Zweigwhite's 2009 AEC Industry Outlook: Strategy and Insight for Design & Construction Firms

August 11, 2010

Executive Summary

2009 AEC Business Trends to Watch
It's no secret that the U.S. and global economies are currently in a crisis of unprecedented proportion. While there are a lot of micro trends and pockets of activity within the AEC industry that warrant a careful eye, the overarching trend—if it can be called that—for firms in this and every other industry to watch in 2009 is the global economic crisis that has crippled credit markets and stunned Wall Street over the past few months.

According to most economists and analysts as of mid-December 2008, we still have not hit bottom yet. Every day brings more bad news from all corners of the globe. We are learning the hard way how far the reverberations from what originally appeared to be just a domestic problem with sub-prime mortgage lending can mushroom into a global economic meltdown of historic proportions.

With that in mind, recession— including the credit freeze— is the number-one trend to watch in 2009. The next three trends we’re tracking in this year’s 2009 AEC Industry Outlook report are problems directly related to the economic turmoil. In the case of the residential real estate downturn, this trend was arguably the genesis of the crisis. On the flip side, increased government intervention in the markets has resulted from the economic crisis as Washington attempts to right the listing ship. President Barack Obama’s anticipated infrastructure stimulus package and other actions that are expected to be announced in the next few weeks or months will also dictate how conditions in the markets may change over the course of the year. This year, we are tracking eight major trends that will impact the AEC industry over the next 12 months:

• Recession
• Increased government intervention in the marketplace
• The anticipated infrastructure stimulus package
• Residential real estate downturn
• Stalled merger and acquisition activity
• A changing labor market and labor expenses
• Globalization of the AEC industry
• Green building






Recession. A major source of headaches for the AEC industry is that there is work out there, but the economic climate has put such a damper on so many project owners’ plans for future growth, that many projects are simply dying on the vine. Projects of all shapes and sizes are being put on hold by their owners as financing for them evaporates, either through loss of wealth in the stock market as many higher education facilities have experienced in taking major hits to their endowments, or through the slowdown in the municipal bond market that affects municipal and government contract work. Many of these projects will start flowing through the pipeline again once the credit markets unfreeze, but in the meanwhile, many firms are sitting idle waiting for the word to get started on projects they’ve already won. In response to this inactivity, some firms are being forced to lay off staff members and power down their offices to cut costs while they wait for the situation to improve. It’s not a pretty sight, and it has developed very quickly in the last quarter of 2008 as an immediate, intense crisis.

Increased government intervention in the marketplace. When the current economic crisis first began to peak in September 2008, federal government took notice and set the wheels in motion to begin immediately dealing with the crisis in a number of unprecedented ways. Since then, Congress and the Bush administration have been moving swiftly to attempt to address each new ripple in the crisis as it emerges. One such action, the $700 billion Emergency Economic Stabilization Act of 2008, was enacted on October 3rd to prevent further erosion of confidence in the U.S. credit markets. The bailout funds have been used to purchase failing bank assets, such as mortgage-backed securities and other risky investments that tipped the scales into the current economic meltdown. In addition, the Federal Reserve slashed interest rates to an unprecedented, rock-bottom rate of zero to 0.25%. These sweeping actions by the federal government signal that we’re dealing with a unique problem, not just a typical, cyclical business downturn. Watch for the government to remain highly involved in the marketplace and enact new and creative measures to revive and regulate the economy in the coming months.

The anticipated infrastructure stimulus package. One of these measures is the much-anticipated infrastructure stimulus package that President Obama has announced will be one of his first agenda items upon taking office. The stimulus package, rumored to be valued between $500 billion and $1.2 trillion, could be a massive opportunity for design and construction firms over the next several years, depending on what’s included in it and how the rules for acquiring projects and funding through the program are written. The package is said to include upwards of $130 billion in roadway, airport, and other transit projects and will be the largest injection of federal spending into the economy since the New Deal. Leaders within ailing sectors such as residential construction, airport, railroads, and even the auto industry are hopeful that the new bill can be a route to economic recovery for them. The added bonus of the plan is that while these sectors can get a boost from the increase in available projects, much-needed improvements to infrastructure across the country may finally be addressed.

