Strategic Realities

2011 has begun with more optimism, for sure.  It is supported by some encouraging facts and activities involving Houston’s energy companies, the real estate community, architects and engineers, even lenders.  However, as it relates to actual non-residential contract awards the facts are still sobering; the market is still significantly depressed.  Data from McGraw Hill suggests that 2011 will be only slightly better for non-residential construction than 2010, well behind 2009, and light years behind the pre-recession 2008 numbers.  While we expect the market to improve over the coming months, it will be gradual, and may not be truly discernible until the 4th quarter of this year.

So what gives reason for optimism?

There are several “front end conditions” that are significantly better than a year ago.  If they continue, they will promote new commercial construction projects over time.  Specifically, the overall Houston economy is better, thanks mainly to the health of the energy companies.  According to the research firm Delta Associates, over the last 12 months the economy has created 56,000 new jobs, which has lead to the absorption of 1.3 millions square feet of space in the 1st quarter.  This is more than all of 2010.

The real estate firms are also reporting significant investor interest in Houston properties as overall vacancy levels are relatively low (12.9%) and rental rates are stable.  Interest rates remain attractive and funding can be found for many projects with terms that are a bit less onerous than in the past 2 years.

The news closer to the industry is even more heartening.  Design firms are hiring again!  One architectural firm reports adding 26 people in the last six months; an engineering firm expects to add 22 this year.  Many others are adding a person or more as well.  Projects put on hold are being brought forward for re-pricing.  There appears to be more awareness that construction prices are very low, and with commodities escalating steadily, this state cannot last.  Consequently, they are exploring their building options.

What Gives Reason for Concern?

But there are clouds on the horizon yet too.  The international economy is recovering steadily, not rapidly, and the US economy is still anemic.  First quarter GDP growth (1.8%) was disappointing, well below the 3.3% that it was supposed to average per quarter.  Unemployment remains at 9%.  Oil at $90+/bbl is good for Houston, but gas approaching $5/gallon is a drag on the recovery.  In addition, the tax breaks afforded the energy companies are under attack in Washington.

There is also concern about the local architect activity being more feasibility studies than real projects.  And, the major market segment for many Houston design and construction firms, Healthcare, remains clouded.  It appears the frenetic expansion programs of all Texas Medical Center institutions are slowing significantly and the reimbursement schedules from healthcare reform are still not definitive.  At best, the structures required moving forward will be smaller, geared to outpatient activities.

And, Houston still has 8.8% unemployment.  Construction is projected to lose jobs this year as backlogs are depleted.  And, the majority of the construction craft workforce remains vulnerable, because of the lack, to date, of comprehensive immigration reform.

Significant Issues Remain

There are still many troubling issues.  Desperation pricing and margin compression is showing no sign of relief.  Additional defaults and failures seem inevitable.  Most bonding companies expect them; they have increased reserves and tightened requirements.  Some are demanding multiple contractors on larger jobs.

As tight as this market is, comparatively, it is still a preferred location for design and construction companies.  Acquisitions of both construction and architectural firms have occurred in the 1st quarter; more are being explored.  Contractors continue to come to Houston.  Local talent is in demand. 

Challenges & Opportunities:

There are challenges and opportunities as well.  Integrated Project Delivery (IPD) continues to evolve.  The single contract, signed by all parties, poses issues that are being resolved creatively.  And experts say the use of BIM and Lean is integral to this process really delivering the value that is possible.

A bill authorizing the use of Public Private Partnerships (P3), where private investors are allowed to take on debt risk in a project instead of the government, is now being considered by the Texas Legislature.  This can open new opportunities for firms who take the time to learn this delivery method.

Perhaps the most exciting opportunity is the efforts by a group of AGC leaders, in cooperation with the owner community, to create a sustainable construction workforce.  Their objective is to make the construction crafts a career of choice again.  This will require training and a competitive wage and benefit package; exactly what other industries seeking the same worker offer.  This is a major challenge leading to an even greater opportunity.

The Prudent Path:

In light of these conditions, the prudent path for senior executives is to:

• Maintain a focus on costs
• Stay close to your talent
• Invest in Business Development and Marketing
• Be a Learning Organization

A calculated approach to today’s strengths and challenges should ensure that prepared owners and contractors emerge from the current market ready to prosper.