An industry overview of 2007 and forecast for 2008

The past few years have brought prosperity to many design and construction firms, with broad-based growth in most sectors of the AEC industry. However, the plummet in residential construction and the weakest U.S. economic growth in five years have raised many questions about what 2008 will hold for the AEC industry.

The 2008 AEC Industry Outlook: Strategy and Insight for Design & Construction Firms, published by ZweigWhite, provides economic outlooks for 2008, market-by-market reviews of 2007, and an industry-wide forecast for the coming year. A synopsis of the report is presented here.

A review of 2007

Recent years have been good for design and construction firms in the United States. Following double-digit growth in 2004 and 2005, however, industry growth slowed in 2006 to the single digits as the residential real estate market began to falter. The nosedive of the housing market in 2007 appears that it will result in the first decline in total construction spending in more than a decade.

How you assess the performance of the design and construction industry in 2007 undoubtedly depends on the markets in which your company works. The residential real estate construction market cratered, but nonresidential and public construction markets both recorded very strong years.

AEC firm leaders surveyed by ZweigWhite reported that 2007 was another good year for their firms, although not quite as good as in recent years; see Figure 1 for recent industry revenues. The ZweigWhite 2008 AEC Business Trends Survey asked respondents to assess their firm’s 2007 performance. More than half (57 percent) of respondents said that business in 2007 was "outstanding" or "excellent." However, the percentage of respondents who said their businesses were "outstanding" fell from 25 percent in 2005 to 15 percent in 2006 to 11 percent in 2007. The percentage of respondents assessing their firms’ performances as "satisfactory" or "poor" increased from 9 percent in 2005 and 2006 to 19 percent in 2007.

Looking ahead

It appears that both the downturn in residential construction and the growth in nonresidential construction will moderate in 2008. It’s unlikely, though, that the strength of nonresidential construction can continue to offset residential construction weakness for much longer. In addition, a weaker economy, coupled with a down housing market, would reduce state and local tax revenue and begin to constrain public construction markets in 2008.

Despite the residential construction slide and the talk about the economy possibly dipping into recession in 2008, AEC firm leaders are pretty bullish on their outlooks for the next 12 months—at least when it comes to their own firms. The 2008 AEC Business Trends Survey asked respondents what they expected their business to be in 2008. Overall, respondents expect 2008 to be another strong year for their firms. Fifty-one percent of respondents expect their firms’ performances in 2008 to be "outstanding" or "excellent." However, survey participants are not quite as optimistic heading into 2008 as they were heading in 2007, perhaps reflecting some dampening of enthusiasm about industry prospects. Going into 2007, 11 percent of respondents expected their firms’ performances to be "outstanding." That percentage has fallen to 5 percent going into 2008.

Commercial real estate

While the residential real estate market plunged, double-digit growth in nonresidential markets, such as commercial real estate, was a lifeline to the AEC industry in 2007. A record $257 billion was invested in commercial real estate in the first seven months of 2007, according to the National Association of Realtors, up from $146.7 billion in the same period in 2006.

Most forecasters expect that commercial real estate construction will not match 2007 activity in 2008 as a slowdown in the economy will have a direct effect on activity. The slowdown in residential real estate also serves to reduce demand for retail construction and office construction for companies that work in the residential industry. However, there are still some positive indicators for commercial markets heading into 2008, such as continued job growth, increasing export levels, and continued increases in business spending.

Education

The education market is one of the largest for design and construction firms. Not only is the market big, but it’s growing. The K-12 and higher education markets have been two of the bright spots in the AEC business in recent years. And the thriving education market isn’t going away anytime soon—there are too many students incoming for that to happen.

The U.S. Census Bureau reports that total education construction (including both K-12 and higher education and public and private construction) grew 7.9 percent in 2006. It appears that 2007 will be an even better year, with the value of construction put in place up 14.1 percent in the first three quarters of 2007.

It seems unlikely that the K-12 market will be able to match the growth of the beginning of the decade, but 2008 should still be a good year for design and construction firms working in the K-12 market.

Going into 2008, higher education should remain one of the hot markets for design and construction firms. According to American School & University, colleges will complete more than $45 billion in projects between 2007 and 2009, that’s up from the $44 billion in future projects reported the prior year.

