By the Editors of Concrete Products
As U.S. cement consumption nears 80 million metric tons, Congressional drama threatens to stifle a return to 2005 record highs.
A year ago, the concern was resolving the so-called “fiscal cliff” that threatened to erase all gains in the 2012 U.S. construction markets just as 2013 was beginning. Thankfully, Congress postponed that crisis, allowing 2013 to experience a 4.5 percent increase in total cement consumption (portland and masonry), over 2012 levels, to slightly more than 82 million metric tons. Additionally, consumption levels are expected to reach 86 million metric tons in 2014, an 8.1 percent year-over-year gain.
However, once again, growth in U.S. construction markets could be dampened by Congressional squabbling, which has the tendency to erode consumer confidence and hinder recovery, according to the latest forecast from the Portland Cement Association (PCA). “American consumers love drama. Moreover, Congress knows how to create it, with more on the way when the debt ceiling talks resume in early in 2014,” says Edward Sullivan, PCA group vice president and chief economist. “Each time the political circus on Capitol Hill addresses extensions of the debt limit, budget approvals or the fiscal cliff, it harms the burgeoning economic momentum.”
Consumer and business confidence is a key ingredient for stronger economic gains, explains Sullivan. Recessions generate pent-up demand to correct their imbalances, and large imbalances need a long correction process. While the economy is positioned for stronger growth, it needs a trigger to unleash this potential. The trigger lies with consumer and businesses willingness to spend and reinvest in capital. Congress can easily derail recovery momentum with political drama created by the federal shutdown and debt ceilings.
During 2014, it is possible that all sectors of construction—residential, nonresidential and possibly public—record growth. While the growth will be broad based, half of it anticipated for 2014 will come from residential construction activity where there is the largest amount of pent-up demand; the commercial and institutional sector will contribute another 25 percent. PCA predicts real construction spending to grow 1.3 percent in 2013 and 8.0 percent in 2014.
Sullivan believes the trough point for roadway construction was reached in 2013. “Improving state finances could provide surpluses by 2015 that states can apply to neglected infrastructure spending,” he affirms.
Perhaps most exciting—and possibly nerve wracking—for cement producers is that according to PCA projections extending to 2018, the end of the forecast horizon, portland cement consumption is expected to reach nearly 119 million metric tons—roughly three percent below the past cyclical peak of 122 million metric tons consumed in 2005, which implies a 14-year recovery. The only reason this may be of concern to U.S. cement producers is that presently the nation’s clinker capacity (assuming all plants are running at 100 percent capacity, which is rare) is approximately 105 million-metric-ton/year, meaning a substantial increase in imported powder—to the tune of about 40 percent of all cement consumed in 2018, according to PCA.
Sullivan reminds us that changes in cement consumption are dictated by changes in construction activity and cement intensity, which measures the amount of cement used per real dollar in building and nonbuilding projects. Many factors impact changes in cement intensity, including the amount of starts activity to total in building and nonbuilding projects, changes in the composition of construction, changes in the regional composition of cement demand, and changes in the competitive price position of concrete against alternative materials.
During the recession, massive declines in construction activity were reinforced by equally large declines in cement intensity—the combination of both factors resulted in the unprecedented 54 million-metric ton decline in cement consumption from 2006-2010. In the initial stages of the recovery, starts as a percentage of total construction activity increased—pushing intensity upward and enabling modest cement consumption gains in the context of marginal declines in overall construction activity. A new pattern of intensity is now under way, whereby construction activity and intensity gains reinforce one another, prompting more robust gains in cement consumption.
A mainstay in construction-industry forecasting and business planning, the Dodge Construction Outlook predicts that total U.S. construction starts for 2014 will rise 9 percent, to $555.3 billion—higher than the 5 percent increase to $508 billion estimated for 2013. The Dodge projections were made at McGraw-Hill Construction’s 75th annual Outlook Executive Conference, earlier this fall in Washington, D.C.
“We see 2014 as another year of measured expansion,” says McGraw-Hill Construction Vice President of Economic Affairs Robert Murray. “Against the backdrop of elevated uncertainty and federal spending cutbacks, the construction industry should still benefit from several positive factors going into 2014. Job growth, while sluggish, is still taking place. Interest rates remain very low by historical standards, and in the near term, the Federal Reserve is likely to take the necessary steps to keep them low. The bank lending environment is showing improvement in terms of both lending standards and volume of loans. And, the improving fiscal posture of states and localities will help to offset some of the negative impact from decreased federal funding.”
