Prospects for 2007
What can your design or construction firm expect in 2007? What are the business trends that are changing the AEC industry? What is the outlook for your firm's target markets? What are the strategies AEC firms will be using to grow in 2007? The 2007 AEC Industry Outlook: Strategy and Insight for Design & Construction Firms, published by ZweigWhite, answers all of these tough questions. A synopsis of the report is presented here.
Performance in 2006
Unlike in prior years when the three major components of the AEC industry—residential, nonresidential, and public construction—all showed broad-based growth, 2006 marked a transition year. The residential construction boom finally ended, but the industry was picked up by a strong performance on the nonresidential and public sides.
The value of residential construction put in place declined each month since March 2006 and was down 8.2 percent from the March peak. If this trend continues, it will likely result in an overall decline in residential construction by the end of 2006. In fact, the U.S. Department of Commerce projects a 7 percent decline in residential construction in 2006.
The ZweigWhite 2007 AEC Business Trends Survey, conducted in September and October of 2006, asked respondents to assess their firms' 2006 performance. Firm leaders reported that 2006 was another good year for their firms, although it wasn't quite as good as 2005. More than half (54 percent) of respondents said that business in 2006 was "outstanding" or "excellent." That percentage is lower than the 64 percent of respondents who in the prior year's survey said that business was "outstanding" or "excellent." However, the 2006 percentage still bettered those of 2003 and 2004.
Outlook for 2007
The AEC industry has performed very well in recent years, even if growth in the industry slowed in 2006. However, looking ahead to 2007, it's a tale of two markets. Nonresidential construction growth should be strong, but residential construction should continue to decline. Since housing construction accounts for more than half of overall construction activity, the downturn in the residential real estate market may be substantial enough to keep the overall AEC industry relatively flat in 2007. In fact, there are even some forecasters projecting a decline in construction activity in 2007.
The 2007 AEC Business Trends Survey asked respondents what they expected their business to be in 2007. Eleven percent of respondents expect business to be "outstanding" in 2007, while 46 percent expect business to be "excellent." (The 57 percent of respondents who expect business in 2007 to be "outstanding" or "excellent" is on par with the 54 percent of respondents who classified their businesses in 2006 as "outstanding" or "excellent.) Only 7 percent of respondents expect business to be "satisfactory" or "poor."
While it's important to remember that overall those expectations for 2007 are still very optimistic, firm leaders are not as bullish heading into 2007 as they were heading into 2006, perhaps reflecting some dampening of enthusiasm about industry prospects. Going into 2006, 73 percent of respondents expected that business would be "outstanding" or "excellent."
What do industry organizations think? McGraw-Hill Construction is forecasting the first decline in the value of new construction starts since 1991. McGraw-Hill Construction forecasts the total value of construction starts will decline 1 percent in 2007 to $668 billion. The major reason for the projected decline is the forecast of a 5-percent drop in construction of single-family homes. McGraw-Hill Construction forecasts that commercial construction starts will increase 2.5 percent in 2007. Among the fastest-growing segments projected in 2007 are hotels and manufacturing buildings, as well as schools and health-care facilities.
The Portland Cement Association (PCA) also projects a contraction in construction activity in 2007. It expects that growth in the nonresidential and public construction sectors will not offset a "harsh decline" in the residential sector. The PCA expects that higher material costs and a slowdown in the economy will also be negative factors weighing on the industry. The association forecasts a 1.8-percent decline in construction activity in 2007.
Ken Simonson, chief economist for The Associated General Contractors of America, said in November 2006 that he expects nonresidential and public construction to remain strong. "I believe the economy is still fundamentally strong, and the housing slide will have limited impacts on other segments. A bigger concern is that fast-rising materials costs have forced cancellation or delay in many projects. Cost increases should moderate in the next few months, but materials costs will still outrun overall inflation."
