GBCo Market Conditions Spring 2012

8/10/2019 GBCo Market Conditions Spring 2012

http://slidepdf.com/reader/full/gbco-market-conditions-spring-2012 1/48

MARKET CONDITIONS IN CONSTRUCTION

GILBANE BUILDING COMPANY

Q2 MAY 2012

C O N S T R U C T I O N E C O N O M I C S



© 2012 by Gilbane Building Company

Gilbane and Cost Advisor are trademarks of Gilbane Building Company

All other trademarks are the property of their respective companies



Gilbane Building Company

Market Conditions In Construction – May 2012

iiiT A B L E O F C O N T E N T S

Summary 1

Construction Starts 3

Construction Spending 5

Inflation Adjusted Volume 11

Jobs/Unemployment 12

Jobs/Productivity 15

Construction Costs General 18

Material Price Movement 18

Cement / Concrete 20

Structural Steel 21

Copper 23

Producer Price Index 24The Baltic Dry Index 26

Architectural Billings Index 27

Consumer Inflation / Deflation 28

Construction Inflation Forecast 29

Some Signs Ahead 29

ENR Index 30

Indexing by Location – City Indices 33

Selling Price 34

Indexing – Addressing the Fluctuation in Margins 36

Escalation – What Should We Carry? 39Data Sources: 44



T A B L E O F C O N T E N T S



v T A B L E S A N D G R A P H S

Table 1 Total Construction Starts 2009-2012 3

Table 2 Total Construction Spending 2006 - 2012 7

Table 3 Construction Spending Public/Private 9

Table 4 Construction Spending Educational Healthcare 10

Table 5 Construction Spending Adjusted to 2012 11

Table 6 BLS 2012 April Construction Employment All Employees 13

Table 7 Construction Employees Major States 14

Table 8 Productivity Inflation Adjusted 15

Table 9 BLS PPI Markets 19

Table 10 BLS Actual Cost Buildings 19

Table 11 BLS Actual Cost Trades 20

Table 12 BLS PPI Construction Related Materials 24Table 13 ENR’s Building Cost Index History (2000-2012) 31

Table 14 BLS PPI Markets 34

Table 15 BLS Actual Cost Trades 34

Table 16 BLS Actual Cost Buildings 35

Figure A: Architectural Billings Index 1

Figure B: Non-residentual Spending Growth 2

Figure C: Inflation/Escalation 2011-2014 2

Figure 1 Construction Starts Moving Average 4

Figure 2 Construction Starts Trend 4Figure 3 Construction Spending Non-residential 8

Figure 4 Construction Spending Adjusted to 2012 12

Figure 5 Jobs per billion dollars spending adjusted 15

Figure 6 Productivity Changes 2003-2012 16

Figure 7 PCA Cement Consumption 21

Figure 8 BLS PPI Steel Mill Products 22

Figure 9 ENR Materials Reinforcing Bars 22

Figure 10 Baltic Dry Index BDI 26

Figure 11 Architectural Billings Index ABI 27

Figure 12 Moore Inflation Predictor Consumer Inflation 28Figure 13 City Location Indexes 33

Figure 14 Escalation Growth vs. Margin Cost 37

Figure 15 Escalation Minimum and Potential 42





1

SUMMARY

SOME

ECONOMIC

FACTORS

AND

MARKET

FACTORS

SPECIFIC

TO

CONSTRUCTION

ARE

POSITIVE

: The Architectural Billing Indicator (ABI) accurately predicted a drop in spending from Q4 2011 through Q

2012. That may be ending. The ABI has been predicting growth starting in May’2012.

Even with the current decline in spending, the rate is still 9% above a year ago and 4% above last summe

Construction Spending should increase over 5% for 2012, more than 6% for non-residential buildings.

Contractors building costs for 2011 were much closer to labor and material cost increases, signaling amovement towards more normalized margins.

Sageworks Financial report on the construction industry shows contractor’s margins improved by 1% in2011, from 0.8% to 1.8%.

