2016 FMI Nonresidential Construction Index

Transcription

1 2016 EXECUTIVE SUMMARY Third Quarter Report ONE OF THE GREATEST PIECES OF ECONOMIC WISDOM IS TO KNOW WHAT YOU DO NOT KNOW. John Kenneth Galbraith The dropped 4 points in the third to That score is well within growth range over a score of 50; however, over the past four s, we are seeing greater variability than in the last few years. While most components in the Index are also still in positive range, scores dropped nearly across the board compared to. Although we are concerned to see so many lower numbers, the score for productivity is the lowest (46.5) since we started the NRCI surveys at the beginning of the Great Recession. This trend for construction mirrors the trend for the nation. While labor and material costs continue to rise, productivity continues to slip. The results are not only a lower contribution to GDP, but also a lower contribution to profits. A majority of our respondents don t expect a recession for the next two years or at least not until late Furthermore, most seem to believe that the next recession, when it arrives, will not be the Great Recession revisited. More likely, it will be the textbook-normal type with too few dollars chasing too many goods with deflationary pressures leading to downsizing and layoffs. Several comments mentioned concerns about continued... CURRENT SUMMARY EXHIBIT 1 Overall economy Overall economy where we do business Our construction business Nonresidential building construction market where we do business Our expected backlog Cost of Construction Materials Cost of Labor Productivity down down down down down higher no change lower (Scores above 50 indicate expansion, below 50 indicate contraction.)

2 Executive Summary markets that are beginning to be overbuilt in this latest expansion. However, as one respondent describes, there are still many things we do not know: Uncertainty is a word that a lot of people are using to describe our world today. Uncertainty of: the current election and politics in general, Brexit, monetary policy, the longest bull-market in history, the length of the current economic expansion, the total debt and deficit spending, etc. The one thing that is certain is that we will eventually have a recession, and I hope this time it is shallow to the point that we are out of it before the economists even measure and announce the two down s! See more detailed responses in this report to discover what we do and do not know. There will be another recession. That is one thing we can say with great confidence. A special thank you to all of the panelists who help make the NRCI a useful gauge of nonresidential construction activity. We value your opinions and appreciate your taking the time to share your experience. 2

3 NRCI Third Quarter 2016 Highlights Overall Economy: NRCI respondents view of the overall economy dropped 7.3 points in the third. While this is a sharp drop from the second results, the second spiked 8.9 points from the first.. Overall Economy Where Panelists Do Business: As with the overall economy, respondents optimism in the second seems to have pulled back to what we have seen in previous s. Now at 60.4, this NRCI component continues in a positive range. Respondents Construction Business: Respondents reported that their outlook for their own business slowed somewhat this, dropping 5.1 points to A few actually welcome the change, since some markets have been overheated. Nonresidential Building Construction Market Where Panelists Do Business: At 67.3, the nonresidential market that respondents work in is still registering high on the component scale, but 7.0 points lower than. Expected Change in Backlog: The Index component for expected change in backlog dropped 7.2 points in the third to a still positive The median backlog for all respondents was 10 months for the third, which is a drop from the last three s but on par with the past two years, where backlog hovered between nine and 10 months. Cost of Construction Materials and Labor: The Index for cost of materials dropped 2.9 points, indicating materials prices are still rising. Likewise, the labor cost component, although unchanged from, continues to indicate higher costs for labor that is still scarce in many areas. Productivity: Productivity continues to be a big concern as the component Index slipped to 46.5, or 5.9 points lower than. This is the lowest score for productivity since we began publishing the NRCI report in Likely, the drop is mostly indicative of the continuing difficulty of finding skilled employees in a tight market; however, there are many other reasons for loss of productivity. 3

4 Current Issues Predicting the recession: We asked respondents to give their estimated opinion about when they think the next recession will begin, particularly as concerns the construction industry. Overall, 78% didn t expect a recession until at least the first half of 2018, and 38% of those respondents don t expect a recession for at least two years. Predicting continued growth during the current expansion: Most people expect a recession sometime, given the cyclical nature of construction and the economy in general, so we asked what kind of growth in construction to expect until the inevitable recession occurs. Thirty-five percent of respondents expect 1 to 2% growth (CAGR) during the remaining expansionary period, while 32% expect 3 to 4% growth. EXHIBIT 2 (NRCI) Scores Q to Q Current NRCI Reading for Q Previous Reading NRCI Score Q1-Q Q1-Q Q1-Q Q1-Q Q1-Q Q1-Q (Scores higher than 50 indicate expansion, below 50 indicate contraction.) 4

