Texas should continue outperforming the U.S. construction market

By Lesley Hensell

A rendering shows the bustling retail and residential activity anticipated for the mixed-use district, West Ave, in Houston’s urban core. The seven-story, five-acre phase one is centered around West Ave Street.

For most of this year, a cursory scan of the daily newspaper and the evening news has struck fear into the hearts of contractors, architects and other professionals who work in the construction industry. According to the talking heads, all is doom and gloom.

But a closer look at the numbers reveals a different picture, particularly in the Lone Star State. While the housing industry nationally has suffered significant setbacks, most of Texas has weathered the residential real estate downturn without serious bloodletting.

Examine the commercial marketplace, and the picture grows almost rosy. While economists seem tentative about their predictions, most agree that Texas will continue to see some amount of growth in commercial construction. But naysayers have nothing to fear, since challenges with labor availability and input costs are looming large.

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Offsetting the housing bust Whether viewed nationally or in Texas alone, the construction outlook remains positive – if the residential segment is removed from the picture:

• United States: In 2008, spending on residential construction is expected to decline by 15% to 20%, compared to 2007, according to Ken Simonson, chief economist for the Associated General Contractors of America. In contrast, spending on non-residential construction will rise between 4% and 8%. Add the two segments together, and you see a total decline of between 2% and 6%.

• Texas: In 2008, spending on all construction will drop by about 2%, according to Kim Kennedy, manager of forecasting for McGraw-Hill Construction Research & Analytics. Spending on residential construction will fall by about 23%, while non-residential construction will rise by a dramatic 35%.

Austin Commercial broke ground on a $295 million W Austin Hotel & Residences, a sign of Austin’s booming condo market bucking national trends.

Follow these links for more data from McGraw-Hill Construction, which publishes Texas Construction, or for information on purchasing a copy of the recently published report, “The Texas Construction Outlook 2008: Midyear Update.”

What stands out most in the Texas growth numbers is a comparison to prior years. Growth of non-residential construction remained flat in 2003 (2%) and 2004 (1%), followed by increased strength in 2005 (8%) and 2006 (33%). After a hiccup in 2007 (-1%), the Texas commercial construction market has roared back to life.

Growth patterns vary dramatically from industry segment to industry segment. According to Kennedy, spending on Texas manufacturing, health care, amusement, and highways and bridges continues to grow in the double-digits or stronger. On the flip side, Texas construction will slow dramatically this year in retail and utility construction.

The Vidorra in San Antonio is another example of the commercial real estate market in Central Texas keeping its legs. The condo project is under way by C.F. Jordan Residential. A second tower is planned.

Skyrocketing costs The classic supply-and-demand curves have gone out the window in the construction industry. Growth in total construction spending has leveled out across the nation, yet costs continue to rise dramatically. While the consumer price index has risen by 17% since the end of 2003, the construction producer price index has climbed by 35%, Simonson says. During that time period, particularly dramatic increases have been seen for:

• diesel fuel (272%)
• copper and brass mill shapes (173%)
• steel mill products (85%)
• concrete products (36%)

"Things are particularly difficult in construction, since the industry remains dependent on specific materials," Simonson adds. "This year, the producer price index will rise from 6 [%] to 8%, mostly because of steel and diesel. I think we're in for years of rising costs, between the cost of materials and the transportation costs to get them from there to here."

An aerial overview of Museum Place, an 11-acre mixed-use development in Fort Worth's Cultural District.

Despite forecasts indicating that the price increases are here to stay, many project owners remain hopeful that a decline may be in the near future. This, among other factors, has extended the decision-making process for owners, says Paul Higgins, a managing director in The Beck Group's Dallas office.

"The market for commodities has become so internationalized, we don't see things drop in price now, even when demand goes down here in the United States," Higgins says. "Most of the projects we are seeing are already price-challenged. Plus, the lending situation has further slowed the process and exasperates the situation. By the time a project is through the entire decision-making projects, the price of materials can have increased by millions."

Higgins cites a particular project with a total cost of $40 million. Since his firm began discussions about the building, the price of steel and concrete alone has risen $1 million.

Steady as she goes While the cost of materials continues to skyrocket, the labor situation in the Texas construction industry looks much steadier. At the end of last year, the industry employed 628,800 workers, or 6% of the state's non-farm employees, according to Simonson. This was a 2.1% increase over the year before, compared to the national average of -2.9%. Average construction pay in the state sat just above the national average at $44,551.

Demand for construction personnel should remain steadily positive as the state grows, according to economists.

"Texas' population growth has been significantly higher than most parts of the United States. From 2000 to 2006, for example, it was nearly twice that of the nation (12.7% compared to 6.4%)," says Ray Perryman, president of the Perryman Group. "In the decades to come, the state's expansion will continue. … For the construction industry, the expected population expansion yields a source of demand for many types of real estate assets. In addition, the large pool of young Texans will provide a source of labor."

This may not, however, lead to a decrease in overall construction labor costs, Perryman added.

"Labor costs run about half the cost of a typical construction project. On a national basis, wage increases in construction-related fields have generally mirrored overall increases," he says. "While slowing residential demand has placed downward pressure on labor costs in some parts of the country, much of Texas has been spared this trend. In fact, localized labor shortages have emerged for particular types of skilled workers."

Rose-colored forecasts Despite increasing costs, Texas should outpace the national construction market substantially in the coming years. Even in the short term, the state is well-positioned to capitalize on a strong local economy. In fact, a recent Forbes study placed four Texas metro areas (San Antonio, Austin, Houston and Dallas-Fort Worth) among the nation's 10 most recession-proof cities. Chief among the reasons were increased construction spending (Houston, 4.7% annually; Austin 5.1%; San Antonio 6.3%).

"We just don't see a huge slowdown here," Higgins says. "We are still seeing a lot of opportunities right now. Yes, decision-making seems to be slow. And time-to-award seems slow. I suspect that everyone is being extremely cautious – more so than usual."

Most positive for Higgins are projects being planned by corporations with an eye toward the future.

"We're seeing some new product types being created specifically for corporate recruitment and retention of personnel," he says. "These are sustainable projects being launched by companies that have survived periods of intense competition and have a great outlook for the future."

Fuel prices are unlikely to fall any time soon, Perryman says, which will keep upward pressure on the costs of many construction materials. But don't expect that to slow down the overall pace of construction in the coming years.

"The bottom line is that a growing economy requires housing, places to work and shop, and infrastructure to support mobility and production needs," Perryman says. "The construction industry in Texas is likely to see a long period of growth in the years to come, though cycles will be inevitable. Costs will likely rise, but not at the pace of the recent past."