Industrial production related to construction is up 5 months in a row and 7.5% in 12 months

SOME ECONOMIC OR SPECIFIC MARKET FACTORS ARE STILL DECIDEDLY NEGATIVE:

Construction Employment increased seven times since February 2010, but dropped 6 times.

In 3 months since December we’ve gained only 5,000 jobs.

The 9 states with the most construction jobs lost 137,000 jobs over the last 4 months.

The Construction Starts trend since October is one of decline, hitting a 15-month low in February 2012.

Construction spending on public jobs is below the levels of a year ago.

After inflation adjustment we see construction volume has decreased 5 years in a row.

Portland Cement Association predicts cement consumption will increase only 0.5% in 2012. B ASED ON THE NEWEST DATA RELEASED SINCE THIS REPORT WAS COMPILED:

March Construction Starts were extremely high, emphasizing the volatility of this indicator.

Revised employment data for April shows jobs nearly flat since January 2012.

Our model shows spending below average in March 2012, as expected by the ABI indicator.

Figure A: Architectural Billings Index

Architectural Billings Index

ABI

Inst

Com

44.0

46.0

48.0

50.0

52.0

54.0

56.0

1 1 - J a n

F e b

M a r

A p r

M a y

J u n

J u l

A u g

S e p

O c t

N o v

D e c

1 2 - J a n

F e b

M a r

above 50 =billings increasing, below 50 =billings decreasing

ABI Institutnl Outlook Com mercl

The ABI predicts activity 9 to 12

months out and indicated a slight

downturn which we are currentlygoing through. Indexes above 50

indicate increasing billings. Since

July 2011, all the ABI market

indices have been climbing. This

bodes well for newly anticipated

work growth in Q2-Q3 2012.



2



Figure B: Non-residentual Spending Growth

NonResidential Spending Growth ($bil)

520

540

560

580

J an-11 Mar-11 May-11 J ul-11 Sep-11 Nov-11 J an-12 Mar-12

The spending plotted here, developed from factors based on actual spending historical data, varies from

the Department of Commerce Seasonally Adjusted Annual Rate (SAAR). Spending is 8% higher than thesame period last year and, since the expected downturn was already built into predictions, is in line with

expectations of cumulative spending year to date.

A DDITIONALLY :

Normal material cost indices do not capture all cost changes when margins are fluctuating

Indexing previous job costs to present requires adjustment for margins.

More recently, contractors are passing along most of material cost increases.

As spending continues to increase, contractors gain more ability to pass along costs.

Figure C: Inflation/Escalation 2011-2014

Inflation / Escalation 2011-2014

0.0%

2.0%

4.0%

6.0%

8.0%

2011 2012 2013 2014

minimum and potential range

In addition to the inability of contractors and suppliers to pass along material price increases, contractor

margins declined by nearly 4% from 2006 to 2010. That downward trend has reversed with a slight increase

in 2011. Increased spending, with further increases expected in the near future, supported by the positive

trending ABI, will lead to greater portions of all costs being passed along to the owner. This is the basis for

our predicted escalation growth, which is expected to continue for the next few years.

Construction Spending still shows

inconsistent performance but over thelast year the trend clearly has been

increased spending. The ABI decline

predicted the current fall-off, but

predicts a strong increase will soon

follow, providing expectations for

growth in Q2-Q3 2012.

Future escalation, in order to capture

increasing margins, will be higher than

normal labor/material cost growth.

We advise carry a minimum of

4% for 2012

5% for 2013

6% for 2014



3



CONSTRUCTION STARTS

Construction Starts published data gives monthly actual data and a seasonal adjusted annual rate (SAAR)

for each set of monthly Starts values. But the monthly values for Starts uctuate wildly. In fact, one ofthe most important things we can say about Construction Starts is that they can be extremely variable from

month to month, presumably dependent on the exact date that any new project gets listed.

SAAR based on monthly data in 2011 had variation from $380 billion to $470 billion (2010 varied from

$380billion to $450 billion). And yet, 2010 and 2011 nished within 2% of each other at $412 billion vs.

$421 billion. Any given month of data is far too volatile to predict the annual total. In the last two years of

data there have been at least 4 occasions when consecutive months have varied by an average 20% and as

high a difference as 25%. This causes unrealistic peaks and valleys in the data. Therefore, we do not use

month to month data to predict annual outcome.