5 Current Issues Predicting the Recession: Predicting the next economic recession has long been a cottage industry in economic reporting. These days it seems to be a growing concern with many online pundits sending out dire warnings, hoping that you will buy something they are selling or gain fame and credit for being the one lone wolf who successfully predicted economic demise. The noise in the media tends to crowd out the level-headed economists genuinely attempting to calculate the ongoing chances for growth or recession. For the purpose of our questions on predicting the next recession, we used the standard applied by the National Bureau of Economic Research (NBER): A recession is a period between a peak and a trough, and an expansion is a period between a trough and a peak. During a recession, a significant decline in economic activity spreads across the economy and can last from a few months to more than a year. Similarly, during an expansion, economic activity rises substantially, spreads across the economy and usually lasts for several years. In addition to the formal definition of a recession, we asked respondents to focus their responses on the potential for the recession to affect the construction industry. Seventy-eight percent do not expect a recession until at least the first half of 2018, and 38% of those responding do not expect a recession for at least two years (Exhibit 2). Since the responses to this question are based on reasoned opinions and experience, we further handicapped the results by asking respondents to estimate the certainty of their responses. Although most responses clustered around the 50/50 level, the longer-term predictions were also the stronger predictions according to respondents degree of certainty where 10 equals the highest degree of certainty. (There were no 10s.) For the first NRCI report, we asked respondents to estimate construction put in place for To provide a counterpoint to the recession predictions above, we asked respondents what growth level they expected for the design and construction industry during the current expansion. Although the questions are not directly compatible, the answers were similar. Thirty-five percent of respondents expect 1% to 2% growth during the remaining expansionary period, while 32% expect 3% to 4% growth until the next recession occurs. (In the first, 31% expected construction for 2016 to grow between 0.5% and 5%. Thirty-nine percent expected growth from 2.6% to 5.0%.) 5

6 We also asked executives responding to our survey this what they thought might be the top-three reasons or causes. We have depicted those responses in a word cloud graphic format to indicate the number of mentions of key words. Although not a highly scientific representation of the data, the graphic shows the larger concerns are not only economic, but also political and global. The economy is, of course, the focus here, and the large print for the economy includes several comments concerning the business cycle and the feeling that we are due or overdue for a recession. The presidential race, uncertainty and even low confidence levels in the government s ability to help prevent a severe recession are also big concerns. Falling demand in the face of overbuilding in some markets is a concern also reflected in the open-ended responses below (Exhibit 5). In the open-ended responses, we can get the sense that this isn t the first time NRCI industry executives thought about these issues and when the recession might hit. There is uncertainty behind many responses, but most seem to agree (or hope) that the next recession might be more of the normal type with no major bubble bursting like the securities markets or residential markets as in the beginning of the Great Recession. There are some who not only feel we are due for a correction, but also think it might be a necessary change from some of the overheated markets faced today. EXHIBIT 3 Word Cloud: Key word responses for reasons and causes of the next recession. (Font size represents number of mentions.) 6

7 EXHIBIT 4 What is your best estimate of when a recession will next affect the economy, specifically the design and construction industry? EXHIBIT 5 How do you expect the design and construction industry to perform during the expansion period from now up to the next recession? (CAGR, Compound Annual Growth Rate) 7