Residential real estate downturn. For the past several years, the exuberance in the housing market has lead to a boom for the AEC industry, even for firms not directly working in the housing market. But with the crash and the subsequent mortgage and credit crisis, the whole house of cards has come tumbling down and the AEC industry—as well as just about all others— are feeling the effects of the void the bursting housing bubble has left. The housing slowdown has also reduced demand for nonresidential projects that spring up around new developments. Among the nonresidential sectors that have been impacted are new retail projects, such as convenience stores, neighborhood shopping centers, and home products stores; office projects for firms working in the housing and financial services markets; schools; and water and sewer projects. A reduction in home building also means a reduction in property tax revenue, which has had an unfortunate ripple effect on public construction markets. The residential real estate crash has had far-reaching consequences and many project owners in all sectors are waiting to see what happens before they make major decisions about new projects or expansions.

Stalled merger and acquisition activity. Over the past several years, strong performance and record profits in the AEC industry have provided many firms with the capital necessary to make an acquisition. Record industry profits have translated into strong cash positions and rising internal stock prices, serving as currencies to fuel additional purchases. A lot of this changed late in 2008 as the stock market tumbled and the economy was pronounced officially as being in a recession. Firms are less optimistic about the performance of the AEC business and the overall economy going into 2009, and that hesitancy is impacting the M&A market. Investors of all shapes and sizes are nervous and many have lost significant amounts of wealth that was tied up in the stock market. Until they can recoup some of these losses, firm leaders who were preparing for retirement through the use of a merger or acquisition may be holding on until the markets stabilize before signing on the dotted line.

A changing labor market and labor expenses. Labor costs are finally beginning to stabilize as a result of the dismal economy and the rising unemployment rate. While the cost of paying employees may have leveled off, the cost of providing health insurance benefits— a significant burden for most firms, especially smaller firms— continues to rise. Health insurance premiums have increased a cumulative 78% between 2001 and 2007, far outpacing cumulative wage growth of 19% over the same period.
When many firms are struggling to contain costs to stay profitable while backlogs may be dwindling or evaporating, the labor market has changed and some firms have been forced to lay off staff. Look for this unfortunate trend to continue in 2009 as firms pull in tight to weather the storm. Globalization of the AEC industry. The world is shrinking, and the AEC industry is going global. That trend will continue in 2009, and the implications for design and construction firms are significant. Globalization of the AEC industry will provide both opportunities and obstacles to U.S. firms, even for those firms that do all of their work domestically. Many American AEC firms will find new markets opening up abroad, at the same time that they face competition from foreign firms for projects closer to home. In 2009, work will increasingly flow to the most competent, lowest-cost professional service provider, regardless of where that person or firm is physically located.

Green building. Green building, or sustainable design, has been one of the biggest trends impacting nonresidential and residential construction in the past few years, and it should continue to be so again in 2009 and beyond. The growth of green building has been driven by a renewal of environmental consciousness in the U.S., particularly in regards to the importance of global warming and the need for action to be taken on a local and global level. In addition, volatile energy costs have made sustainable design and energy efficiency much more attractive from an economic perspective. Corporate greening has also driven the rise in the sector and will continue to do so, especially as the new federal government makes the creation of “green jobs” a top priority. It’s clear now that anyone who thought the green building craze was just a passing fad was wrong.

Market Forecasts
The 2009 AEC Industry Outlook report contains market analyses and predictions on all of the major markets in the AEC industry. ZweigWhite also determined which markets will likely present the best opportunities for AEC firms in 2009 and the three markets which will likely struggle the most in 2009. The “hot” markets in 2009 will be health care, power and energy, and transportation, while the “coldest” markets will be residential real estate, office, and higher education.

