The surprises of the midterm election are behind us, and the uncertainty of 2023 lies ahead. In the last year, we experienced skyrocketing energy prices that eventually moderated, historically high inflation that has begun to temper, and major legislation kicking in that is likely to keep the good times rolling for many architecture, engineering and environmental consulting firms well into the future. In this issue of The Friedman File, we assess various markets served by A/E/C firms and venture an educated guess at their outlook for the coming year.
The Housing Divide
One of the biggest and most unexpected developments of late 2021 and early 2022 was the health of the housing construction market across all types. The National Association of Home Builders (NAHB)/Wells Fargo Housing Market Index stood at a near-record-high level of 83 in January 2022, but gradually began to drop as the year went on. In November 2022, the index – which is derived from a monthly survey of NAHB members rating market conditions for new single-family home sales – had plummeted to 33, its lowest level in over 10 years.
NAHB Chief Economist Robert Dietz said in August that the U.S. is in a housing recession. In a release on the November Housing Market Index results, the group said that 59% of builders are now using incentives to bring more buyers into the market. “In November, 25% of builders say they are paying points for buyers, up from 13% in September. Mortgage rate buy-downs rose from 19% to 27% over the same time frame. And 37% of builders cut prices in November, up from 26% in September, with an average price of reduction of 6%. This is still far below the 10%-12% price cuts seen during the Great Recession in 2008.”
Multifamily properties, on the other hand, have not seen such a drastic decline. The NAHB’s Multifamily Production Index slid noticeably in the third quarter of 2022, but this was largely due to a hit in the for-sale (condo) sector. And the Census Bureau’s figures on permits showed only a minor reduction nationally for buildings with five or more units from September to October (the latest figures available), but a year-over-year gain of 11.2%.
Fannie Mae’s outlook for the housing market in 2023 is not optimistic. The mortgage financing giant predicts a mild recession in 2023, with the housing market bottoming out in the second quarter. It projects a much stronger 2024, as mortgage rates and supply both fall. And while the Multifamily market is unlikely to continue at its best pace in over 35 years, it does not predict a fall off the cliff.
“While we expect continued solid multifamily construction going forward, when compared to the sector’s torrid pace of this past year, we forecast multifamily starts to slow over the next year. We forecast multifamily housing starts to fall 29.3% in 2023, after rising 12.9% in 2022 to the highest annual pace since 1986,” Fannie Mae said in a November 21, 2022, economic and housing outlook report.
Commercial Markets Rebounding
Anecdotally, we’re hearing that activity is picking up across most commercial markets, including some that have been written off coming out of the COVID-19 slowdown (e.g., restaurants, hospitality, office). The U.S. Census Bureau’s data on construction put in place supports this theory, as year-over-year figures for commercial markets, office buildings and hospitality all improved.
The value of construction put in place for the commercial market, which includes restaurants and retail, rose 22.4% from September 2021 to September 2022. Lodging was up 16.1%, and even office ticked up 0.7%.
Industry economists show cautious optimism about a continued comeback for commercial markets in 2023. For example, the recently released “Emerging Trends in Real Estate 2023,” a joint publication of PWC and the Urban Land Institute, noted, “It might be easy to assume that the consensus outlook for the retail sector in 2023 would be glum, given the outsized challenges that retail has faced in recent years and with economic uncertainty on the horizon. But instead, there is a general sense of wary optimism, though not without considerable concern about the direction of the overall economy.”
The American Institute of Architects (AIA) Construction Consensus Forecast projects a 13.8% growth rate over 2022 for hotels, 3.5% for offices and 3.2% for retail and other commercial in 2023.
Public Infrastructure Looks Strong
Sectors such as transportation and water/wastewater will not only benefit from the Infrastructure Investment and Jobs Act (IIJA), they continue to receive support at the ballot box. In the midterm elections, nearly every ballot question seeking funding for infrastructure passed successfully. For example, New Mexico approved two amendments supporting improvements to public infrastructure for residential purposes, and Massachusetts voters narrowly agreed to add a 4% surcharge to taxpayers with an adjusted gross income over $1 million that will go directly to transportation and education.