8 EXHIBIT 6 Selected comments on the chance and causes of potential recession or expansion for the construction economy: 75% overbuilding and rising labor and material costs. Costs increases are spotty, so overall, not sure what heavy increases there might be. There are many needs such as infrastructure, flat office building market, education reform, bigger than normal cultural changes that increase the obsolescence of old buildings, thus new buildings are required. Our dominant market, Memphis, is growing with an energy like never before, and that creates construction potential. Election results could cripple the U.S. economy for further growth. Too many entitlement promises would further shift spending to programs that do not improve infrastructure or entice business development. States will not be able to support themselves, thus no incentives for business. Everything always comes to an end. The economy is on an eight-year uptick since the start of the Great Recession and typically runs max out at eight years. This one will probably run a little longer because of interest rates being kept so low for so long. Everything is cyclical. Expansion because indicators still show increased need and demand. People resources are hindering growth. Flight to safety in the U.S.A., which should lead to increased investment in buildings and infrastructure. I think we will continue to see steady growth in our industry. There may be some bumps in the road, but I do not believe there will be anything like what happened in If the rising cost of construction continues, owners are going to begin shelving projects until the cost comes back down. We are already seeing this happen in the Miami (South Florida) market with condos. We will also face a slowdown with the general election this year. If another democratic president gets elected, the construction industry will suffer. In our markets, the engineering and architectural firms are reporting to be very busy. We will be very busy for at least two years after they slow down. Industry is currently building too much to sustain the level of activity. We are overbuilding some segments of the market due to low cost of money. And with the rising cost of construction due to the amount of work in the pipeline and scarcity of labor, some projects no longer pencil. Instability overseas. Either a crash in the Japanese yen or the failure of a major bank in Europe. It will not be another financial meltdown. It will be something geopolitical if there is a big recession. The next recession will be a market correction where developers have overbuilt an area of the market, and the market does not sustain the demand. It will be a more typical recession. Locally, we see many apartments, hospitals and breweries springing up and expanding. Housing sales just exceeded pre-recession levels. There are state and local bonds for schools. We are in a boom for another year or two (it took almost two years for the recession to hit us locally, and then it hit hard). It looks like a very similar boom/bust 8

9 cycle, and I have no confidence that either presidential candidate will be good for the economy long term. No recession in sight. There always is a slowdown but for different reasons. The world climate is unsettling, but we have not been able to identify a specific cause for the next downturn, Overbuilding of multifamily and health care. Stress of the coal, oil and gas industry. Overbuilding is a significant risk, particularly in multifamily. Prodigious talent loss at the bottom of the last trough has not and will not be replaced in a stagnant (less than 2%) growth economy. This is a problem for the design, construction and civil authorities fields and will persist until the replacement employees gain experience. Further, the people who enter the industry at this time are not same caliber as we saw in earlier expansions, which will exacerbate the talent drain. Technology leaps are being implemented in an industry that has traditionally skimped on training, utilizing on-the-job experience as a substitute for instruction. Increasing labor costs will be combined with diminished productivity. Slight expansion because of pent-up demand and low interest rates. Some geopolitical event that cannot be predicted. The Bay Area office market is strong but declining to the zero side (net leases) with 20% sublease space vacancy competing with normal office turnover and another 3 million to 4 million feet of new site space coming on market within months. Classic oversupply dynamics forming, coupled with overvalued, pre-ipo tech firms that are having their funding cut or reduced will lead to headcount layoffs. In addition, lack of sales growth for large firms, along with the dollar costing them money outside the U.S., leads to M&As to grow and layoffs to show profits. We have seen RFP requests downtrend for six months to what would appear to be normalized levels, but, in fact, they continue to downtrend monthly and ly. For now, it all looks like a normal 9