PCA’s Sullivan reminds readers in his report that forecasts are assessments based on assumptions, historical trends and correlations, and that the association’s Market Intelligence Group has always assumed that Congress eventually acts rationally given what is at stake for the economy. “This assumption implies that politicians eventually reach compromise and thereby minimize the near-term disruptive economic aspects associated with budgetary matters,” he says. “With some frustration, our assumptions regarding the political arena have proven faulty—time and again.
“The latest shut-down of the government offers only the most recent evidence. Each time the political circus on Capitol Hill addresses extensions of the debt limit, budget approvals or the fiscal cliff, it harms the burgeoning economic momentum—adversely impacting the implied economic recovery path of the economy. PCA’s assumption that Congress acts rationally, without imparting harm on the economy, has been a faulty assumption,” Sullivan concludes.
PCA now expects Congress’ irrational behavior will continue and has incorporated this as a structural reality in forecasting near-term economic growth, thereby assuming congressional actions will have a short-lived, adverse action on economic growth. The association assumes the debt limit compromise crisis, and the resulting disruption to economic momentum, will become an annual event.
PCA estimated that the recent political impasse resulting in the government shut down cut fourth-quarter GDP 0.2 to 0.3 percent. In addition, the stride of growth was disrupted. Through 2016, PCA assumes a 0.4 percent reduction in GDP growth attributed to Congress’ high-wire politics and its adverse impact on the economy in 2014 and an incrementally smaller reduction in 2015; no reduction is made in election-year 2016, when Congress is expected to behave.
A significant strengthening of real GDP growth, approaching 3 percent in economic growth, is expected to materialize soon. This assessment is based on the continued improvement in the underlying fundamentals, an easing in lending standards, stronger consumer and investor confidence, and the gradual release of huge amounts of pent-up demand.
PCA expects a gradual recovery in economic sentiment will materialize through the end of 2013. After that, attention will flow back to Washington, and sentiment gains are likely to be briefly derailed, with economic growth becoming somewhat subdued. Beyond the first quarter, sustained gains in sentiment are expected to materialize—setting the stage for stronger 2014 economic growth.
Nearly half of the anticipated growth in 2014 cement consumption is expected to be attributable to gains in residential construction, according to PCA. Homebuilders are unlikely to significantly accelerate construction activity until two critical conditions are met: 1) low levels in inventory of unsold new homes reflecting no higher than five months’ supply; and 2) stable or rising home prices. Both conditions are likely to be required to insure an adequate ROI for homebuilders to spur an increase in building activity. PCA believes both conditions are in place, but if either condition is lacking, a substantive recovery in home building will not materialize.
Home inventories are lean and home prices are rising, sending a clear signal to homebuilders to accelerate building activity. This assessment is further amplified in the context of stronger 2014 economic growth, job creation and consumer sentiment. Housing starts are expected to reach more than 1 million units, with single family construction near 750,000 starts during 2014—expected to reach nearly 1 million starts by 2015. Strong multifamily construction is expected to persist throughout the forecast horizon.
Single family sales increased by 9.6 percent in 2012 and are on pace to grow another 11 percent in 2013. PCA expects single family sales will increase another 10 percent in 2014. The dynamics shaping single family sales, however, are rapidly changing. The combination of low mortgage interest rates and declining home prices in the context of steady job growth resulted in a dramatic improvement in home affordability measures. This affordability improvement was amplified due to the large presence of distressed properties in the market resulting from short-sales and property defaults.
According to the National Association of Realtors, the price discount for foreclosed properties ranged from 14 to 34 percent, depending on the condition of the home. For short-sale properties, the price discount ranged from 12 to 22 percent, again, depending on the condition of the property. At its peak, roughly 36 percent of total single family sales during 2010 involved distressed properties. These “bargains” enabled marginal prospective buyers an unprecedented opportunity to purchase a home. In addition, the “bargains” attracted cash-paying real estate investors. Both factors played a significant role in single family sales gains of the past two years.
Single family distressed properties accounted for 36 percent of total single family sales. Currently, distressed properties account for 18 percent of total sales, and it is likely that distressed sales will account for an even smaller share of overall sales into the future. This assessment is based on the reduction in foreclosure activity, the ability of distressed homeowners to refinance and avoid default, as well as the improvement in the job market—all working to reduce the amount of distressed properties coming on the market in the near term.
This implies that the burden for generating sustained gains in home sales going forward will increasingly fall on the underlying improvement in homebuyer fundamentals. PCA believes the fundamentals support continued strong gains when the following is considered:
Job Growth: Job creation is critical in generating household formation and favorable homebuyer affordability. The U.S. is on pace to create 2.2 million jobs in 2013. Looking ahead, PCA expects roughly 2.2 million additional jobs to be created during 2014 and roughly 2.5 million in 2015.
