When do you think the construction industry will sustain its momentum?”

“Sustainability is uncertain, but industry growth rates have been positive for two years. We expect moderate growth through 2018 with more variable local markets.” [Response to question sent via Twitter @FMICorporation]

There you have it. If all you need is a tweet or two to make decisions about running your company or investing your hard-earned cash, the rest of this report is just fluff. For anyone looking for a hot tip, we might truncate our tweet to just 14 characters: Infrastructure. Alternatively, we might choose the more encompassing term “fundamentals.” It is sort of a “Back to the Future” kind of approach. This doesn’t mean reliving the past, but it is worth thinking about some of the things that the construction industry has accomplished in the past that have helped to make America thrive and become a great place to live. Most of us have enjoyed freedom of travel over mostly good roads and bridges. We have had the benefit of clean, safe drinking water and sanitation systems. We have also had good manufacturing jobs that helped pay for the other amenities of life. This short list can be expanded greatly, but without these fundamentals, most of the other benefits of life are transitory at best.

Looking at history doesn’t mean that we are doomed to repeat it, but rather it calls for us to use what we have learned over the years to improve the future. In the last couple of decades, we have thrived on exports of American goods and technology while benefiting from cheap imports of finished goods produced with the technologies and jobs we have exported. The results have been inexpensive cell phones, computers, clothing, toys, automobiles and tons of the other stuff of our daily lives. Good times, the American Dream on steroids. These practices are unsustainable. There have been hidden costs as our appetite for more stuff has been fed.

From roads and bridges to unseen water pipes and sewer systems, those necessities of civil life are surpassing their design life and have begun to fail at a greater rate. That is changing in some areas of the United States. Here and there, some towns have begun a revival to keep people from leaving and to attract business and tourists. It’s an uphill battle, and therein lays opportunity. Like aging baby boomers, our infrastructure is developing a hardening of its arterials both above and below the ground. Setting the question of funding highways aside — that seems to be the popular way to treat the issue these days — cities and towns across the nation are literally fighting in the trenches to solve problems with underground plumbing for water, wastewater, storm water and gas.

These unseen systems are becoming more noticeable and making headlines. Most recently, in the midst of a severe drought, a water main failed in Los Angeles gushing 8 to 10 million gals of water onto the streets and creating serious flooding on the UCLA campus. Toledo, Ohio, instituted a ban on water use for several days after algae-related toxins were detected in its water source, Lake Erie. Fortunately, the testing systems in place worked and no one got sick. Among those who study and report on our nation’s water infrastructure, the EPA, the American Water Works Association (AWWA), American Council of Engineering Companies (ACEC) and the American Society of Civil Engineers (ASCE), all agree the need for maintaining and upgrading our water and wastewater systems far outstrips current investment, and in 20 years, investment in water-related infrastructure will be over a trillion of dollars in the hole, so to speak, on spending to meet our needs.

Clean drinking water is a critical health issue, but we also must have sufficient water for manufacturing, farming and recreation needs. Oil and gas mining in shale deposits has proven to be one of the hottest areas for new construction in selected regions around the United States and Canada in the past several years. But water, wastewater and environmental development could be one of the next big growth markets, IF — and that has to be a big IF — communities, governments and private investors can find a way to fund new systems and upgrades to current waterworks. That is no small challenge. However, we are beginning to see a manufacturing renaissance and lower energy prices are among the reasons to relocate manufacturing to the United States.

For water, wastewater and gas pipeline systems, trenchless technologies are playing a larger role in the solution. Adding to those opportunities, more people looking for work or young folks looking for careers and holding off investments in new homes are moving to the cities. That means improving and increasing infrastructure capacity like adding new or replacing old water and gas lines.

So, Maybe It Is Not Like a River
Like most markets these days, infrastructure improvements will be driven by need, greed, fear, regulations and reality. Many water and wastewater improvement projects are being driven by court decrees. For now, most Americans enjoy safe, clean drinking water despite the challenges. In fact, much of our public water supply is good enough to bottle, as many of the water suppliers do with a little processing.

Many of the traditional economic signs are improving to the point that the construction industry is facing labor shortages in many areas. When we look at our forecast, some of the fastest growing or recovering sectors include what we might call the fundamental sectors — residential, power, manufacturing and transportation.

The slow comeback of manufacturing has to be the most notable, as it was devastated in the recession. As we pointed out last quarter, commercial construction is slow to come back due to big-box stores struggling to find their place in a growing e-tail environment. That trend may be accelerating, as many recent financial reports by chain stores show signs of low profitability and loss. There is more talk about shutting stores than there is about new stores. If the economy is like a river, we know we can’t step into the same river twice. If it is not like a river, businesses looking to thrive in the future will need to be more creative problem-solvers, because it is getting harder to guess which way the economy will turn in the future.

