Thursday, August 18, 2011 analyst’s comments about weak outlook for commercial construction

Commercial Construction Outlook: Weak

By: Dirk van Dijk, CFA (Analyst at

August 17, 2011

Today the American Institute of Architects (AIA) released its Architecture Billings Index (ABI) for July. It is a “Magic 50 index” sort of like the ISM, where any reading over 50 means that billings for architectural services are increasing, and below 50 indicates a contraction. The ABI fell to 45.1 down from 46.3 in June, its fifth decline in a row. It is now at its lowest level since February 2010.

Why should we care about the ABI?

Because it is the best leading indicator out there for construction spending outside of residential investment in single-family homes.

Construction of office buildings, hotels, shopping centers, hospitals, schools and apartment buildings almost always requires the services of an architect, even for stores that appear to be cookie-cutter copies of other stores in a chain.

If work slows down for architects, then nine to twelve months later so will construction work on those sorts of big projects.

The index fell dramatically in early 2008 -- after the recession officially started, but long before it was widely acknowledged to be underway. It stayed deeply in negative territory until late in 2010, but has again been on a steep declining trend since the start of this year.

Given the lag between when the architects draw up the plans and when the actual construction happens, that means we might get a little bit of help in GDP growth from non-residential construction in the third and fourth quarters of this year, but it is not going to last. It will once again be a drag on GDP growth by first quarter of 2012.

While so far the index is still well above the lows it was during the darkest days of the recession in late 2008 and early 2009, the trend is not good, and we sure don’t need any more drags on economic growth.

In the second quarter of this year, investment in non-residential structures added 0.20 points of the 1.30% growth. In the first quarter it subtracted 0.40 points from growth. In other words, if non-residential construction has simply stayed unchanged from the fourth quarter, then growth in the first quarter would have been 0.8% not 0.4%.

Breakdown by Region and Sector

The weakness was widespread, both geographically and by type of work. Regionally, the South was the strongest, with a reading of 46.9, followed by the West at 46.6. The Northeast had an index of 46.4 and the Midwest was the worst at 44.9. 

The AIA tracks activity by the predominate type of practice in architects offices. The commercial/industrial sector had a reading of 47.9. That covers the construction of things like office buildings, hotels and shopping centers. The reading for Institutional activity, the building of things like schools and hospitals, was 47.2.

Institutional activity is largely driven by public spending, and with the money from the ARRA gone, that activity is drying up. Mixed practice was at 47.1 and multi-family residential was at 44.7. It is surprising that the multi-family residential was the weakest of the four areas, since apartment vacancy rates have been falling, and rents are starting to rise.

The multi-family sector has been the one relatively strong area of residential investment of late. In July, housing starts for buildings with five or more units were up 66.7% over July of 2010, while single-family starts were down 0.9% year over year.

The renewed weakness in the ABI is bad news for firms that rely on non-residential construction. Some examples of firms that would be hurt by further weakness in the commercial construction sector of the economy are Watsco (WSO - Analyst Report), AAON Inc (AAON - Analyst Report), Lennox International (LII - Snapshot Report), Martin Marietta Materials (MLM - Snapshot Report) and Texas Industries (TXI - Snapshot Report).

All this, not to mention the long-suffering construction industry, which has been responsible for 30% of all jobs lost since the start of the Great Recession.

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