Lending Standards: Tight lending standards have been a hindrance to the housing recovery. From 2007 through 2010, lending standards tightened dramatically in response to rising home loan defaults. Through 2011 and the first half of 2012, neither the tightening nor loosening of lending standards materialized. Since the second half of 2012, lending standards for conventional mortgages have eased on a significant and sustained basis. Recently, some easing has also begun to materialize for non-traditional mortgages. Lending standards for home mortgages are expected to ease throughout the foreseeable future as the perceived lending risks subside, but are not expected to return to pre-bubble levels and instead are expected to remain more in-line with long-term norms.
Consumer Affordability: Mortgage interest rates have increased nearly 100 basis points since the start of the year, but remain 230 basis points below the past cyclical peak. Mortgage rate increases, coupled with the ongoing recovery in home prices, have combined to increase the average monthly payment by $150. Average monthly payments, however, remain 32 percent below the past cyclical peak. While affordability may become a concern in the back-end of the forecast, it is not expected to pose a significant threat to near-term stronger sales activity.
Consumer Willingness to Buy: Consumer attitudes, according to PCA’s scenario, increasingly focus on the positive economic fundamentals rather than the adverse political uncertainty. This leads to rather significant second-half gains in sentiment. Furthermore, rising home prices may stir potential homebuyers to act more quickly.
PCA believes the economic environment seems poised to support strong annual gains in overall home sales. While distressed properties will remain on the market for years to come, they will play an increasingly less important role in sales activity. As foreclosures and short sales exit the market, the share of new home sales is expected to increase. Based on a 20-year average, new homes sales represented 14 percent of all home sales. Since 2009, this number was cut more than in half to 6.7 percent. This gradual refocusing on new homes is expected to add support to stronger new home construction outlook going forward.
Homebuilders are unlikely to significantly accelerate construction activity until low levels in inventory of unsold new homes reflecting no higher than five to six months’ supply. Overall, home inventories currently stand at 2 million homes or five months’ supply. This represents roughly a 135,000-unit reduction in homes on the market and a significant improvement from six months’ supply in 2012. Keep in mind, this measure is based on current daily selling rate. The expected increase in home sales will likely translate directly to new home construction given the very lean inventories. With respect to inventory conditions, the signal for home builders to accelerate starts activity is in place.
Homebuilders are also unlikely to significantly accelerate construction activity until stable or rising home prices materialize. Existing home prices increased nearly 7 percent in 2012, are expected to end up more than 11 percent in 2013, and are projected to increase nearly 6 percent in 2014. This is predicated on PCA’s assessments regarding foreclosures, economic growth and accelerated sales activity.
The Dodge Construction Outlook forecasts single family housing to grow 26 percent in dollars, corresponding to a 24 percent increase in unit starts, to 785,000 (McGraw-Hill Construction basis). The positives for single family housing are numerous—the pace of foreclosures has eased, home prices are rising, and mortgage rates remain near recent lows. However, the demand for housing will continue to be restrained by careful bank lending practices, believes McGraw-Hill Construction’s Robert Murray.
“The 2014 picture bears some similarity to what’s taking place during 2013, with single family housing providing much of the upward push; multifamily housing showing a slower yet still healthy rate of growth after four years of expansion, and commercial building gradually ascending from low levels,” notes Murray. “One change that’s expected for 2014 is that institutional building will no longer be pulling down nonresidential building and total construction.”
Multifamily starts recorded a 40 percent gain in 2012, and are running at a 23 percent growth pace in 2013. PCA expects an additional growth of 13 percent in 2014 to 345,000 units. Household formation continues to strengthen while damaged credit due to foreclosure activity and tight mortgage lending standards have combined to create robust apartment demand. Furthermore, the U.S. population is aging and through the foreseeable future demand for multi-unit, assisted-living complexes and condominiums will increase further.
Finally, many would-be entry-level home buyers are burdened with high student loan payments—delaying their entry into the single family market to the benefit of multifamily demand. This bright outlook for demand has reduced banks’ perceived lending risk to multifamily investments resulting in greater access to capital markets. The formula of strong demand conditions and easier access to capital leads to sustained gains in multifamily construction throughout the forecast horizon.
