Caution: Turbulent Waters Ahead

It had to end sometime, but we'd all rather it had gone out with a whimper than a bang. The nation's decade-long run of good economic luck—historians will record it as America's longest period of economic prosperity—has come to an abrupt halt. And now the best that can be reasonably hoped for is that the nation is in the middle of—not just beginning—the current p...

12/01/2001


It had to end sometime, but we'd all rather it had gone out with a whimper than a bang. The nation's decade-long run of good economic luck—historians will record it as America's longest period of economic prosperity—has come to an abrupt halt. And now the best that can be reasonably hoped for is that the nation is in the middle of—not just beginning —the current period of recession.

Prior to the terrorist attacks on the World Trade Center and the Pentagon on Sept. 11, the U.S. economy was walking a precarious tightrope. Throughout the summer, manufacturers' new orders fell, unemployment rose and retail sales were sluggish. However, there were some positive signs as well. Home sales remained strong, interest rates were low, consumer confidence stabilized after a period of decline and federal tax rebate checks carried the potential to boost retail sales into the critical holiday buying season.

But then a metaphorical earthquake hit the nation on the second Tuesday in September, and a tragically ironic 9-1-1 call went out to help an economy that couldn't possibly maintain its balance on the high wire. The devastating physical and psychological damage caused by the terrorist attacks made a recession unavoidable.

Further, the indeterminate economic impact and political uncertainty resulting from the Sept. 11 attacks and their aftermath renders standard forecasting models all but useless. It's difficult—no, actually, impossible—to quantify, much less predict, the economic impact and ultimate consequences of a war against an enemy that aspires to martyrdom.

The outlook for 2002 hinges upon a host of intangibles almost too numerous and amorphous to identify. So this time around business planning is particularly fraught with difficulty. Given a reasonable degree of diligence, discipline and careful incorporation of past experience, M/E firms can usually develop budgets, business expansion plans and marketing initiatives in which they have a high degree of confidence, plus or minus 10%, allowing some room for the unexpected or unknowable. But in planning for 2002, the degree of underlying uncertainty makes plus or minus 25% about as accurate a goal to which the industry can truthfully aspire.

Economists may be in a better position to make educated guesses than the general population about how 2002 will ultimately play out. But, truth be told, at this uncertain juncture in our political history, economists are no more prescient about the global economic future than are market-savvy engineers.

U.S economic outlook

Nevertheless, there is a general consensus developing that the U.S. economy won't grow much more during 2002. Following gross domestic product growth of 4.1% during both 1999 and 2000, it now looks like the economy will be lucky to expand by 1.1% during 2001.

The arguably "bright" side of this scenario is that the United States is likely to enjoy low interest rates and low inflation during 2002. The federal government has made it clear that it will pursue as loose a monetary policy as is necessary to maintain the integrity of the global financial system. And weak worldwide demand will keep commodity and materials prices low, while simultaneously dampening labor market inflationary pressures.

Furthermore, in the aftermath of the terrorist attacks, President Bush and U.S. Congress have committed themselves to an economic stimulus package worth between $70 billion and $120 billion. Although the details are taking a long time to work out, it's clear that consumers will benefit from additional tax rebates/cuts and that businesses will enjoy at least temporary benefits from investment tax credits and accelerated depreciation schedules.

Despite these welcome incentives, it's hard to imagine they'll be enough to overcome the negative forces unleashed by the events of Sept. 11th. Overall, there's an inertial wait-and-see attitude governing both business and consumer behavior because of the enormous degree of uncertainty regarding the economic outlook. In the uninspiring weeks immediately following the always-feared—but now intensely-experienced—terrorist threat, it seems that the only thing we have to fear is ... everything. And this has been more than enough in recent months to send an already-skittish economy into a full-blown recession.

Despite the current unnerving state of affairs, however, comfort can be taken in the fact that the economy is in reasonably good shape to weather even this once-in-a-generation sort of storm. Unlike the time of our last recession, more than a decade ago, neither housing nor commercial construction markets are overbuilt. Building activity has fallen and vacancy rates have risen since the recession began, but there isn't a huge inventory of speculative space that burdened the market during the early 1990s. And manufacturers, wholesalers and retailers have all been working for the better part of a year now to pare excess inventories. These factors will all cushion the current blow and put the economy in a good position to realize solid gains in activity—once the recovery materializes.

Another difference is the fact that the economy has become more closely tied to the economies of the rest of the world. This increased interdependence means that any pickup in the fortunes of the United States would be quickly transferred to our major trading partners, and would help reinforce and even accelerate the global economic recovery. But at the same time, any further deterioration in the health of the economy could lead to even less consumer and business demand for products made elsewhere in the world, and could send the world economy spinning into a dizzying downward spiral unlike any we've experienced since the Great Depression.