Geographic hot spots
It appears again that design and construction opportunities in the United States will be stronger in the South and the West compared with the Northeast and Midwest. Specifically, the U.S. Census Bureau regions expected to have the fastest project growth, thereby driving the most opportunities for AEC business, are the following:
- Mountain (including Arizona, Colorado, Idaho, Montana, Nevada, New Mexico, Utah, and Wyoming);
- South Atlantic (including Delaware, District of Columbia, Florida, Georgia, Maryland, North Carolina, South Carolina, Virginia, and West Virginia); and
- West South Central (Arkansas, Louisiana, Oklahoma, and Texas)
The regions with the slowest projected growth are the following:
- Middle Atlantic (New Jersey, New York, and Pennsylvania);
- East North Central (Indiana, Illinois, Michigan, Ohio, and Wisconsin); and
- New England (Connecticut, Massachusetts, Maine, New Hampshire, Rhode Island, and Vermont).
Respondents to the 2007 AEC Business Trends Survey were asked in an open-ended question to name the three markets that they anticipate will be the "hottest" in 2007. For the fourth year in a row, survey respondents ranked health care as the most promising market in the coming year. One out of every three respondents identified health care as one of the hottest markets in 2007. Higher education was the next most common response from participants, followed by water supply and wastewater, highways and bridges, and power (energy, utilities, et cetera).
Land development and public works are of primary interest to civil engineers, so here is a summary of the major markets in these arenas:
Commercial real estate—Prospects for the commercial real estate market are closely tied to the economic and employment outlook of the United States. While not as strong as in 2005, the U.S. economy produced solid results in 2006, although there are some question marks about the economy going into 2007.
The Wall Street Journal reports that some major corporations, such as Wal-Mart, Amazon, and Intel, plan to cut back on capital spending in 2007. "There's clearly a deceleration coming, but we'll still see growth rates that are respectable next year," Richard DeKaser, chief economist at National City Corp., told the newspaper. Most economists believe that, even at a slower growth rate, capital spending will still be relatively strong in 2007 and outpace overall economic growth. DeKaser projects capital spending growth to slow from 8.7 percent in the fourth quarter of 2006 to 5.9 percent in the fourth quarter of 2007. There is a risk that businesses could overreact to the potential of an economic slowdown and curb spending too much.
Commercial markets have been in the forefront of the sustainable design trend, and that should continue in 2007.
Residential real estate—Throughout this decade, residential real estate has been the real stalwart of the AEC industry. Bolstered by the economy and low interest rates, residential real estate construction rose to record levels. For the past couple of years, forecasters have predicted on a regular basis that the "bubble" would finally burst. However, the market continued to defy expectations, growing 11.1 percent in 2005 to a record high, according to the U.S. Census Bureau.
In 2006, the predictions of the bursting bubble finally came to fruition. Housing starts, new home prices, and new construction have fallen off, and the trend will likely continue into at least the first half of 2007. While multi-family real estate construction is still growing, single-family real estate construction is in decline.
Most industry analysts expect that the residential real estate market will continue to retreat in the first half of 2007. It's possible that the market will bottom out during the middle of the year and begin to grow again in the second half of the year. Single-family and condominium construction will likely decline in 2007 compared with 2006, but apartment construction is showing signs of growth.
Water and wastewater—The municipal water and wastewater market has been another mainstay of the environmental industry during the past decade. Sprawling populations, water scarcity, state and federal regulations, and aging infrastructure are some of the prominent non-economic drivers that kept the market growing. Continued growth in residential real estate development has also been a factor in driving demand for sewer and water connections. Improvements in municipal and state budgets have also helped with funding projects.
Underground Construction reports that, "As has been the trend since the late '90s, rehabilitation spending continues to increase at an even greater rate than new construction." Spending on sewer rehabilitation is projected to increase from $3.4 billion in 2005 to $3.7 billion in 2006, while water rehabilitation is projected to increase 15.8 percent from $1.1 billion to $1.3 billion.
As of October 2006, Reed Construction Data forecasts that water/sewer construction will increase 12.3 percent in 2007.
Transportation — The Safe, Accountable, Flexible, Efficient Transportation Equity Act - A Legacy For Users (SAFETEA-LU) will continue to be the biggest driver of transportation projects in 2007—and for the remainder of the decade. The effect is expected to be widespread as every state will see increased funding from the bill. It will spur highway, bridge, and transit projects throughout the country.
Transportation measures fared well at the ballot box in November 2006 and should provide work for AEC firms in 2007 and beyond. Voters in 13 states approved 21 out of 30 state and local transit-related ballot initiatives, authorizing expenditures approximating $40 billion.