According to the Dodge Construction Outlook, multifamily housing will rise 11 percent in dollars and 9 percent in units. While growth continues, the percentage gains will be smaller than the previous four years, reflecting a maturing multifamily market, says the Dodge report. This structure type is still a favored investment target by the real estate finance community, which in the near term should lead to more high-rise residential buildings in major cities.
Nonresidential construction declined 45 percent during 2008-2011. Amplified by severe intensity weakness, nonresidential cement consumption declined 75 percent during the same period. The nonresidential sector has shown a solid recovery since 2011 and is expected to achieve sustained gains in both construction activity and cement intensities throughout the forecast horizon. These factors are expected to result in moderate-to-strong gains in cement consumption.
Currently, nonresidential cement consumption is tracking at nearly a 22 percent year-over-year gain for 2013. PCA expects nonresidential cement consumption will increase near a 20 percent growth rate through 2016. Even with these strong growth rates, 2016 nonresidential cement consumption will remain roughly 17 percent below 2007 levels.
About 25 percent of the anticipated growth in 2014 total cement consumption is expected to be the result of expected gains in nonresidential construction. These gains will likely be driven by growth in the expected ROI for commercial properties. However, several issues still confront the recovery in nonresidential construction. Expected ROI’s will continue to be hindered by high-but-improving vacancy rates and soft-but-improving leasing rates. Commercial asset prices are expected to rise gradually with the slow easing in tight lending standards. In each instance, the conditions are improving and will add to supporting growth in nonresidential construction activity.
The rate of improvement will depend on job creation, which either directly or indirectly, translates into higher occupancy and leasing rates. Combined, these factors determine the expected ROI for most commercial properties. An improvement in office construction, for example, occurs only after job creation is strong enough to improve occupancy rates and reduce vacancy rates. Given sustained job creation and a lowering of vacancy rates, the leasing rates will first stabilize and then improve. Only when both conditions are present—declining vacancy rates and improving leasing rates—will expected increases in commercial construction activity materialize.
Nearly 7.5 million jobs have been created since the economic collapse. PCA expects 2.2 million additional jobs will be created in 2014 and an additional 10.3 million new jobs will be created by the end of the forecast horizon (2018). Such growth sends a signal to investors that there is a need for commercial expansion. The rate of improvement will vary widely among regions in the United States.
This growth also sends a signal to banks that the risks associated with loans to commercial real estate are declining as the economy gains traction. The commercial real estate market has been plagued with refinancing issues and tight lending standards. According to the Federal Reserve’s senior loan officer survey, the lending standards facing commercial real estate loans have eased significantly, reflecting 10 consecutive quarters of decline. This adds to the fundamentals facing commercial construction.
PUBLIC WORKS ON THE MEND
As the economy gains momentum, job gains will add strength to states’ ability to spend, and rising home prices will eventually support stronger construction spending at the local level as well. Still, both these conditions need some time to brew before resulting in a significant positive impact on public spending.
Roadway construction accounts for the largest area of public cement consumption. While this sector has suffered difficulties, PCA believes a trough point was reached in 2013. Growth, enabled by improving state finances and Transportation Infrastructure Finance and Innovation Act (TIFIA) spending is expected to push this sector to record successive gains during the back end of the forecast horizon. The expected growth in road construction is not tied to a new robust highway bill.
In terms of highway spending, MAP-21 (Moving Ahead for Progress in the 21st Century) allows for a 1.5 percent increase for inflation in fiscal 2014. Thereafter, PCA holds nominal spending constant through 2018, although inflation is expected to gradually reduce the potency in each successive year in the forecast. A new highway bill, funded at higher levels, would imply upside risks to the forecast.
According to PCA’s scenario, roadway construction is tied to a recovery in state and local finances. State revenue collections have been increasing in tandem with job creation. PCA expects 2.2 million jobs will be created in 2014, 2.4 million in 2015, and even stronger job growth through 2018. This suggests continued strong growth in state revenue collections and an eventual return to budget surpluses by fiscal 2015.
With this, PCA expects an increase in state spending. Although discretionary state construction spending was hit hard during the recession, during the 10 years preceding the economic downturn, state highway/road construction discretionary spending accounted for roughly 2.4 percent of total state expenditures. Cutbacks in state discretionary highway/roads spending accounted for only 2.1 percent in 2008, 1.9 percent in 2009, and 1.8 percent in 2010. PCA expects the share of state spending dedicated to road construction will increase once state fiscal conditions turn to surpluses.
According to PCA’s forecast, the share rises to nearly 2.0 percent. This increase in spending share is mindful of competing state spending priorities, but also recognizes that infrastructure spending has been neglected during the downturn and the potential of pent-up demand that has been generated. The combination of stronger fiscal conditions and the potential of a gradual increase in emphasis on infrastructure spending within state budgets implies stronger state spending.