Commercial Real Estate. The commercial real estate market contains lodging, manufacturing, office, retail, and mixed-use. Overall, economists are predicting that the commercial market will struggle in 2009. The office market was ranked by ZweigWhite as being one of the “coldest” in 2009 because of the surging unemployment rate that is driving down rents and increasing vacancies and inventory. The retail market is also expected to suffer as a result of the rising unemployment rate, the drop off in residential construction, and a decline in consumer confidence. The manufacturing and mixed-use sectors are expected to be flat in 2009, which may actually help elevate the expectations for the whole commercial real estate market.

Education. The education market, made up of the K-12 sector and the Higher Education sector, are forecast to struggle in 2009. The K-12 sector has been negatively impacted by the rising rate of foreclosures, which has put a strain on property tax receipts in states all around the country. The higher education sector, which has been forecast to be one of the “coldest” in 2009, is being impacted by the massive losses in endowment funds colleges and universities around the country have experienced in the plummeting stock market.

Environmental. The environmental market consists of the air pollution, brownfields/remediation, solid waste/hazardous waste, and water/wastewater sectors. In the past few years, prospects for environmental markets have been improving again, as concern about environmental matters is increasing among the general public, government officials, and corporate boardrooms.

Overall, the market has been a strong one in recent years for water and wastewater services, however, the slowdown in residential development has had an effect on the market in 2007 and 2008. Brownfields have fared well with the increased focus on revitalization and redevelopment of urban areas. The strength of commercial real estate markets has also helped to spur brownfields opportunities, but their difficulties in 2008 have slowed progress in the market. The air pollution market has been bolstered by regulations and long-term thinking about possible regulation of greenhouse gas emissions. The solid waste and hazardous waste sectors of the environmental industry continue to struggle. The 2009 AEC Industry Outlook report provides much more highly detailed information about the recent performance of and the prospects for the various environmental markets as one of the expanded sections in this year’s report.

Health Care. Health care was rated as the “hottest” market for design and construction firms for the sixth year running in ZweigWhite’s annual AEC Business Trends Survey conducted each fall in conjunction with the AEC Industry Outlook report. The sector has posted strong growth over the past several years and despite the turmoil affecting the wider economy, this sector is projected to fare better than most in 2009 and beyond.

However, the sector is entering something of a slowdown. The value of construction put in place for health care peaked in 2007. Since then, construction in the sector fell in the first half of 2008 and has been flat for the second and third quarters. The rising unemployment rate means that more and more people are losing health insurance benefits, which will likely put a strain on hospital systems that provide charity care. However, the market appears to be stronger than all others and will likely perform fairly well in 2009.

Power and Energy. The recent spikes in energy costs have provided record profits for power utility and energy companies and a correlating spike in construction activity in the sector in 2008. While the decline in fuel costs at the end of 2008 has impacted the market and put some projects on hold, the power and energy market is expected to be the second best performing market in 2009. This anticipated slowdown won’t be as strongly felt and won’t necessarily be a bad thing for some engineering and construction companies that have been struggling to keep up with the surge in power plant construction projects in the fastest growing markets.

Residential Real Estate. The residential real estate market, the source of so much pain in the wider economy is expected to be dismal again in 2009. The rise in foreclosures and the drop in home prices in combination with the drying up of the credit markets has killed the residential real estate market. The backlog of homes on the market has increased to about 10 months, and there’s little hope in sight that things will improve much in the coming months. The single-family market has struggled more than the multi-family market, but even so, neither shows good prospects for 2009, and therefore, the residential market was ranked the “coldest” in 2009.

Transportation. The transportation market is made up of the aviation, highway and bridges, ports and waterways, railroads, and transit sectors. Transportation is a real wildcard market heading into 2009. States are struggling with massive budget shortfalls that ordinarily would squelch any major prospects for market growth, but this year, with the anticipated economic stimulus said to contain enormous funding allocations for various transportation and infrastructure projects, the market could enjoy a strong up tick once the bill passes. Therefore, ZweigWhite rated the transportation market as one of the top three “hottest” markets in 2009, but this projection will depend entirely on what happens with the economic stimulus package.