For a more in-depth look at the prospects for the New Year, including many more market-by-market outlooks, order the 188-page, 2007 AEC Industry Outlook at www.zweigwhite.com/store, or call 1-508-651-1559.
Sidebar: Growing strong
The survey asked respondents which growth strategies they plan to pursue in 2007. Perhaps not surprising considering the immense staffing challenge facing AEC firms, increasing hiring and recruiting activities is the top growth strategy that firms will pursue in 2007. It has grown in importance each of the last three years and has replaced expansion of marketing activities as the top growth strategy. An increasing percentage of firms will also be looking to pursue geographic expansion in the coming year. Compared with the prior year's survey, the percentage of firms looking to enter new markets dropped 20 percentage points, perhaps indicating that firms are looking to stick to their core specialties and, if looking to expand, to do so geographically.
Which of the following growth strategies will your firm pursue in the next 12 months?
- Increase hiring and recruitment activities: 72%
- Geographic expansion: 63%
- Expand marketing activities: 58%
- Introduce new services to existing markets: 50%
- Teaming (not joint venturing): 50%
- Pursue a merger or acquisition: 41%
- Enter new markets: 36%
- Pursue design-build opportunities: 34%
- Pursue program management opportunities: 19%
- Enter new international markets: 14%
- Pursue construction management opportunities: 13%
- Joint venture: 8%
Sidebar: Business trends
How your firm responds to management, industry, and market trends—which present both threats and opportunities—will have a significant impact on how your design or construction firm performs in 2007 and beyond. Planning for and adapting to the changes that are in store for the AEC industry will determine which firms make it and which firms don't. Firms that can adapt to these trends can gain a strategic advantage over the competition. They will be the ones that can avoid being viewed as commodities by their clients.
Some of the business trends to watch in 2007 are specific to the design and construction industry, and others are not. While gathering information on external markets is critical in your strategic and marketing planning process, it only makes sense that what's happening inside the AEC industry and inside your design and construction firm is as important to your firm's success as what's happening outside of it. Truly effective market research incorporates both internal and external factors.
In its 2007 AEC Business Trends Survey, ZweigWhite asked respondents to rank the major challenges potentially facing their firms in 2007. Respondents rated eight challenges based on a scale where "5" is "extremely important" and "1" is "not at all important." As the following table shows, respondents rate the inability to find qualified staff as the most important challenge facing their firms in 2007.
Most important challenges facing AEC firms in 2007
- Inability to find qualified staff: 4.42
- Training of staff : 3.81
- Performance of U.S. economy : 3.76
- Cost of health insurance: 3.49
- Increasing competition: 3.34
- Declining use of QBS: 3.12
- Cost of building materials: 3.11
- Cost of professional liability insurance: 2.99
Sidebar: Green gets legs
The green building movement—exemplified by the U.S. Green Building Council's Leadership in Energy and Environmental Design for New Construction (LEED-NC) rating system—is poised for significant growth during the second half of this decade, according to Jerry Yudelson, P.E., LEED AP, principal with Yudelson Associates. "Based both on the success of the LEED program to date in transforming the marketplace for green products, green buildings, and sustainable design, as well as 'macro' factors such as energy costs, environmental sensibilities, successful sustainable developments, and public concern about global warming, it is easy to see that this movement has 'legs,'" Yudelson wrote in a recent report, 2006 Green Building Update. He predicts that the annual number of LEED-NC registrations will more than double during the next four years, from 1,122 in 2006 to more than 2,400 in 2010.
One deterrent to more rapid growth of LEED-registered projects is a perception that these projects cost a lot more, Yudelson says. But he reports "an increased acceptance of the 'business case' for green building" as decision-makers realize the financial, health, marketing, and public relations benefits provided.
Additionally, Yudelson sees an effort to move beyond current green standards. "Many in the green building industry," he says, "are beginning to look at how to move beyond LEED requirements, toward buildings and neighborhoods that are 'restorative' or 'regenerative,' producing all of their own power (at least on an annual average) and most or all of their water, along with restoring habitat and, in some cases, restoring natural stream drainage patterns."
Jerry Yudelson is a former national board member of the U.S. Green Building Council and has more than 25 years of technical and business experience with renewable energy systems, green building design, and environmental planning.