consumer spending, another potential growth driver, picked up during the first few months of the year but in the absence of associated income growth is unlikely to sustain. And with the high rate of unemployment persisting, consumers will be hard-pressed to rebuild their depleted balance sheets while simultaneously continuing to spend.  

This palpable uncertainty over the economic recovery is reflected in the lead indicators of nonresidential construction like contracts awarded data and the architecture billings index. Both of these indicators have recovered from the precipitous decline rates of 2009 but have stagnated over the past few months. The good news is that nonresidential construction spending is expected to find steady footing by the year’s end following two years of freefall. The bad news is that there is no indication yet of a V-shaped recovery, a pattern that was predominant in the past cycles.  

Although we are not quite there yet, we now have a fair idea about the bottom of the nonresidential construction cycle. Since we have been concentrating hard on getting a glimpse of the bottom we have not had the time to fathom how or when we are likely to climb out of this pit once we have reached the bottom. What do you think? Let me know your thoughts on the current state of the market and when you predict recovery. And, for more on what might lie in store for the nonresidential construction market, stay tuned for my next blog post later this month.

Best regards,
Andy

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Route to Recovery

10:25AM on Thu 17 Dec 2009
The imminent demise of recessionary tendencies in the overall economy encourages one to surmise about an impending turnaround in commercial construction. But the route to recovery appears to be tenuous and tardy given the current circumstances. Beyond the customary lag between a revival of the economy and that of commercial construction, there are several other factors that are likely to impede any rapid recovery for this market in 2010.

Currently, the core concern for the commercial construction industry seems to be the estimated $1 trillion plus in commercial real estate mortgage debt that will mature in the 2009-2013 time period. Delinquency rates in this market have been rising steadily through 2009 and recent estimates suggest that a majority of these loans could be ineligible for refinancing. The sustained freeze in the Commercial Mortgage-Backed Securities (CMBS) market further complicates the financing and refinancing scenario.

And as mentioned in my previous blog, neither the American Recovery and Reinvestment Act (ARRA) nor the Term Asset-Backed Securities Loan Facility (TALF) program has been able to resolve the financing conundrum in commercial real estate. 

A cursory glance at the construction drivers for the major building segments within the commercial sector further accentuates the gloomy outlook for 2010. Although the economic recession appears to have receded, employment figures are expected to remain lackluster well into 2010. Consequently, office vacancy rates are forecasted to rise until 2011 and compel building owners to reduce rents and increase incentives. Supply of new office space in this environment will likely be improbable as companies adopt a cautious approach to any new construction.

Residential construction, a leading indicator for the retail building segment, continues to recover from its protracted slump but consumer discretionary spending is still quite modest as individuals pause to repair their balance sheets.  A persistently high unemployment rate will also adversely impact consumer spending going forward. On a more positive note, it seems that some discount and food retailers have expansion plans to meet the demands of an increasing number of price sensitive customers.

Relative to the office and the retail segments, the primary institutional building categories (education and healthcare facilities) had a superior growth in 2009. However, the gradual erosion of tax receipts due to rising unemployment is straining state and local finances, the principal drivers of institutional construction. Additional factors, like decline in endowment fund values and uncertainty over healthcare reform, will restrain spending in higher education and healthcare facilities respectively. But over the long-term construction in the education and healthcare segments will be driven by broad socio-economic trends like rising school enrollment and increasing demand for medical care by aging baby boomers.

So, the commercial construction market is not in recovery mode yet and it looks like the market will get worse before we see any signs of a sustained recovery.
 

Regards,
Andy Nag

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This time it’s different!

10:13AM on Wed 09 Dec 2009
The onset of the trough in a cyclical industry like commercial construction often enthuse folks to compare the elements of the current downturn with those in previous ones. And most comments on the topic tend to run the gamut from “Seen it before” to “This time it’s different”. The question is, in midst of this deep commercial construction trough, have we seen it all before or is it really different this time around?
   
The problem with capturing the essence of a complex and multi-faceted industry like ours in cut-and-dry terms like those mentioned above is a futile exercise, even more so in a volatile macro-economic environment like the one we face at present. So, the short answer is both – there are elements that are predictable and ones that are atypical, if not entirely novel.

Since the 1970s, we have had five distinct cycles in commercial construction; including the current one. At a fundamental level, the present one is a “seen it before” cyclical downturn; however, a noticeable feature, relative to the previous four, is that the magnitude of the decline, from the peak to trough, is forecasted to be significantly greater. The cycle duration also seems to have lengthened over time.

Another “seen it before” aspect is the decline in commercial construction following a downturn in the residential market. But the scale of overbuilding in the commercial market is not even remotely comparable to the unprecedented housing market inventory build-up we had during the past decade, before the housing collapse. This suggests that the commercial market is likely to escape an overly extended period of decline like the housing market. This does on necessarily imply that it will jump start to a meaningful growth trajectory.

Commercial real estate lending tightens during down cycles but the extent and expanse of the credit crisis preceding the current market decline threatens not only potential new projects, but also existing projects whose debt is about to mature and need refinancing. Although the debt-refinancing situation is not unique during a down cycle, the scale of it in this current cycle certainly is.

Another point that comes to the front, through the maze of market forces driving the downturn, is that the sheer scale of the changes occurring is extraordinary. And so it is with the antidote provided to alleviate the impact of the downturn. The robust monetary and massive fiscal stimulus unveiled to counter the recession is unparalleled. But the pertinent questions are: did it favorably impact commercial construction and if not, will it do so going forward?

To date, the American Recovery and Reinvestment Act (ARRA) had negligible effect on commercial construction. The Term Asset-Backed Securities Loan Facility (TALF) program too has done little to unfreeze the credit markets for commercial real estate. Anecdotal evidence seems to suggest that bureaucratic tangle, among other issues, is responsible for the ineffectiveness of the federal initiatives. Precarious state and local government finances, brought about by the recession and low tax receipts, do not help the situation either for publicly funded projects.

To revert to the initial question as to whether we have seen it all before or this time it’s different, it seems that history repeats itself but with twists and this time around with more twists than usual.

So, what’s in store for commercial construction in 2010? For a glimpse, stay tuned to Kawneerosphere …  And, be sure to give me your insights as well.


Regards,
Andy

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