In addition to these markets, the 2009 AEC Industry Outlook also investigates the recent performance and prospects in other markets such as amusement/recreation, criminal justice, government, religious, and telecommunications.

U.S. Forecast
Across the country, recent years have been good ones for design and construction firms. 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 in the housing market that began in 2007 and continued into 2008 had the unfortunate consequence of spilling over into other areas of the economy.

The long-standing optimism felt by insiders over the past several years is gone now, replaced by an overwhelming sense of uncertainty. According to ZweigWhite’s AEC Business Trends Survey, conducted in conjunction with the 2009 AEC Industry Outlook report, only 16% of AEC firm leaders expect their firms’ performances in 2009 to be “outstanding or “excellent,” a significant drop from the 51% of respondents who said they were optimistic that firm performance would be “outstanding” or “excellent” heading into 2008. This is no doubt a reflection of the uncertainty many firm leaders and others in the industry are feeling about the state of the economy in the U.S. heading into 2009.

Similarly, heading into 2008, only 5% of respondents reported that they expected business in the coming year would be “poor;” this year that figure has tripled, jumping to 15%, indicating that some firm leaders have turned pessimistic about their firms’ prospects in 2009.

Regional Forecasts
As with any economic downturn, the impact of the crisis is worse in some places and better in others. However, this time there seem to be fewer pockets of good news than in other recessions in recent memory. From East to West and across all sectors of the industry, the economy looks gloomy, according to The Beige Book from the Federal Reserve Board and most other major economic indicators. Despite this dismal situation, there is still work for design and construction firms out there, and some firms are reporting that while times are tough, they are staying afloat and some are even capitalizing on the difficult situation and making modest growth gains.

Reed Construction Data reported in October that only four large states still had expanding economies: Texas, Louisiana, Virginia, and New York. In total 14 states were found to have economies that were still growing in October, measured on a three-month moving average basis. The list is expected to get much shorter by the beginning of 2009, Reed Construction Data reported, as the full effects of the credit freeze begin to show up in the data. Figure 2 shows Reed Construction Data’s State Economic Activity Index broken down into regions.

Figure 1: Expectations for 2009
In 2009, what do you expect your firm’s business to be?
Outstanding 4%
Excellent 12%
Good 46%
Satisfactory 23%
Poor 15%
Source: 2009 AEC Business Trends Survey (ZweigWhite)






Every year, ZweigWhite gathers data for its Financial Performance Survey of Architecture, Engineering, Planning & Environmental Consulting Firms from participating firms about their projected revenue growth over the coming three-year period. The survey’s 2008 findings, listed in Figure 3, show that firms located in the Middle Atlantic region are anticipating the highest percentage of growth, with a three-year projected firm revenue growth rate of 37.2%. Firms located in the mountain region ranked their growth rate second at 31.9% and firms located in the South Atlantic rounded out the top three with a projected 28.1% three-year growth rate.

These findings are similar to the AIA’s latest Architecture Billings Index (ABI) rating released in December 2008 that shows that while billings are at their lowest level across the board, firms in the North East and in the South are reporting somewhat better performance over firms in the West and Midwest, as Figure 4 shows.

ZweigWhite’s 2009 AEC Industry Outlook report explores in depth how each of the nine U.S. Census Bureau regions have performed in 2008 and are expected to do in 2009. The nine regions covered are: New England, Middle Atlantic, East North Central, West North Central, South Atlantic, East South Central, West South Central, Mountain, and Pacific.