Construction Forecast


Energy prices remain relatively low, overall inflation is low, unemployment is holding around 6.2 percent, GDP is still a bit unsteady and growing slower than we would like to see, but it “increased at an annual rate of 4.2 percent  in the second quarter of 2014, according to the ‘second’ estimate released by the Bureau of Economic Analysis.” Consumer confidence is rising steadily, building permits and housing starts have bounced back, and banks are starting to lend again, that is, if the applicant has good credit and cash flow. FMI’s Nonresidential Confidence Index also remains solidly in positive territory.

Add to the list a number of other leading economic indicators, and one might think we are on the verge of a boom in the economy. And we are, if one modifies what one thinks of as a boom. Some of these positive indicators are still a bit shaky; for instance, there is the problem of the discouraged unemployed who are no longer in the job market looking for work. Consumers are back in the markets, but they are being more careful with their dollars. Manufacturing has its ups and downs, but indicators are mostly up. We are projecting continued growth for manufacturing, ending up around 7 percent growth in construction put in place for 2014 with that rate continuing through 2016 until the markets work off some pent-up demand and slow slightly to 6 percent for 2017-2018.

As we have been noting for some time now, the growth in the construction industry has not touched everyone yet. With the continued forecast of solid, slow growth, we still do not expect to reach the CPIP levels of the pre-recession boom until sometime around 2017. That’s some distance away in dog years, but soon enough for many companies to continue thinking about how and where they will ramp up their businesses, especially when it comes to having sufficient capacity to perform new work.

Sectors like power, conservation and development and transportation will continue to see growth ahead of GDP in our forecast horizon, but water supply, sewage and waste disposal and highway and street will be weak. In other words, even though there is a need, as noted in our introduction, government spending is not expected to pick up significantly in the near term and other funding is yet uncertain. Health care and educational construction also continue to struggle to get their mojo back, and they may not get it back for some time to come, as these sectors are looking at possible changes in many aspects of education and health care delivery.

After dropping 54 percent in the dark days of 2010, lodging is making a strong comeback, which we expect will moderate by 2016. Office construction is also presenting signs of growth, especially in “A” markets in large cities. If the weaker areas make a comeback in the next few years, we can say the industry is once again hitting on all cylinders and booming right along. However, as we said in our opening tweet, sustainability is uncertain, but industry growth looks more sustainable than it has in many years.

RESIDENTIAL


Our forecast for residential construction has come down since the rebounding boom of the last two years, but we expect strong growth of 14 percent for 2015 and just a bit lower through 2018. Multi-family construction is still expected to grow at a healthy pace of 13 percent in 2015 after reaching a near-record pace in 2014. The inventory for new homes increased to six months in July, showing some weakness in sales, but housing starts in July were 21.7 percent above July 2013 levels. Foreclosure rates were down 16 percent in July over July 2013, according to RealtyTrac. Mortgage rates have also remained low, thus helping potential homebuyers on the edge make decisions to buy now. Those decisions have been helped along by improving unemployment numbers and wage increases. Consumers have more confidence, so those looking to buy a home are more likely to do so as long as those numbers look good. Nonetheless, there is still some reluctance for first-time homebuyers as more move to the city and look for rental residences, thus rents have gone up and vacancies have gone down. Growth in multifamily has also been boosted by retiring baby boomers looking for independent living centers.

NONBUILDING STRUCTURES


Power
After some large swings in recent years, we expect power construction to moderate to between 6 percent and 8 percent through 2018. Next year and subsequent years should see new highs for construction spending in this sector reaching $102.5 billion in 2015. The power industry is in flux due to changing fuel supplies using more natural gas and less coal, as well as variable rates of growth in alternative energy sources like solar and wind. Wind generation facilities grew last year at the end of federal subsidy programs, but will slow in the current year. Like the communication industry, the power industry will continue to look at consolidation as the average consumer reduces power use, although there will continue to be growing demand due to population growth.

Sewage and Waste Disposal
The good news for sewage and waste disposal construction is that we expect modest growth from 2 percent to around 4 percent for the forecast period. That is an improvement over the last few leaner years. As we noted in our introduction, the need for improving infrastructure in this sector is increasingly important, but needs the will of the people and the purse to change the outcome.

Water Supply
As in other areas of public infrastructure, the need for improvements in our water supply is great, but the investment is lean. Our forecast calls for $13.7 billion to be spent on water supply construction in 2014 and growth of just 2 percent to $13.9 billion in 2015. The drought crisis in California may be instructive for the rest of the nation, as California will have to increase spending on water resources.
Phil Warner is a research consultant, at FMI Construction.

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