One way to look at the data is to calculate a forecast based on the latest month, last 3 months and last 6months. One month trend data is always too volatile to predict the year, but shows the current monthly

trend; 3-month trends smooth out the data and give a near term trend and better prediction; and 6-month

trends atten the data even more and show a smoothed long-term trend.

Historically, we see only 7% of annual Starts in some months while we nd other months have 10% of

the annual Starts for the year. We see lowest Starts in November through February and highest Starts in

Jun through October It is not unusual to see huge increases or decreases in volume from month to month.

Historically, for non-residential buildings, there are 20% more Starts in Jun than in May and 30% more

Starts in October than November The SAAR factors are weakest during these periods and therefore at times

during the year the SAAR report can produce signicant variation from actual data and historical averages.

Our forecasting model is based on the actual data and historical averages.

Table 1 Total Construction Starts 2009-2012

TOTAL CONSTRUCTION STARTS Forecast 2012 based on

Actual Actual Actual 1 month 3 month Trend2009 2010 2011 actuals actuals predicion

Non-residential Buildings $ 167,955 $ 152,033 $ 154,782 $ 135,716 $ 141,140 $ 160,000

-9.5% 1.8% -12.3% -8.8% 3.4%

Residential Buildings $ 111,851 $ 119,360 $ 123,444 $ 146,499 $ 141,234 $ 145,000

6.7% 3.4% 18.7% 14.4% 17.5%

Non-building Construction $ 141,899 $ 141,078 $ 143,195 $ 117,342 $ 117,817 $ 120,000

-0.6% 1.5% -18.1% -17.7% -16.2%

Total Construction $ 421,705 $ 412,471 $ 421,421 $ 399,557 $ 400,191 $ 425,000

percent change yoy -2.2% 2.2% -5.2% -5.0% 0.8%

dollars in millions Feb’2012 Dec/Jan/Febforecast based on historical cumulative factors

http://en.wikipedia.org/wiki/Coal




4



EXPECTATIONS AS OF A PRIL 2, 2012 BASED ON DATA THROUGH FEBRUARY : In the early part of the year Starts will seem to indicate no more than a $400,000 annual rate for the year

Non-building Construction, Infrastructure work may continue to decline

Total Starts will probably remain low due to steep declines in Non-building Infrastructure work

by May data we should see stable but slow growth in non-residential buildings.

The recent months of upward movement in the Architectural Billings Index should lead to growth in non-

residential Starts. Non-residential building Starts (our primary market) should end the year near $160 billion,

representing approximately 3% growth over 2011.

Figure 1 Construction Starts Moving Average

Construction Starts Moving Avg $bil

Nonresidential and NonBuilding Only

MHC saar

250.0

260.0

270.0

280.0

290.0

300.0

310.0

320.0

J a n - 1 0

M

a r - 1 0

M

a y - 1 0

J

u l - 1 0

S e p - 1 0

N o v - 1 0

J a n - 1 1

M

a r - 1 1

M

a y - 1 1

J

u l - 1 1

S e p - 1 1

N o v - 1 1

J a n 1 2

GBCo mo actual / mo hist performance

S A A R =

S e a s o n a l A d j A n n u a l R a t

Figure 2 Construction Starts Trend

Construction Starts Trend is Shifting

NonresNonbldg

major declines

due to non-bldgResiden

-

20.0

40.0

60.0

80.0

100.0

120.0

140.0

160.0

180.0

based on last 6 mo last 3 mo 1 month

Total Year 2012 $bil predicted base d on data thru Feb'12

A smoothed moving average shows a bit

better trend graph of Starts Activity. Starts

have been falling since October. ButOctober was the “out-of-the-ordinary” high

month that is skewing the chart. October

was bracketed on either side by months

15% and 20% lower. We don’t see that

kind of variation from month to month in

the spending data. So we need to be less

concerned about monthly uctuations in

Starts and more concerned about long-term

trends.