On the other hand, given the checks and balances of modern economic systems, and the sophistication of economic policy makers in the United States and other nations of the world, a total loss of control over global economic forces is highly unlikely.

Making sense of the numbers

So, what does all of this mean for construction industry developers, suppliers and distributors? In a general sense, the fluidity and unpredictability of the year ahead means that the direction of the global economy and U.S. markets is more important than ever. The combination of plunging business and consumer confidence, higher unemployment and slow to no growth in household income can't help but have negative implications for construction end-markets.

However, as strange as it may be, some building and construction markets may fare even better during 2002 than previously forecast, as a result of lowered interest rates and substantial funding appropriated for rescue, recovery and cleanup.

Although office and industrial vacancy rates rose steadily throughout 2001, they're still reasonably low by historical standards. Without an overbuilding boom, the market should be able to avoid any real danger of bust in this period of diminished demand.

Some comfort can also be taken in the fact that the construction industry entered this recession in reasonably good shape—certainly in much better health than the nation's manufacturing sector. While the rest of the economy was struggling to keep its head above water throughout 2001, the construction sector continued to grow through the first nine months.

Through the first three-quarters of this year both housing starts and single-family home sales defied the consensus forecast and expanded at modest rates. And the value of total residential market construction—with improvements—was 6% greater over the first nine months of 2001 than from January to September of 2000.

Spending for the construction/renovation of nonresidential buildings was still growing at a 5.4% annual rate through September of this year, down only modestly from the 8.1% growth recorded between 1999 and 2000. But market conditions were clearly deteriorating during the late summer and early fall—particularly for the commercial subsectors—and the full-year 2001 gain will undoubtedly be several percentage points lower than the current year-to-date trend.

The general sense of what sectors will be the weakest during 2002—in terms of declines in the actual dollar value of construction work completed—are:

  • Hotels.

  • Retail buildings.

  • Office buildings.

  • Industrial buildings.

  • Airport terminal construction and renovation projects.

  • Any public project requiring a substantial amount of state/local matching funding.

  • Convention centers, sports stadiums, movie theaters, theme parks or other recreational facilities.

The strongest —or "least weak" markets, given the realities of the overall economy during 2002—are:

  • Institutional facilities.

  • Apartment buildings.

  • Retail buildings focused on consumer basics such as grocery-store-anchored strip malls.

  • Back-up capacity for critical functions, involving parts of all commercial financial transportation and industrial sectors.

  • Security-enhancing redesign/renovation projects for the whole spectrum of existing private and public buildings.

A new reality

All times, in their own way, are challenging for businesses. But these times are especially so. Most businesses—construction-market-related and otherwise—feel a new vulnerability, a new aversion to risk and an increased awareness of the fragility of the "just-in-time" economy in the wake of Sept. 11.

The situation has caused many firms to re-evaluate, postpone and, in a few instances, actually cancel some planned construction projects. And activity will be further constrained in the months immediately ahead because many banks and other funding sources have tightened up their lending standards, particularly for commercial development.

Recessions do not last forever, however, and there's every likelihood that the current one will be a not-too-distant memory at this time next year.

And despite the fact that the near-term outlook may fall just short of "bleak," the medium- and long-term outlook remains decidedly positive. Although the recession of 2001-2002 is unlikely to let any business prosper—except, perhaps, the odd defense equipment or antibiotic manufacturer—profitability and market share improvement is still eminently attainable for companies that are well-managed and focused in the year ahead. Despite the significant challenges that the building/construction industry will face during 2002, the nation's history of resilience in the face of adversity ensures a return to prosperity once the successful "War On Terrorism" promotes a renewed sense of consumer and business optimism.

Nonreidential Construction Forecast

Billions of Dollars 2000

2001(f)

2002(f)

Annual % Change 2000

2001(f)

2002(f)

Source: U.S. Department of Commerce (f) = forecasts [Cahners]

Total Nonresidential Construction

$292.4

$302.3

$300.8

8.1

3.4

-0.5

Commercial Buildings

133.5

129.5

122.4

10.9

-3.0

-5.5

Office Buildings

55.7

55.0

53.2

17.0

-1.2

-3.3

Retail Buildings

61.4

60.1

56.8

8.0

-2.1

-5.5

Hotels/Motels

16.4

14.4

12.4

2.8

-12.1

-14.0

Industrial Buildings

32.1

32.4

30.3

-1.7

1.0

-6.6

Institutional Buildings (Private & Public)

126.8

140.4

148.1

8.0

10.7

5.5

Hospital & Other Healthcare Buildings

18.6

19.2

20.5

6.4

3.0

7.1

Educational Buildings

54.9

63.4

68.4

13.0

15.6

7.8

Other Public & Private Buildings

53.3

57.8

59.2

3.9

8.5

2.3



M/E Firms Gear Up for a Challenging 2002

Even though the economy has entered some rough seas, M/E firms are hoping to keep their heads above water by shifting their focus to more lucrative market sectors—such as pharmaceuticals, schools and hospitals—and by expanding their services.

