These are confusing times for AEC firms wondering where their markets are heading. Most sectors are recovering as economies in the U.S., Canada and across the globe emerge from the pandemic-induced slowdown. Some – particularly in the commercial and educational spaces – continue to struggle in many locations. Add to this the threat of inflation in materials pricing leading to escalating project costs, and the potential of a $1.9 trillion U.S.-government-backed infrastructure package, and you have an industry in flux.
In this issue of The Friedman File, we assess the current state and outlook for the markets that AEC firms serve, as well as disruptors and catalysts that could dictate the health of the industry for the next several years.
Recovery in Full Swing
Since 2003, consulting and publishing firm PSMJ Resources, Inc. has surveyed its customers about the outlook for the major AEC markets, using proposal activity as a metric. In its latest survey for the 1st Quarter of 2021, the Quarterly Market Forecast (QMF) reported improved performance for all 12 major markets assessed and 54 of the 58 submarkets included in the survey. Even the few markets that lost ground showed solid proposal activity; they were simply unable to retain their lofty performance from the 4th Quarter of 2020.
By contrast, every major market fell in the 2nd Quarter of 2020 when compared with the 1st Quarter, and just three of the submarkets (hospitals, medical labs and pharmaceutical production) improved in that three-month stretch.
The PSMJ survey uses its own creation – the net plus/minus index (NPMI) – to measure proposal activity. The index marks the difference between the percentage of respondents that saw growth in a market or submarket during the quarter, and those that saw a decline. For overall proposal activity as reported by all respondents, the NPMI increased from 5% in the 4th Quarter of 2020 to 51% in the 1st Quarter of 2021, its fifth-highest NPMI on record. Other sources report similarly strong results across the majority of market sectors, suggesting that the markets that are not fully recovered are on their way back.
Housing Busts Out
Because the housing market helps to drive the relative health of many others – retail, restaurants, transportation, energy, etc. – researchers watch it closely. Since summer 2020, housing has been on fire across all subsectors (e.g., multifamily, single-family, senior living). Even the condominium market, which has lagged in recent years, shows signs of renewed life.
The NAHB/Wells Fargo Housing Market Index (HMI) is one of the research sources reporting exceptional opportunities and optimism in housing. Based on a monthly survey of NAHB members designed to take the pulse of the single-family market, the index has recorded its best stretch since its founding in 1985. Before last summer, the index’s high point was 78 in December 1998. After reaching 78 again in August 2020, the index climbed as high as 90 in November and has stayed above 82 for nine consecutive months (through May).
The survey asks respondents to rate market conditions for the sale of new homes, currently and in the next six months, as well as the traffic of prospective buyers of new homes. “Builder confidence remains strong due to a lack of resale inventory, low mortgage interest rates and a growing demographic of prospective home buyers,” says NAHB Chairman Chuck Fowke.
The U.S. Census Bureau’s report on permits, starts and completions reveals not only a fully recovered market, but one with potential to grow rapidly. Preliminary figures for April marked the ninth straight month with a seasonally adjusted annual rate of more than a million new single-family building permits issued. The South leads the permitting activity, accounting for 53.6% of the total in April. The West is next (23.9%), followed by the Midwest (13.0%) and Northeast (9.5%), according to Census data.
Permits for private multifamily buildings of five units or more were also elevated in April at 559,000 (annualized), the second-highest level in the past year. The NAHB is concerned that supply shortages and rising costs could curtail activity into 2022, but long-term indicators suggest that any slippage will be short term.
“Though the multifamily sector is performing much better than nonresidential construction, developers are facing stiff headwinds in 2021,” said NAHB Chief Economist Robert Dietz. “Shortages and delays in obtaining building materials, rising lumber and OSB (oriented strand board) prices, labor shortages and a more ominous regulatory climate will aggravate affordability woes and delay delivery times.”
AEC firm leaders working on independent and assisted living properties also reported stronger-than-average proposal opportunities in the 1st Quarter. Given the approximately year-long average lifecycle of multifamily projects, this portends well for the second half of 2021 and into 2022.
The National Institute on Aging (NIA) reports that approximately 8.5% of the global population is 65 or over, and aging.com projects that two million housing facilities will be needed for senior residents for adequate living space by 2040.
Soaring and Lagging Markets
Though widespread and well-entrenched in most geographic areas, the recovery remains uneven, as a few markets have yet to join the fun. Below is a summary of the hottest and coolest markets heading into the second half of 2022.
- Work in healthcare remains abundant, despite challenges and changes brought on by the pandemic and regulatory uncertainty. Firms working in healthcare can anticipate that its strength will continue across all subsectors. Global construction of continuing care facilities (CCFs), for example, is projected to grow nearly 7% from 2020 to 2026, and research firm Global Market Insights says the worldwide CCF market will total more than $1.5 trillion by 2026.