This chart shows non-building (i.e.,

infrastructure) Starts are the major factor

in recent declines. If construction Starts,

particularly for non-residential buildings,

continue to decline then future construction

spending and jobs in our primary markets

will remain depressed. This trend needs to

change dramatically upward before we willsee increases in future spending and jobs

growth. The shorter term trends give an

indication of the next direction the long term

trend.



5



Inationary inuences have the effect of reducing the value of new Starts, and so, Starts at a rate lower than

the real ination rate would mean construction Starts in terms of building volume (not in terms of revenue)

are actually falling. If ination for the year comes in at 4%, then Starts need to be greater than 4% to realize

any growth.

CONSTRUCTION SPENDING

WHAT SHOULD WE EXPECT FOR 2012? HOW ARE WE DOING SO FAR ?

DOESN’T SOUND GOOD, DOES IT? OK, ’LET’S TAKE A LOOK .

Quoted from a February 7, 2012 post in my Gilbane blog

“it is widely agreed by many expert economists that we may experience a slowdown in the coming months…

(note- at this point December spending data had just been released).”

Quoted from a March 5, 2012 post in my Gilbane blog

“Earlier in 2011 the Architectural Billings Index showed work on the (architect’s) books declining. That

signaled an expected drop in construction 9 to 12 months out. We may be currently seeing this in the

declining new Starts….that could continue through April 2012….last year’s declining ABI billings indicated

Starts and spending would be lower for a period.”

Quoted from my Q4’2011 economics report

“The Architectural Billings Index has been signaling all year that we should expect further declines in

spending. A reliable indicator of work 9 to 12 months out, new Starts and spending results will always lag

the ABI.”





6

First: It cannot be said this drop was UNEXPECTED. I’ve been

predicting the drop for a few months. Two leading indicators showed

an expected decline in Q1’ 2012 and previously reported jobs movement

followed suit. Now if the drop continues for 4 to 6 more months, that’s

unexpected.

Second: the Department of Commerce SAAR factor for January appears

to give a somewhat “too high” expectation for that month. On top of that,

December was an unusually strong month. So this is skewing the data

upon which all other news services report.

Third: January and February were the ONLY months that showed declines

in the last 7 months, and that’s undoubtedly because Q4’ 2011 was so

unusually strong and set a very high comparable. Furthermore, January

and February show spending at almost exactly the same rate, and bothstill show spending at a rate comfortably above Q3’ 2011.

My statistical monthly averages show from January to February the

monthly decline was only 0.2%, spending combined is 8% higher than the

same period last year and is within 0.1% of expectations cumulative year

to date. Since the bottom, spending has increased 9 out of 12 months and

the current rate for Jan-February is well above the rate last June, July, and

-August On an ination-adjusted basis, we’ve just had the best December,

January, and February period since ‘2008-’2009. It would appear so far

we are right on track.

The recently release CIRT (Construction Industry Round table) SentimentIndex Report, issued by FMI, representing collective input from

approximately 100 non-residential construction executives, includes these

data and responses: 42% of executives expect spending to improve only

modestly, from 0.5% to 2.5%, 26% expect little to no growth and 27%

expect spending declines. I do not share that sentiment.

I PRECICT THAT 2012 SPENDING FOR ALL CONSTRUCTION WILL BE $832 BILLION, A GROWTH OF 5.4%.

Given the most recent trends that take into consideration the 2011

midyear downturn in the ABI and a Q4 drop in new Starts, but thatmonthly spending rates increased in 9 out of the last 12 months,after factoring in an expected slowdown in the first quarter, my modelpredicts total spending will climb slowly for the remainder of the year,reflecting a growing ABI and slightly stronger economy, and will end the year 2012 at $832 billion spending for all construction, 5.4%above 2011. That represents a growth of only 2.2% after inflation.