"There's no question that the worldwide economic slowdown will affect us, but I believe we are sufficiently diversified so that strong performance in good markets will offset problem markets," says Thomas J. O'Neill, president and CEO of Parsons Brinckerhoff, New York.

On a similar note, John Patelski, executive vice president of A. Epstein and Sons International, Chicago, anticipates that a shift in market needs will mitigate the effects of a sluggish economy.

"While certain private sector projects may have been curtailed by recent events, other projects and opportunities designed to address these events are coming to the forefront," says Patelski.

But just how everything will balance out remains a big question mark.

"We are projecting an increase in revenues for 2002," states George E. Toth, a senior vice president with The RJA Group, Chicago, but "no one really knows what will happen."

However, in RJA's case, a recent merger has positioned the firm to grow their security consulting business to compliment the core fire-protection engineering business—two services likely to be in greater demand in light of recent events.

Similarly, Lockwood Greene, Spartanburg, S.C., hopes to compensate for a loss of industrial projects by picking up more security work for airports as well as government, institutional and corporate asset protection.

Concerns over anthrax and biochemical warfare may also create a market niche where engineers can offer their expertise.

"We have been receiving inquiries as to suggested preventive measures with regards to air-intake locations, filtration types, locations of water supplies and susceptibility to potential security breaches in the M/E/P infrastructure," explains Robert Derector, P.E., of Robert Derector & Assoc., New York.

Derector has also seen corporations evaluate the option of decentralizing their personnel and assets in reaction to the events of Sept. 11.

"Certain firms who favored centralization of their locations for logistic purposes are evaluating options to diversify for disaster recovery/business continuity purposes. We anticipate that the eventual implementation of a site-diverse strategy will be the source of additional work," he predicts.

In addition to catering to the market's shifting needs, expanding consulting and construction services appears to be a critical component of a successful M/E business strategy for 2002.

"Those in the M/E industry whose business is primarily based on design and have not shifted their focus to solving M/E facilities problems will suffer," anticipates John F. Hennessy III, chairman and CEO of Syska & Hennessy, New York. "Those who have made the shift will likely grow."

For example, Parsons Brinckerhoff plans to "move beyond our traditional engineering services and offer our clients the full spectrum of design and construction services, including program management and management consulting," states O'Neill.

Overall, many engineers appear cautiously optimistic about the coming months, although not entirely.

"2002 will be a challenging year for the industry with more consolidation, increased unemployment among engineers and more business failures," claims Dr. Yorgos Papatheodorou, a manager for strategic development with Lockwood Greene.

However, as Toth points out, "We are coming off a 10-year expansion of the construction economy. If it softens and turns down slightly, it won't be that bad."

A Little Business Advice

Addressing an audience of construction professionals at Construction Market Data's recent North American Construction Forecast Conference in Washington, D.C., Fortune magazine Editorial Director Geoffrey Colvin offered some perspective on current economic conditions and sound business advice as to how to survive the recession.

"Ten years of economic prosperity have colored our vision of what's good and what's bad," noted Colvin. "From 1971 to 1986, unemployment never went below 5.3%, and now we're worried that it's exceeding 5%. This [the current economy] isn't bad; it's just worse than we've had."

Nevertheless, Colvin predicts that we are in for some tough times. In order to deal with the challenge, Colvin offers a few general suggestions to corporate and business leaders:

Deal with reality as it is now, not as it was, and not as one wishes it would be.

Focus on people. They are the core competency of every institution. The tendency is to cut back on training and development costs during tough times, but developing and evaluating people requires significant investment and is key.

Increase productivity and cut costs.

Drawing from his close contacts with Fortune-500 CEOs and time spent following business trends over the past several years, Colvin also shares a number of specific suggestions as to what companies need to do right now:

Use the slowdown to more critically evaluate people.

Expand the pond. Focus on providing more products and services to clients as opposed to competing for market share.

Get closer to clients to develop a better idea of what their specific needs really are.

Nurture new business ideas.

Lower the company's break-even point by cutting costs.



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