- Many industrial markets, led by pharmaceuticals, biotechnology and anything related to warehouse/distribution, appear to be returning to normal levels of activity.
- In contrast, fossil-fuel-dependent markets (e.g., petroleum, mining) and chemical-related markets are struggling to regain their pre-pandemic footing. With renewable energy among the hottest of all subsectors at this point in the recovery, these markets may never fully recover.
- Power plants and pipelines trail other energy markets, while the transmission and distribution subsector is rallying. Researchandmarkets.com reports that the global electric power generation, transmission, and distribution market is expected to grow from $3.3 trillion in 2020 to $3.5 trillion in 2021, a CAGR of 5.8%. The group expects the market to reach $4.5 trillion by 2025.
- Among environmental markets, early-stage subsectors (e.g., permitting, site characterization, resource management) are strongest per PSMJ.
- Transportation markets are spotty, but show promise and could explode if a comprehensive Infrastructure Plan launches in Washington. The American Road and Transportation Builders Association (ARTBA) projected a 5.5% decline across all markets in 2021. This was off a record year for transportation projects, however. With most states allowing construction to continue as an essential service during the pandemic, ARTBA reports that the value of work for U.S. transportation projects was $294.2 billion in 2020. ARTBA Chief Economist Dr. Alison Premo Black expects that to fall to $278.1 billion in 2021.
- The water/wastewater market held up well during the pandemic, primarily because its design and construction capital expenditures are largely derived from customer fees, not taxes. It continues to be a growing market with extensive needs due to population expansion and aging infrastructure.
- Education projects were off the pace of other markets even before the pandemic, but much of that was (and continues to be) regional. Higher Ed, after a boom in the mid-2010s, has slumped, with the exception of laboratories in some locations. The outlook for K-12 work depends largely on individual state and local funding ability and willingness.
- The commercial markets suffered most during the pandemic – not surprising given that restaurants, retail stores and hotels/motels saw substantially reduced activity, and offices were left vacant by telecommuters. Yet, conversations with AEC leaders and secondary research sources indicate that these markets are recovering slowly, albeit with a great variance depending on location and other factors.
- A study on the rate of recovery for the office sector by Integra Realty Resources, published in Commercial Property Executive, found that some cities (e.g., Austin, Charlotte, Nashville) are expanding their office market, others (e.g., Cleveland, Memphis, Orlando) remain in recovery, while still others (e.g., Boston, Chicago, Dallas, New York, Phoenix, Seattle) will likely still be in an office-building recession for much of 2021.
Rising Material Prices, Shrinking Availability
Among the industry’s hottest topics, and greatest concerns, are the rising costs and shrinking availability of some building materials. Coming out of the worldwide pandemic, the market was ripe for this type of threat. With many sources of production shut down, and demand for products remaining high and now increasing, the potential for inflated prices and project cost escalation was predictable. According to the NAHB, the average cost of a new home rose by $36,000 just from January 1 to April 30 due to skyrocketing lumber costs.
In March, the Associated General Contractors of America (AGC) noted, “If a contractor or subcontractor submitted a fixed-price bid in March 2020 based on material costs at that time, but did not buy the materials until a year later—a common occurrence—its cost for the materials would have risen an average of more than 12%.”
AGC CEO Stephen Sandherr notes that the pandemic is not the only factor inflating prices. Federal policies, particularly tariffs and quotas on key building materials like lumber and steel, are also contributing to price spikes, supply shortages and delivery delays.
“The Biden administration must address soaring lumber and steel costs and broader supply chain woes,” said Sandherr in a statement. “Without tariff relief and other measures, construction employers will have little ability to invest in new equipment and hire new employees.”
The Politics of Infrastructure Investment
The final puzzle piece is the infrastructure and climate plan being debated in Washington. Biden proposed a $2 trillion plan, which was countered by Congressional Republicans at about half the original amount. The sides are attempting to work out a compromise to show bipartisan support for infrastructure improvement, but it remains to be seen if they can come close enough together on what should be included and how to pay for it.
For example, Biden’s bill calls for spending $45 billion to replace every lead water pipe and service line in the nation, but the Republicans have historically (and recently) considered the cost too steep. The lead water line replacement program is not included in the GOP’s counter plan.
Any significant infrastructure measure enacted into law would almost certainly lead to major growth across most AEC market sectors. However, given the divisiveness of U.S. politics today, and the recent difficulty presidential administrations have had in passing groundbreaking infrastructure legislation, AEC leaders shouldn’t count on any additional government help.
Chasing “hot” markets and abandoning “cold” ones is rarely a winning strategy for AEC firms. Yet, it is helpful to be aware of market trends as you create, adjust and execute your business development and marketing strategies. If you have anything to add to this conversation, I’d love to hear from you at firstname.lastname@example.org or (508) 276-1101.