10 cycle downturn recession of 10-30%, but if credit markets begin to show pain in the form of defaults on corporate bond debt or commercial real estate defaults due to valuation adjustments, look out; could be really bad. For now, we see a mid-2017 normal recession call lasting two to three years as supply versus demand normalizes. The November presidential election results will impact the overall national economy. If a Republican wins the election, I expect that the economy will expand. If a Democrat wins the election, I expect that the economy will grow at a slower pace and may turn toward recession. Uncertainty is a word that a lot of people are using to describe our world today. Uncertainty of: the current election and politics in general, Brexit, monetary policy, the longest bull market in history, the length of the current economic expansion, the total debt and deficit spending, etc. The one thing that is certain is that we will eventually have a recession, and I hope this time it is shallow to the point that we are out of it before the economists even measure and announce the two down s! We are anticipating a mild to moderate recession within the design and construction industry in late Expecting to see signs at the consumer retail level of the economy to appear in late 2018, which will be an early indicator of recession of nonresidential construction approximately 12 months following a slowdown in early indicator industries, such as retail, housing and automobiles. The next recession will likely be induced by government policy. As the economy improves globally in 2017, interest rates (should) rise. As interest rates rise, governments will be forced to face looming deficits and aging population demographics. Europe, Japan and North America are included in this situation. Belt tightening in the form of reduced government spending stimulus or increased taxation will cause headwinds for global GDP, pushing us into our next recession, which we are expecting should be mild to moderate, as we find our way forward. We believe there is no long-term confidence in the industrial market clients. They will plan or budget a project but don t have a definite schedule. When they choose to do a project, it starts immediately, and they compress the schedule. They are in a reactionary mode. We don t have the capacity to expand as an industry. A recession would help us catch our breath and function more normally than we are now. We are keeping an unsustainable pace now. Let s slow it down for all our sakes. We need a change in Washington to get our economy to grow. Not sure Republicans in the House can get organized and work with the Senate to get something done. Just not optimistic about our federal government. We need to get back to a normal economy with slightly higher interest rates so banks can become more profitable and not so conservative when lending to small businesses. What goes up must come down. By the time we have the next significant recession, it might be about 10 years from the beginning of the Great Recession. The Bay Area is white-hot and has been for the past year, will be for the next year (I hope), so I expect a drop off sometime in 2018 due to all the above. Who controls the federal government? 10

11 EXHIBIT 7 Detailed Results by Market Sector Overall Second Quarter 2016 Overall Third Quarter 2016 Business Outlook Three Months NRCI Component Results Q Business Outlook Three Months NRCI Component Results Q Improving over last Remains the same as last Worse compared with Improving over Remains the same as last Worse compared with Commercial 45.3% 53.8% 0.9% % 51.7% 3.4% 70.8 Education 40.0% 53.0% 7.0% % 53.5% 11.1% 62.1 Health care 41.9% 52.1% 6.0% % 53.3% 9.5% 63.8 Lodging 44.9% 53.1% 2.0% % 47.3% 8.1% 68.2 Manufacturing 24.1% 69.0% 6.9% % 52.7% 10.8% 62.8 Office 33.1% 64.5% 2.4% % 69.6% 5.4% 59.8 Other 41.7% 58.3% 0.0% % 33.3% 14.3% 69.0 Business Outlook - One Year Business Outlook - One Year Commercial 37.1% 56.2% 6.7% % 48.3% 6.7% 69.1 Education 39.5% 50.0% 10.5% % 54.5% 12.1% 60.6 Health care 52.6% 38.8% 8.6% % 46.7% 9.5% 67.1 Lodging 34.4% 54.2% 11.5% % 57.3% 13.3% 58.0 Manufacturing 29.5% 62.5% 8.0% % 50.7% 12.3% 62.3 Office 33.3% 58.5% 8.1% % 58.0% 16.1% 54.9 Other 50.0% 47.2% 2.8% % 40.9% 4.5% 75.0 Business Outlook - Three Years Business Outlook - Three Years Commercial 19.6% 52.0% 28.4% % 34.9% 36.0% 46.5 Education 35.1% 38.7% 26.1% % 51.0% 21.4% 53.1 Health care 41.7% 45.2% 13.0% % 41.7% 16.5% 62.6 Lodging 21.1% 45.3% 33.7% % 36.0% 46.7% 35.3 Manufacturing 28.7% 48.3% 23.0% % 36.1% 30.6% 51.4 Office 17.6% 53.8% 28.6% % 48.2% 35.7% 40.2 Other 32.4% 50.0% 17.6% % 54.5% 13.6% 59.1 NRCI Scores > 50 indicates growth (better) < 50 indicates slowing (worse) * A note on the use of the diffusion index: Do not interpret diffusion index values in the same manner as averages, because a simple increase or decrease in a diffusion index does not necessarily imply an improving or declining result. For example, if a diffusion index moves from 31 to 35 this, it does not imply the market has improved. A reading above 50 indicates improving or expansion, 50 indicates remaining the same, and below 50 indicates worse or contracting. Therefore, if a reading goes from 31 to 35, then the result still implies a decline from the previous because 35 is below 50; but the decline is not as great as the previous decline because 35 is above 31. As another example, if the diffusion index changes from 31 to 65, it implies improvement over the previous, not because 65 is above 31, but because 65 is above