7



Table 2 Total Construction Spending 2006 - 2012

U.S. Total Construction Spending Summarytotals in billions U.S. dollars

Actual Forecast

2006 2007 2008 2009 2010 2011 2012

Non-residential Buildings 339.4 403.7 438.0 375.5 288.5 277.8 294.9

% change year over year 12.5% 18.9% 8.5% -14.3% -23.2% -3.7% 6.2%

Non-building heavy engr 207.9 248.3 271.8 273.3 266.4 266.6 274.9

12.4% 19.4% 9.5% 0.6% -2.5% 0.1% 3.1%

Residential 619.9 500.3 357.7 254.3 248.7 244.9 262.4

0.4% -19.3% -28.5% -28.9% -2.2% -1.5% 7.1%

Total 1167.2 1152.3 1067.5 903.1 803.6 789.2 832.2

5.7% -1.3% -7.4% -15.4% -11.0% -1.8% 5.4%

Residential includes new, remodeling, renovation and replacement work.

Source: U.S. Census Bureau, Department of Commerce.

Forecast 2012 - GBCo

Historically, the period of June through October shows the highest monthly rates of spending during the

year, all 5 months each over 9% of annual volume, with the highest monthly volume being reached in

August. Long-term averages show that spending in December, January and February each account for only

±7% of the annual volume. For example, in January and Feb, the lowest activity months of the year, history

leads us to expect to spend 7.0% of the total for the year. In August we expect to spend 9.5% of the total for

the year. If we see spending of $70 billion in January and $95 billion in August, this increase by $25 billion per month from January to August is seasonal, not an indication of growth. It simply indicates the rate

of spending in each of those months has reached the expected seasonal average rate for that month. Both

monthly values would predict the same year end total. We must use caution to not consider these increases

as an improvement in the rate of spending. The monthly rate-of-spending trends are holding through this

winter.

The months November through March have a high standard deviation from average and can produce wide

uctuations in year end data predicted from monthly data. However, the months of May through September

have a very low standard deviation and monthly data from that period gives a much more reliable year-end

prediction. Unfortunately, that means the current data for the past 4 months is among the least reliable to

predict the entire year.

Historical monthly activity can also be used to develop cumulative year-to-date data activity. This

eliminates some of the monthly uctuations and the total annual prediction gains more weight each month.

By September each year for 10 years, we had realized on average 75% total annual spending, with a

standard deviation of less than ±1%.



8



Non-Residential Construction

NON-RESIDENTIAL CONSTRUCTION CONSISTS OF TWO MAIN CATEGORIES:

non-residential buildings

non-building construction projects

Non-building projects are composed of heavy engineering, heavy industrial and infrastructure projects.

They include transportation, communication, power, highway and street, sewage and waste disposal, water

supply and conservation and development. Almost 60% of non-building work is public work.

Total non-residential construction spending hit a low in February 2011 (and again in April), dropping below

$525 billion annual rate of spending, a level not seen since 2005. By the end of the year non-residential

spending rate reached $560 billion. The rate of growth in spending for the last 5 months of 2011 was greater

than any 5-month period dating back to October 2009. That’s a really good indicator looking forward.

The AIA Consensus 2011 Construction Forecast midyear report, an aggregate of analysis by 6 rms,

predicted non-residential construction spending for 2011 would end down -5.6%. Individual predictions

ranged from -2.5% to -8.0%. Actual 2011 non-residential construction came in at -3.7% below 2010. That

same midyear consensus report had forecast an increase of 6.4% in 2012. Individual predictions in the AIA

report for 2012 ranged from +2.0% to +11.3% growth.

The AIA Consensus 2012 Construction Forecast January report forecasts 2012 non-residentialconstruction spending will grow only 2.1%. Individual predictions now range from -2.5% to +5.3%.My data leads me to a more optimistic forecast.

Non-residential construction spending reached a highpoint in 2008 of $710 billion, followed by $649 billion

in 2009, and $544 billion in 2011.

I PREDICT THAT 2012 SPENDING FOR ALL NON-RESIDENTIAL CONSTRUCTION WILL BE $570BILLION, A GROWTH OF 4.7%.

