Download 2012 Q3 Vermeulens Market Update

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Continuing signs of
stable growth.
Beyond Estimation
Q3 Market Update
SINCE 2006, VERMEULENS has been reporting on the
state and direction of the construction market. Our guiding
philosophy in forecasting is that the inflation targets of the
Federal Reserve and Canada’s Central Bank will propel
monetary policy and subsequently construction prices.
This approach led to the successful forecast of a future
drop in prices during the 2007 and 2008 price peaks.
Previous recessions have been analyzed and have framed
our positions on both the size and extent of the price dropoff we have seen in the most recent recession.
Looking ahead we see a bumpy road for recovery and
therefore buying opportunities for owners.
As the money supply and credit growth stabilizes, rescue
packages from central banks will continue or wind down as
conditions permit.
As financial markets recover to pre-recession levels, institutional buyers will be able to plan for construction in the
near to medium term.
See Vermeulens blog http://vermeulens.com/blog/
for more discussion on this and other topics.
Selling prices have
increased by 6.5%
since the trough of
the recession
FOLLOWING THE GLOBAL RECESSION construction selling prices for institutional projects fell by 14% from their
peak in 2008. During 2011 Vermeulens saw an average selling price increase of 3% The first three quarters of 2012 have
seen an increase of 4.5%. In addition to a surge in commodity pricing the increase can be attributed to contractors’ need to
claw back margins to remain in business.
The end of QE2 and
uncertainty at home
and abroad have
moderated growth.
THE TABLE BELOW AND LEFT looks at several of the key economic indicators that drive construction volume and
subsequently construction costs. On balance, current indicators support stable construction costs. Some signs of shortages
in local markets are driving the rate of price increases above the Consumer Price Index Trendline. Due to recent monetary
policy, nominal and real interest rates as well as financial and real estate assets will support an uptick in activity. Likely
changes to fiscal policy will work against this.
Cu
rre
nt
Fo
rec
ast
Indicator
CPI Inflation
Moderate
ICI Demand
Low Increasing
Nom Interest Rates
Low
Real Interest Rates
Stable
Gov Spending
Turning
Gov Deficits
Negative
Financial Assets
Stable
Real Estate Assets
Low Stable
Construction Prices
Turning
Construction Employ
Low Turning
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After resetting to the
CPI Trendline, 2011
and 2012 have escalated at a rate just
above CPI
FOR THE PAST 25 YEARS construction costs have
trended toward a 3.3% annually compounded escalation
rate. In 2008 construction costs reached a peak and adjusted rapidly downward then stabilized for two years.
Similarly, costs peaked in 1990 and 2001. The rate of escalation seen in construction costs are indirectly tied to the
goal of 2 - 3% annual inflation and the monetary policy
used to achieve this goal. From 1986 to 2006, construction
costs escalated approximately 15% faster than CPI due to
lower inflation achieved in other sectors of the economy
and the reduction in real interest rates.
This environment came to an end with the financial crisis
and high inflation in various sectors of the economy.
Billings in decline
The chart above illustrates bid prices (‘Vermeulens Project
Bids’) for institutional/commercial/industrial projects relative to the Vermeulens Cost Index and the 3.3% construction
trend line (1986=100) and the 2.9% CPI trend line. The
balance of current factors has resulted in establishing a new
lower trend line such as in the 1990’s. As inflation in other
sectors of the economy—commodities for example—
moderate, and real interest rates reduce, escalation in the
construction sector will have room to increase at a higher
rate.
Architecture firm billings declined for the
fourth consecutive month in July, although the
pace of decline slowed slightly from the drop
seen in June. The AIA’s Architecture Billings
Index (ABI) score for the month rose to 48.7,
indicating that fewer firms reported softening
business conditions last month than during the
previous month. Inquiries into new projects
remained steady, although firms reported that
the value of new design contracts continued to
decline modestly.
Firms located in the South reported an uptick
in their firm billings in July, although business
conditions continued to soften in the other
three regions of the country. Firms located in
the Northeast region reported particularly
weak business conditions.
http://www.aia.org/practicing/AIAB095765
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Construction volume
has increased 9.4%
from it’s bottom in
March 2011.
CONSTRUCTION VOLUME
IS THE NUMBER ONE
DRIVER OF CONSTRUCTION COSTS. As volumes
increase and hence contractor
bidding opportunities and
backlogs grow, the margins
included in a bid will grow.
Residential volume appears to
be recovering and is currently
16.4% higher than its recent
bottom in July 2011. Put In
Place Residential Construction
is currently 40% of the value
http://www.census.gov/const/www/c30index.html
seen in March 2006. Existing
home inventories have begun
to decline and are now at 6.4
months which is well below
the value of 12.5 months seen in July of 2010. Existing home inventory remained constant through Q2 2012.
Construction levels are lower than what is required historically to satisfy long term household formation. During the depression and second world war residential construction ran below long term averages. As incomes
supported renewed consumption after the war residential volumes boomed. Using this as a model, employment
and income growth will need to re-establish themselves before a real recovery occurs in this sector.