Health care

The health care market is growing in both the public and private sector. The seasonally adjusted annual rate of health care construction put in place by the private sector increased 10.3 percent between September 2006 and September 2007, reaching $37.9 billion. The seasonally adjusted annual rate of health care construction put in place by state and local government increased by a robust 29.7 percent between September 2006 and September 2007, reaching $7.3 billion.

The news should continue to be good for design and construction firms working in the health care market in 2008. The market drivers of aging facilities, an aging population, new medical technology, and the increase in available capital are still strong. The outlook in all areas of the health care sector looks very bright.

Residential

Throughout the first half of this decade, residential real estate, particularly single-family housing, was the engine that propelled the growth of the design and construction industry. Bolstered by the economy and low interest rates, residential real estate construction rose to record levels.

However, the "bubble" finally burst on the residential real estate market in 2006; and 2007 was a horrendous year for AEC firms working on residential real estate projects, as the subprime loan crisis took another bite out of the market. Housing starts and home prices have trended downward, and that should continue into at least the first half of 2008, if not throughout the entire year.

Multi-family housing is more likely than single-family housing to post gains in 2008; however, there is still a very real possibility that multi-family housing will suffer a slight decline. It appears that the apartment market will be in better health in 2008 than the condominium market as the subprime mortgage crisis continues to bedevil the market.

Transportation

Through the first nine months of 2007, the value of transportation construction put in place is up 12.7 percent from the first nine months of 2006. Reed Construction Data forecasts that spending in the transportation category will increase by 14.3 percent in 2007.

The massive airline delays in the summer of 2007 and the tragic collapse of the I-35W bridge in Minneapolis in August 2007 renewed focus on the state of America’s transportation infrastructure. There was a great deal of talk in the wake of the collapse about the need to invest much more governmental money in transportation infrastructure. However, that talk has yet to translate into any meaningful infusion of funds.

The impact of SAFETEA-LU will wane as the bill’s expiration in September 2009 begins to approach. Past history has shown that the pace of transportation projects begins to slow in the latter years of the federal transportation bill as owners are reluctant to begin planning and designing multi-year projects when the funding picture is uncertain for the final years of the project. On the aviation side, as of November 2007, Congress had yet to approve a new multi-year aviation bill. Further delays in passage of that bill could negatively affect airport projects.

In November 2007, the House and Senate reached agreement on a transportation spending bill for Fiscal Year 2008. However, the agreement still needed White House approval. The bill boosts highway spending by 3 percent (or $1.25 billion) to a record level of $40.2 billion. It includes an additional $1 billion for deficient bridges and $195 million for construction of the replacement bridge for I-35W in Minneapolis. The bill includes $3.5 billion for the Airport Improvement Program, on par with 2007 levels.

A potential damper on the transportation market is the rising cost of building supplies and energy. In addition, high petroleum costs would have a sustained impact on the high price of asphalt. If building material prices remain high, that may squeeze available funding for AEC services and limit the number of projects that transportation agencies can afford.

As of November 2007, Reed Construction Data forecasts that transportation construction will increase 17.5 percent in 2008, faster than the 14.3 percent growth projected for 2007.

Hot markets

Which markets are going to provide the best opportunities for design and construction firms in 2008? As part of the 2008 AEC Business Trends Survey, ZweigWhite asked respondents in an open-ended question to name the three markets that they anticipate will be the "hottest" in 2008. For the fifth year in a row, survey respondents ranked health care as the most promising market in the coming year. Higher education was the next most common response from participants.

Based on ZweigWhite’s analysis of the markets, the following are the ones that should provide the best growth opportunities for AEC firms in 2008. Note that some of the markets differ from the survey respondents’ opinions on the top markets in 2008.

* Health care
* Higher education
* Power and energy
* K-12 schools
* Telecommunications

For a more in-depth look at the prospects for the new year, including more robust market-by-market outlooks on these and other topics, order the 174-page 2008 AEC Industry Outlook: Strategy and Insight for Design & Construction Firms at www.zweigwhite.com/bookstore or call 508-651-1559.