In PSMJ’s Quarterly Market Forecast (QMF) survey of proposal activity in the third quarter, the two leading major markets among the 12 surveyed were Water/Wastewater and Transportation. Of the top 10 submarkets of 58 assessed in the survey, four were from Water/Wastewater (Water Distribution was 2nd, Wastewater Treatment was 4th, Water Supply was 5th and Water Treatment was 6th) and three were from Transportation (Roads 8th, Bridges 9th and Transportation Planning 10th). Since 2003, the PSMJ QMF has used an index to track quarter-to-quarter growth in proposal activity.
Given that proposals are one of the earliest metrics to track in a project lifecycle, a strong showing in the PSMJ QMF indicates a positive outlook in a market for at least several months ahead.
Renewables Pacing Energy
Keeping with the PSMJ QMF survey, Renewable Energy has been the leading submarket throughout 2022. In the third quarter survey, 72.7% of respondents said that proposal activity grew from the second quarter, while only 3% said it declined. This results in a net plus/minus index (NPMI) of 69.7, which is the standard used in the PSMJ survey. In the previous quarter, Renewables’ NPMI was 71.4, indicating a market that continues to show amazing growth.
Utility Distribution has also excelled in the PSMJ survey, scoring a 65.5, the third-highest of the 58 measured. Among respondents working in the market, 69.0% said they experienced growth in proposal opportunities, while only 3.5% said it dropped.
K-12 Driving Education Revival
We’re also hearing from clients that education projects, particularly K-12, are returning to high levels of activity. This is supported by the PSMJ survey, in which education lagged along with commercial markets throughout most of 2021 before bouncing back to more-than-respectable levels. In the third quarter, K-12 recorded an NPMI of 35.1, compared with 19.0 for Higher Ed and 20.4 for support facilities.
The AIA Consensus survey isn’t exactly bullish, but it anticipates a decent growth rate of 5.2% for educational projects in 2023.
Health Care Stays Steady
The Healthcare market was affected dramatically by the early stages of the COVID-19 pandemic, with hospitals and other facilities pivoting to deal with those infected with the disease. The pause was brief, however, and most of the planned projects that were put on hold were quickly resurrected.
Several trends are driving the Healthcare market. These include:
- Redefining in-patient facilities. Healthcare networks are reserving hospital space for more acutely ill patients, while less intensive treatment is handled in medical offices or clinics.
- Decentralization. In conjunction with the preceding trend, healthcare providers are placing smaller facilities in areas closer to patients.
- Telehealth. The pandemic finally brought it to prominence as a treatment method, and while its use is waning as the COVID crisis eases, it remains relevant, still influencing the design of facilities and need for technology.
- Repurposing. One trend we’re seeing is the conversion of small former office spaces into small medical office buildings (MOBs).
The AIA Consensus forecast projects 5.7% growth for Healthcare in 2023, while the PSMJ QMF had it the fourth-strongest major market in the third quarter.
Manufacturing, Public Safety Lead Others
Growth in manufacturing facilities, potentially bolstered by the CHIPS and Science Act of 2022, appears solid in 2023. This follows a year-to-date (through October) in which value of construction put in place grew by 43.3% year-over-year, and 7.6% quarter over quarter.
The AIA projects Public Safety construction to grow by 5.5% in 2023, with Moody’s Analytics and Dodge Construction Network both calling for a rise of better than 10%.
Among Environmental markets, Resource Management has paced the results from the PSMJ QMF, with Environmental Permitting also fairly strong.
There is still a lot we don’t know as we stare down the barrel of 2023. Will the Fed keep raising interest rates? How well will investors stomach the increases that have already occurred? Will the decreases in energy prices and inflation continue? And then there’s always the unexpected – pandemics, natural disasters, political upheaval, stock market crashes, and so on.
Throughout it all, however, the design and construction industry tends to show incredible resilience – if only because the demand is so great. Prognosticators expect 2023 to be slightly better for most markets, with the possible exception of housing. But, as always, an architecture, engineering or environmental consulting firm that does the right things, hires the right people and puts the right strategies in place will almost always do just fine in the end.
What do you think about what’s coming in 2023? Share your thoughts with me at firstname.lastname@example.org.