12 EXHIBIT 8 NRCI Component Indexes Comparisons of Results: Q to Q NRCI components Q NRCI components Q NRCI components Q NRCI components Q The overall economy The overall economy where panelists do business Panelists' construction businesses Nonresidential building construction market where panelists do business Cost of construction materials Cost of labor Productivity Expected change in backlog Median Median Median Median Approximate current signed backlog in months Note: NRCI scores and component scores are based on a diffusion index where scores above 50 represent improving or expanding, a score of 50 represents remaining the same, and a score below 50 represents worse than or contraction. Greater than $1B 8% EXHIBIT 9 Size of the Organization in Annual Revenue $51M to $200M 42% $50M or Less 23% $201M to $1B 27% 12

13 EXHIBIT 10 Type of Contracting Business Commercial General Building Contractor 43% Roofing 0% Painting 1% Masonry 2% Concrete 2% Electrical 2% Other 11% Mechanical/HVAC 12% Construction Manager 16% National Contractors 9% EXHIBIT 11 Primary Region in Which Panelists Work South 34% Northeast 11% Midwest 20% West 26% 13

14 EXHIBIT 12 (NRCI) Component Results Q to Q NRCI Component Results Q NRCI Component Results Q Improving over Staying the same as last Worse compared with NRCI components Q Improving over Staying the same as last Worse compared with NRCI components Q Overall Economy 31.5% 67.8% 0.7% % 68.5% 7.7% 58.1 Overall Economy Where Panelists Do Business 40.4% 58.9% 0.7% % 63.8% 7.7% 60.4 Panelists' Construction Business 56.2% 39.7% 4.1% % 42.6% 7.8% 70.9 Nonresidential Building Construction Market Where Panelists Do Business 50.0% 48.6% 1.4% % 46.9% 9.2% 67.3 Backlog in Months High Median Low High Median Low Approximate Current Signed Backlog Grow faster than last Stay about the same as Shrink compared to Grow faster than last Stay about the same as Shrink compared to Expected Change in Backlog 37.7% 56.8% 5.5% % 55.8% 13.2% 58.9 Higher than Same as last Lower than Higher than Same as last Lower than Cost of Construction Materials 51.0% 47.6% 1.4% % 41.5% 1.5% 22.3 Cost of Labor 76.0% 24.0% 0.0% % 24.0% 0.0% 12.0 Improving over last Same as last Declining compared to Improving over last Same as last Declining compared to Productivity 11.6% 81.5% 6.8% % 80.6% 13.2% 46.5 NRCI Scores > 50 indicates growth (better) < 50 indicates slowing (worse) * A note on the use of the diffusion index: Do not interpret diffusion index values in the same manner as averages, because a simple increase or decrease in a diffusion index does not necessarily imply an improving or declining result. For example, if a diffusion index moves from 31 to 35 this, it does not imply the market has improved. A reading above 50 indicates improving or expansion, 50 indicates remaining the same, and below 50 indicates worse or contracting. Therefore, if a reading goes from 31 to 35, then the result still implies a decline from the previous because 35 is below 50; but the decline is not as great as the previous decline because 35 is above 31. As another example, if the diffusion index changes from 31 to 65, it implies improvement over the previous, not because 65 is above 31, but because 65 is above

15 HOW TO BECOME AN NRCI PANELIST If you are an executive for a construction firm in nonresidential building markets and would like to become a panelist for the, please send your information or questions about this survey to Phil Warner at pwarner@fminet.com. The survey is sent to panelists ly and should take approximately 10 minutes to complete. Panelists will receive the full ly report free of charge. CONFIDENTIALITY All individual responses to this survey will be confidential and shared outside of FMI only in the aggregate. All names of individuals responding to this survey will remain confidential to FMI. ABOUT THIS REPORT The data in this report is presented as a sampling of construction industry executives voluntarily serving as panelists for this survey. The responses are based on their experience and opinions, and the analysis is based on FMI s interpretation of the aggregate results. All trends are based on a limited series of data that may or may not represent the larger population. We must caution that major decisions should not be made without additional investigation and research of specific geographic and construction market segments.

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