Figure 3 Construction Spending Non-residential

Construction Spending Annual $bil

NonRes Bldg

NonBldg

0.0

100.0

200.0

300.0

400.0

500.0

600.0

700.0

800.0

2006 2007 2008 2009 2010 2011 2012



9



THE RECENTLY RELEASED CIRT SENTIMENT INDEX REPORT, REPRESENTING COLLECTIVE INPUT FROM NON-RESIDENTIAL CONSTRUCTION EXECUTIVES INCLUDES THESE RESPONSES:

More than 70% of executives expect the strongest increase of the year in Industrial/Petrochemical. Approx. 50% expect next strongest yearly increases in manufacturing and healthcare, but approximately

50% expect manufacturing and healthcare to remain the same or decline.

The educational sector still has the worst overall outlook 1 and 3 years out.

Non-Residential Buildings

Non-residential “buildings” construction spending reached a highpoint in 2008 at $438 billion, followed by

$376 billion in 2009, and $278 billion for 2011.

I PREDICT THAT 2012 SPENDING FOR NON-RESIDENTIAL BUILDINGS WILL BE $295 BILLION,

A GROWTH OF 6.2%.Private construction is predominantly residential. 97% of all residential work is private and constitutes

just under half of all private work. (A historical note: in 2005-2006, residential work constituted 70% of all

private work and more than half of all construction spending. For the last 3 years residential comprises

just less than 50% of private work and only 30% of all construction). Manufacturing (8%) and Commercial

(7.5%) are the next largest private “buildings” sectors. Non-buildings make up a large portion of private

work; ALL Power (17%) and Communication work (3.5%) is private work.

Private Construction spending reached a highpoint in 2006 at $912 billion and in 2011 was $506 billion.

I PREDICT THAT 2012 PRIVATE CONSTRUCTION SPENDING WILL BE $555 BILLION, AN INCREASE OF 9.8%, BUT STILL 40% BELOW THE PEAK .

Table 3 Construction Spending Public/Private

U.S. Total Construction Spendingtotals in billions U.S. dollars

Actual Forecast

2006 2007 2008 2009 2010 2011 2012

Private 911.8 863.4 758.8 588.1 500.4 505.7 555.0

% change year over year 4.8% -5.3% -12.1% -22.5% -14.9% 1.1% 9.8%

Public 255.4 288.9 308.7 315.0 303.2 283.5 277.2

9.0% 13.1% 6.9% 2.0% -3.7% -6.5% -2.2%

Total 1167.2 1152.3 1067.5 903.1 803.6 789.2 832.2

5.7% -1.3% -7.4% -15.4% -11.0% -1.8% 5.4%





10



The largest public construction markets are Highway and Educational. Those two markets alone represent

more than half of all public construction, followed by Transportation, a distant third, and Waste Disposal

fourth. All other markets together make up less than 30% of public work. Slight increases show up

in Highway from September through January, and Waste Disposal from October through February

Educational has been showing a steady decline for 6 months and Transportation, after deep drops since

2010, has been at since August.

Public Construction spending reached a highpoint in 2009 at $315 billion and in 2011 was $284 billion.

I PREDICT THAT 2012 PUBLIC CONSTRUCTION SPENDING WILL BE $277 BILLION, A DROP OF 2.2%, 12% BELOW THE 2009 PEAK .

Healthcare and Educational, the two largest “buildings” sectors, represent 23% of all non-residential

construction spending. Those two sectors represent 40% of non-residential “buildings”. Both peaked in

2008, educational at an annual rate of $105 billion and healthcare at $47 billion.EDUCATIONAL IS PREDOMINANTLY PUBLIC WHILE HEALTHCARE IS PREDOMINANTLY PRIVATE.

Table 4 Construction Spending Educational Healthcare

U.S. Total Construction Spendingtotals in billions U.S. dollars

Actual Forecast

2006 2007 2008 2009 2010 2011 2012

Educational 84.9 96.8 104.9 103.2 88.2 84.7 82.0

% change year over year 6.5% 14.0% 8.4% -1.6% -14.5% -4.0% -3.2%

Healthcare 38.5 43.8 46.9 44.8 39.9 39.7 42.4

12.2% 13.8% 7.1% -4.5% -10.9% -0.5% 6.8%

Total 123.4 140.6 151.8 148.0 128.1 124.4 124.4

8.2% 13.9% 8.0% -2.5% -13.4% -2.9% 0.0%


includes public and private


Educational spending in 2009 was $103 billion, in 2011 was $85 billion.