Although it can mostly be attributed to several large scale projects, Non-Residential construction has increased
14% from its bottom. Along with cues from the continued increases in the AIA Billings Index, the NonResidential sector may have stabilized.
Infrastructure spending peaked in August 2009 and fell by 12% to its bottom in Feb 2010. Infrastructure
spending has rebounded since by 4.2%. New fiscal policy will be an important driver in this sector.
Capital markets continue to moderate
demand in the construction market.
Stable commodity
prices will help to
allow low interest
rates to stimulate
construction demand.
THE NYSE (black line) IS A
STRONG PREDICTOR (Vs
index green line) of construction costs. The reason for the
correlation is that improving
equity markets provide capital
and investment spending. Markets have moved ‘sideways’
for much of the last two years.
This is due to uncertainty with
debt levels, default concerns
and minimal growth in the jobs
market. If markets return to
growth this will lead to increased construction volume
and consequently support for
construction prices.
COMMODITY PRICES are
an indicator but not necessarily a predictor of construction prices. The era of stagflation (rising prices and low
growth) that has prevailed for the last 10 years may be reaching an end. The energy sector is particularly important as it underlies all economic activity. Technical advances and peak oil will continue to do a dance for some
time until significant “unconventional” supplies and efficiency reductions to demand come on stream. In North
America, natural gas is in surplus and local crude oil is also in surplus, trading at a significant discount to West
Texas benchmark rates.
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Construction employment at lowest
level in 16 years
There will be enough
labor capacity to
support noninflationary growth
for some time.
Attrition in the labor
force will bring an
end to wage reductions.
CONSTRUCTION EMPLOYMENT
PEAKED (,000’s) understandably at the
same time as construction put in place
(March 2006). However, the sharp
downward decline in employment did
not occur until approximately 12 months
later. From the peak, construction employment has fallen by 29% or by 2.3M
workers. With such substantial layoffs
the remaining workers are generally the
most experienced and productive resulting in improved productivity and consequently lower costs to suppliers. Improved productivity has offset annual
labor wage increases. As we move back
towards increased construction volume
there is substantial capacity for the market to grow without labor shortages.
However, the non-inflationary level of
employment will reset to a lower amount
as workers will leave the construction
labor market.
CAPACITY UTILIZATION RATE
(Chart Left) is calculated by taking the
ratio of current construction employment
to the peak construction employment and
allowing for a sustainable rate of growth.
Generally, a utilization rate of greater
than 85% will begin to put upward pressure on construction labor costs. As you
can see from the chart on the left, the
majority of U.S. states are well below
their peak levels of employment. However, it is important to note that several
states are entering the “warm” zones
which may begin to put upward pressure
on labor rates.
CONSTRUCTION UNEMPLOYMENT
(bottom chart) in the US has been on its
seasonal downward swing during the
summer months. Fall will turn this trend
around to increased rates. Expect the
labor force to continue to shrink. This
should bring unemployment into the 1015% band in the next 12 to 24 months.
Unemployment seasonally fluctuating
between 5% - 10% will tend to put upward pressure on labor costs (20042007). A range of 15% - 25% will put
downward pressure on labor rates (20082011). A range of 10% - 15% is considered stable. Most regions are still in the
downward pressure range however as
seen with unemployment rates and the
labor utilization charts we have been
moving to the intermediate zone.
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Strong confidence
leads to increases in
contractor margins.
The CICI survey shows that respondents are a little less confident. However, private-sector markets once again
were considered the most active. Applying the CICI rating formula, the power sector was up three points, to 69,
tying it with petroleum (up one point) and multi-unit residential (also up one point) as the strongest markets as
perceived by the survey respondents. The hospital/health-care market also is seen as being strong, but it fell in
the third quarter by three points, to a CICI rating of 65. The only other market showing significant gains was
the environmental/hazardous-waste sector, which rose three points, to 58.Several sectors were seen as falling
from the previous quarter. The biggest decline was in the industrial and manufacturing sector, which fell six
points, to 56, as corporate owners hold off launching projects pending the election. Buildings sectors also fell
or were flat. The commercial-office (CICI 46 rating), hotels-and-hospitality (50) and higher-education (53)
sectors all were down three points. Survey respondents continue to believe project financing has stabilized;
until it becomes more readily available, the recovery will be slow. Mcgraw Hill/ENR Survey
Discretionary spending at the federal
level will be reProspects for fiscal 2013 appropriations
strained for the fore- are not encouraging. President Obama
seeable future
launched the 2013 spending round on
Feb. 13, when he sent his budget request
to Congress. The proposal seeks some
construction program increases but also
recommends many cuts. Final word on
which line items will be trimmed—and
how severely—won’t come until late this
year. But industry officials say the outlook isn’t bright.” ENR 1Q Cost Report.
Construction prices are firming and have begun to increase. With the current labor market capacity and continued lows in
construction volume being put in place it is Vermeulens’ opinion that construction cost will escalate closer to the CPI Trend
Line rather than the historic Construction Trend Line for the medium term.
2012: 3%-6%
2013: 4%-8%
2014: 4%-8%
Vermeulens congratulates James Vermeulen for becoming President of the Canadian Institute
of Consulting Quantity Surveyors.