Extreme Makeover: Commercial Construction Industry, Post-Crisis Edition

CHICAGO, Ill. —Many wondered if the U.S. commercial construction industry would ever recover from the darkest days of the recession, particularly in late 2009 and early 2010. Jones Lang LaSalle's 2013 Construction Outlook finds that “Extreme Makeover” couldn"t be more appropriate for the commercial construction industry comparing 2009 to present. Just a few years after the recession brought the U.S. commercial construction sector to a standstill, the annual report paints a picture of a recovering, more diversified industry with less risk and revived funding.

“The construction industry has evolved significantly in the last five years,” said Todd Burns, president of JLL's Project & Development Services group with responsibility for the Americas. “In particular, commercial construction is now characterized by an absence of overbuilding, coupled with a diverse focus that is less dependent on residential housing. Growth in sectors such as healthcare, retail, distribution and lodging has shaped a more stable industry in the long-term.”        

By The Numbers
According to three key industry indicators, “cautious optimism” is the pervading sentiment among industry leaders in the fourth quarter of 2013. In August, the Dodge Momentum Index, which tracks projects in planning stages, surged 11.1 percent from the second quarter of 2013. Likewise, the American Institute of Architects Architecture Billings Index — based on inquiries for new projects and construction spending — reached 52.7 and regained momentum lost during the first quarter of 2013. The Construction Backlog Index also demonstrated steady improvement, rising to 8.2 months of contractor backlog.

Then & Now:   Four Characteristics of the Post-Crisis Construction Industry
The Jones Lang LaSalle Construction Outlook identified four trends helping — and hindering — construction growth in this new economic cycle:

Makeover Factor One:   Financing is Back
Then: A frenzy of overheated lending precipitated the real estate market and drove record construction starts, even as the global financial crisis emerged in 2008. By 2009, construction lending froze, as banks scrambled to reduce risks.
Now: Echoing the healthy activity in construction spending, commercial lending conditions are improving, even while lending standards have remained stagnant. The low cost of capital and re-emergence of the CMBS market have both enabled increased liquidity and easier lending. New CMBS issuance totals $50.8 billion so far through the beginning of August 2013, twice the level achieved through the first eight months of 2012. According to the Federal Reserve Board's Commercial Lending Sentiment survey, 47.8 percent more respondents reported higher demand for commercial real estate loans in the third quarter of 2013 compared to the second quarter. This dwarfs the 23.4 percent response seen this time last year, and represents the biggest improvement in demand in more than a decade.  

Makeover Factor Two: Construction has Become Expensive
Then: Building materials kept construction costs manageable before the crisis. High demand for new construction and free-flowing financing drove bulk purchases at lower prices.
Now: Construction costs are outpacing the recovery in most of the country. The booming single-family home sector has generated rising construction costs for the commercial sector as well, including driving up the cost of labor. According to Rider Levett Bucknall's Construction Cost Index, which uses construction fees to derive a trend in overall construction costs, the cost of construction increased 3.6 percent this year. This compares to a 1.5 percent increase this time last year, and annual growth rates that barely eclipsed two percent in the last two years.

Makeover Factor Three: All Buildings are Green Buildings — the Best are Both Green and Smart
Then: Green building features were incorporated upon request, but were generally viewed as expensive and “nice to have” luxuries.
Now:  Sustainable features are viewed as table stakes by owners and developers, and attention to green building materials is considered a core competency.

LEED v4 formally launched this month and introduced new changes to enhance green building standards. Major new provisions in LEED v4 include expanding property type-specific designations, weighing points more heavily on optimizing energy performance, and a new “cradle to cradle” component. The cradle to cradle provision seeks to ensure products and resources used during construction are safe and designed for recycling or composting, and that the manufacturing process for construction materials manages its carbon footprint.

“Enhanced LEED certification is a competitive differentiator, particularly with any project driven by the federal government,” said Dermot Roe, managing director and national construction lead for JLL. “We anticipate that most projects will strive to be certified under LEED 2009 until 2015, when it will be phased out. Others may seek IgCC certification — it will be interesting to see these two standards collaborate and compete.”

Makeover Factor Four:   Sandy, Stimulus and PPPs Shape Revenue
Then: Demand for construction came primarily from private-sector economic expansion.
Now: Much-needed infrastructure updates and rebuilding in the wake of severe storms are driving construction recovery in many geographies.  

While infrastructure is clearly an issue facing the U.S., there are little funds available to states for new projects. As a result, public-private partnerships are emerging as a solution when public funding is limited. Natural disaster reconstruction remains “top of mind” for construction executives on the one-year anniversary of Superstorm Sandy, as climate analysts predict more frequent volatile storms in the future.

“While there is a steep learning curve associated with managing storm recovery and large-scale infrastructure projects now, construction firms who invest the time and resources to be successful in this sector will be well-positioned for growth in the future,” said Roe.