Strategic Realities: Mid-Year 2012

Activity Still Outpaces the Numbers, but The Picture is Becoming Brighter

We are well past the mid-year point; everyone is reporting increased bidding or proposal opportunities; yet, at the end of June 2012, the amount of non-residential new commercial construction contract awards was still tepid, even slightly behind last year, at this same point.  Specifically, total new non-residential contract awards totaled just under $1.8 Billion, indicating a market of around $3.6 Billion for this year.  That number would still be appreciably better than last year’s $3.35 Billion.  (Note: These numbers do not include Exxon/Mobil, which is certainly well underway.)

To be a better year, however, the market needs to shake off the “2nd half syndrome”.  In all of the past 3 years, decent mid-year numbers declined in the last 6 months.  There is every reason to predict that won’t happen this year, however.  Here’s why:

• The number of office projects in pre-construction planning or design keeps expanding.  Tim Relyea has projected 25 office projects in March; that number has grown to almost 50 in July, according to several sources.
   
• The drivers of construction activity all remain bullish.  Recent reports from the Greater Houston Partnership’s Economic Advisory Panel, (where my partner Candace Hernandez is a member) show:

1. Office Absorption year-to-date (YTD), 1.4 million square feet (msf) has been absorbed; 75% of that has been in West Houston.  Currently, there is 2.7 msf under construction; 50% of that is pre-leased.  The 2nd quarter overall vacancy rate is 13.9%, and the Woodlands has 99% occupancy.
    
2. Industrial Space (Warehouse, Flex/Service and Manufacturing Buildings) – CBRE reports 4.5 msf under construction; 53 industrial projects, most of it in the 290 corridor.
    
3. Retail Space – The vacancy rate remains low at the mid-year point, 7.9%, with 1 msf under construction.  Out of town retailers continue to seek a Houston presence; for example Arhaus Furniture from Ohio just leased the old Barnes & Nobles in the Galleria.
    
4. Multi-family Housing – Occupancy has now reached 89.4%, up another full percentage from the 1st quarter.  Absorption in the 2nd quarter was 6,500 units, outpacing the 1st quarter number of 6,000 units.  Another 9,478 units are under construction, down from the historical average of 10,000 units under construction, but well above the recession low of 1,121 units.

• Other Houston economic activity is increasing as well.  The city will add 85,000 jobs this year, more than projected earlier.  Port tonnage is up 6%; home sales are up 16% and InfoNation expects 315,000 automobiles to be sold in 2012, revising their original forecast of 275,000 units.  Auto sales are up 33.4% over last year, through July. This town is alive.
   
• But the granddaddy of all drivers remains the energy business, and oil north of $80/barrel (bbl) portends continued expansion.  If natural gas, now hovering around $3/Mcf, can move to the mid-$4 range, then there will be even more activity.  The U.S. Energy Information Administration (EIA) projects West Texas Crude to average $88 per barrel for the 2nd half of 2012 and natural gas to average just $2.58 because of the current trillion cubic foot inventory.  (As of this writing, oil is over $90/per barrel and natural gas at $2.75/Mcf.)
   
• Eagle Ford Shale is a true phenomenon, an old fashion “boom”, similar to the gold rush days, with man camps and travelers from everywhere.  Projections of how long it will last vary widely, but 10 years seems to be the very minimum!

Only two historically strong markets remain relatively dormant, the Medical Center and K-12 schools, but there are stirrings in both.  M.D. Anderson has some projects getting under way and several other institutions are reviving or initiating plans.  Houston ISD plans to ask voters for $1.9 billion in November; other districts are planning for bond programs as well.  Districts with approved bonds, but no maintenance and operations funds, are seeing some relief as employment increases and their tax revenues expand.  Institutional, religious and other types of public work markets remain steady or are increasing slightly.

When you look at everything going on, the numbers should become increasingly stronger over the last six months.  The total volume of new contract awards in the 10 county area around Houston should fall into the $3.6 to $3.8 Billion range, not including the Exxon/Mobil project.

But, we still could be affected by negative forces both domestically and internationally.  The anemic U.S. employment growth in the first six months of the year is slowing; employment remains too high, at 8.2 %.  The election rhetoric, so viciously negative, dampens growth spirits, as do the real uncertainties: taxes, regulations and health care options.  Businesses are still reluctant to make hiring or capital commitments.

Western Europe remains in turmoil, Greece and Spain, in particular.  Many large American banks have net exposures in the billions in these countries.  Brazil’s economy has slowed dramatically; and China’s and India’s economies have cooled as compared to their past patterns.  There is still global tentativeness about making growth-driving investments, in most places.

That does not seem to be the case in Houston, however; people appear to be capable of committing to projects, finding the funding and moving toward construction.  This condition sets up an opportunity to re-examine your current strategy and mindset.  The markets of late 2012, 2013 and forward for 3 – 5 years should allow you to choose segments where you can be compensated for differentiated value that brings competitive advantage.  The “survival mode”, low-margin, low-fee environment and all of its consequences, should be able to be abandoned completely over the next 12 months; but firms must consciously choose to change!

As you think about revising your strategy however, there are hard realities to consider.  Here they are:

• In the short term (3 to 6 months) fees will stay unbelievably low.  Some companies must show year over year revenue growth for investors.  They will “buy” it if necessary.
   
• Many current projects were acquired, by a number of companies, at brutally low margins or fees with no profit.  As the market expands, these firms will not have the working capital necessary to complete projects.  Bonding companies anticipate increased failures.  Know your partners well.
   
• As work expands, the skilled worker shortage will escalate rapidly.  The adoption of the Construction Career Collaborative (C³) program must be accelerated, and immigration reform becomes even more imperative.
   
• Additional companies are seeking an entrance into Houston.  Talent raids will increase.  Stay close to your team.
   
• Payment cycle time is increasing, especially on the part of corporate America; 90 to 120 days is becoming the norm.  Don’t be blindsided.
   
• There is a real trucking shortage because of Eagle Ford Shale and the Permian Basin expansion.  It is affecting deliveries of construction supplies.

Certainly there is still the need for tough-minded management of all day-to-day activities and costs.  But also, it is a time for leadership-making strategic choices to give your firm a value-based competitive advantage and a time to then create the changes that will allow you to realize those gains.  It is a significant and positive change from this point last year!

The mission of Kiley Advisors, LLC is to support CEO and Senior Executives, in Commercial Construction Firms, with their Strategy and Leadership responsibilities.