Figure 2: State Economic Activity Index, by Region
Great Lakes -3.30%
Pacific -2.80%
Rocky Mountain -2.50%
South Atlantic -2.40%
Plains -1.60%
Mid-Atlantic -1.40%
New England -1.30%
Gulf Coast 1.00%
Source: Reed Construction Data and the Philadelphia Federal Reserve Bank








Figure 3: Three-Year Projected A/E Firm Revenue Growth Rates by Region
Middle Atlantic 37.2%
Mountain 31.9%
South Atlantic 28.1%
New England 24.2%
South Central 21.2%
North Central 21.1%
Pacific 21.0%
**Note: South Central and North Central regions combine East and West divisions reported by the U.S. Census Bureau. Source: 2008 Financial Performance Survey of A/E/P & Environmental Consulting Firms (ZweigWhite, 2008)







Figure 4: AIA Billings Index, November 2008
North East 39.5
South 36.8
West 33.5
Midwest 31.4
Source: The American Institute of Architects (AIA)




International Forecasts
How the rest of the world is faring in economic terms is vitally important to AEC firms if not directly by their doing work there, then indirectly for the AEC firms that are working overseas and all the other areas of the economy that are linked to the international marketplace that can affect business at AEC firms in the U.S. As each year passes, the AEC industry becomes increasingly globalized, as more and more firms participate in international projects and set up offices on foreign soil. The international summaries section of the 2009 AEC Industry Outlook report was greatly expanded over previous years and contains lots of information about what AEC firms working overseas can expect to see happen in 2009.

Entering international markets has been a viable growth strategy for numerous design and construction firms in recent years, and 2009 will also offer opportunities to U.S.-based firms looking for work overseas. An international strategy can help protect firms from a downturn in U.S. markets by increasing geographic diversity and allowing firms to tap into rapidly expanding markets in other areas of the world.

However, while looking for work abroad can be a great coping mechanism, most industrialized nations around the world are experiencing a slowdown or recession similar to what’s going on in the U.S. Canada, the UK, most of Western Europe, and parts of Asia are feeling the same pressures as the U.S. on a slightly delayed schedule. Some Latin American economies and China have already implemented massive infrastructure stimulus programs to combat the downturns they are facing at home.

There are few bright spots in the international AEC community, as nearly every country has been exposed to the economic crisis in one way or another. Some countries in Africa and the Middle East are expecting large growth rates in 2009, but these figures in nearly all cases are still significantly smaller than these countries have seen in recent years. India and China felt the economic crisis impact very suddenly at the end of 2008. The whole world, it seems, is seeing a shift in economic activity and an evaporation of wealth.

2009 AEC Business Trends Survey Results
In conjunction with the AEC Industry Outlook report, each autumn ZweigWhite surveys firm leaders about their businesses in the previous nine months and what they see coming down the pike in the year ahead. For the first time since ZweigWhite began compiling this report, AEC firm leaders have turned generally pessimistic about their firms’ performances in 2008 and 2009. According to this year’s survey, only 16% of firm leaders think their business will be “outstanding” or “excellent.” Another 15% feel that business will be “poor” in 2009.

Similarly, a majority of firm leaders (58%) feel that both the AEC industry and the U.S. economy will perform the same. This is a worrying sentiment, because in the past, AEC firm leaders have always been bullish about the prospects for their industry. This year, only 35% of AEC firm leaders responding to the survey felt that the AEC industry will outperform the U.S. economy, the lowest total ever, and an indicator that the economic crisis is hitting the AEC industry hard.

For more details about what AEC firm leaders think of business in 2008, the prospects for 2009, how the new presidential administration will impact them, and other major issues facing their firms in 2009, see Chapter 4 of ZweigWhite’s 2009 AEC Industry Outlook report.

Figure 5: In 2009, what do you expect your firm’s business to be?
Outstanding 4%
Excellent 12%
Good 46%
Satisfactory 23%
Poor 15%
To order your copy of ZweigWhite’s 244-page 2009 AEC Industry Outlook: Strategy and Insight for Design & Construction Firms report filled with over 100 full-color graphs, charts, and the most current information available, please visit www.zweigwhite.com/go/outlook2009 today.





         
 

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