Furthermore, the new highway bill reinforces the likelihood that state and local spending will increase significantly during the forecast horizon. According to the new highway bill, a 10-fold increase in funding of TIFIA is planned. Compared to fiscal 2012 funding levels of $122 million, TIFIA funding increased to $750 million in fiscal 2013 and should reach $1 billion in 2014. These increases provide greater ability for state and local governments to finance large-scale construction projects.
Finally, PCA expects an increase in local spending on public construction beginning in fiscal 2016. While localities receive state and other funding, roughly 75 percent of tax revenues are based from property taxes. Unfortunately, property values declined dramatically during 2006-2011, thereby reducing local budgets and construction spending.
Using local employment as a proxy for local spending activity and home prices as a proxy for property taxes, PCA estimates there is a three-year lag between changes in home prices and local spending activity. On a national basis, home prices began recording sustained gains in mid-2012. This implies an increase in local spending activity could begin in mid-2015 (fiscal 2016). Furthermore, analysis suggests that municipalities have gradually increased the millage rates applied to properties. As home prices rise, therefore, there is the potential that localities receive an additional boost to budgets via the higher property tax rates.
According to the Dodge Construction Outlook, public works construction will drop 5 percent, pulling back after a 3 percent gain in 2013 that was lifted by several large highway and bridge projects. The report predicts that more focus on deficit reduction will limit federal support for environmental public works, although the improved fiscal position of state and local governments will help cushion the extent of decline.
BEST OF THE REST
Based on significant research and in-depth analysis of macro-trends of 2013 activity and 2014 prospects, the 2014 Dodge Construction Outlook details the forecasts for each of the remaining construction sectors:
• Commercial building will increase 17 percent, a slightly faster pace than the 15 percent gain estimated for 2013. Both warehouses and hotels will continue to lead the way, while stores and office buildings pick up the pace. The positives for commercial building are improving market fundamentals and more bank lending for commercial development. Next year’s activity in dollar terms will still be 28 percent below the 2007 peak.
• Institutional building will edge up 2 percent, turning the corner after five years of decline. For the educational building category, colleges are revisiting capital expansion plans, and passage of recent construction bond measures in several states should help K-12 school projects. Healthcare construction is expected to remain flat, given continued emphasis on cost containment.
• Electric utility construction will retreat 33 percent, continuing the 55 percent correction estimated for 2013 that followed the current dollar high reached in 2012. Capacity utilization is down sharply, limiting the near term need for new generating capacity. The need for transmission line work remains strong.
Superior Walls licensees log gains in residential market
Evidencing further positive home building market trends through the third quarter of 2013, above- and below-grade precast wall system licensor Superior Walls of America reported year-to-date order activity 16 percent and 24 percent above figures for the first nine months of 2012 and 2011, respectively.
Superior Walls’ Xi Plus system
“This has been an exceptionally good year with significant growth gains in several geographic pockets across the country,” affirms Superior Walls President Jim Costello. “In the Midwest, our sales have increased 45 percent over the same time period for 2012. Virginia has seen a sales increase of 38 percent over last year and North Carolina a 30 percent increase. These numbers are growing every month, which is a sure indicator that housing starts in these markets are on the rise.”
Superior Walls licensees produce precast concrete foundation and wall panels for residential and commercial applications. Superior Walls insulated precast concrete wall systems have earned the National Green Building Standard Green Certified Product designation by Home Innovation Research Labs (formerly the NAHB Research Center).
Builders throughout Virginia have been “back to business” in 2013 as the rate of single-family permits rises into the double digits against prior-year activity. “Our phones literally stopped ringing in the last quarter of 2008 when the recession hit, but the calls are now flooding in again,” says Jim Avery, vice president of Superior Walls of Central Virginia. “The custom builder market we had been servicing dried up during the housing market collapse. Now we’re seeing that those builders who survived the downturn have again started new projects.”
In Michigan, a market much harder hit than Virginia, year-to-date sales of Superior Walls products are up almost 50 percent over the same 2012 timeframe. “[Ours] was one of the first states to go into a recession, and now it appears to be one of the first states to come out of it,” notes Great Lakes Superior Walls President David Van Baren. “While there are hot spots in the Grand Rapids and Traverse City areas, the entire state—and actually most of the Midwest—is seeing positive growth. I expect this acceleration of sales to increase through the end of 2013 and into 2014.”