I PREDICT THAT 2012 SPENDING FOR ALL EDUCATIONAL CONSTRUCTION WILL BE $82BILLION, A DECLINE OF -3.2%.

Healthcare spending in 2009 was $45 billion, in 2011 was $40 billion.

I PREDICT THAT 2012 SPENDING FOR ALL HEALTHCARE CONSTRUCTION WILL BE $42BILLION, AN INCREASE OF 6.8%.



11



INFLATION A DJUSTED V OLUME

Spending is typically reported in unadjusted dollars, total revenue. It is a true indication of current dollars

spent within any given year, but does not give quite as clear a comparison of volume from year to year. Tosee that clear comparison, we must look at ination adjusted dollars. If spending increases by 2% from

one year to the next, but ination drove up the cost of products by 5% during that same time, then ination

adjusted dollars would show that net volume actually declined 3% during that time period. Dollars spent

would have needed to grow by 5% just to keep pace at no-growth with the previous year.

The following table adjusts Total Construction Spending for construction ination and the changes in

margin costs over the last 6 years. All dollars are adjusted to 2012 equivalent.

Table 5 Construction Spending Adjusted to 2012

U.S. Total Construction Spending Summary ADJU.S.TED to 2012totals in billions U.S. dollars all ADJU.S.TED to 2012

Actual Forecast

2006 2007 2008 2009 2010 2011 2012

Non-residential Buildings 361.1 399.7 413.2 383.2 306.9 289.2 294.9

% change year over year 3.6% 10.7% 3.4% -7.3% -19.9% -5.8% 2.0%

Non-building heavy engr 233.6 260.3 268.0 287.3 285.5 278.1 274.9

9.2% 11.4% 3.0% 7.2% -0.6% -2.6% -1.1%

Residential 495.9 400.2 319.4 244.5 243.8 242.5 262.4

-2.0% -19.3% -20.2% -23.4% -0.3% -0.6% 8.2%

Total 1090.6 1060.2 1000.6 915.0 836.2 809.8 832.2

2.0% -2.8% -5.6% -8.6% -8.6% -3.2% 2.8%

Residential includes new, remodeling, renovation and replacement work.

Source $ Data: U.S. Census Bureau, Department of Commerce.

Indices references: GBCo Margin Index, S&P/Case-Shiller Home Price Index, BLS Residential PPI inputs

see Escalation Growth vs. Margin Cost for GBCo ination/deation adjusted margin cost

The most signicant data we see from these ination adjusted values is 2008 and 2009 were NOT declines

in volume of -15.4% and -11.0%, as shown in unadjusted data (Table 2) but instead declines of only 8.6%

per year. A major part of those declines was a drop in prices due to reduced margins. Total revenues

decreased 15% and 11%, but workload volumes in 2008 and 2009 dropped only -5.6% and -8.6% in

ination adjusted spending.

I PREDICT THAT THAT 2012 WILL SHOW A 5.4% INCREASE IN REVENUE, BUT ONLY A 2.8%INCREASE IN VOLUME AFTER INFLATION ADJUSTED DOLLARS.



12



Figure 4 Construction Spending Adjusted to 2012

Construction Spending Annual $bilAll Indexed to 2012 $

Nonres Bldgs

Nonbldg engr Residential

200

250

300

350

400

450

500

550

600

2003 2004 2005 2006 2007 2008 2009 2010 2011 2012

actual volume converted to 2012 dollars

WHY IS IT SIGNIFICANT TO ANALYZE BOTH REVENUE AND VOLUME?

Contractor fees are generally determined as a percentage of revenue. However, workload volume

determines the size of the workforce needed to accommodate the annual workload. It is valuable to know

from the past several years of data, not only from the macro view but also the micro view, how many

employees were required to accomplish the workload volume. From the standpoint of workforce planning,

we are not concerned with the value of the revenue, only the volume of the work. There is a bit more to this

analysis, so we will investigate this further under the Jobs/Productivity section of this report.

JOBS /UNEMPLOYMENT

There is a signicant difference in what is represented by the “unemployment” rate and the number of lost

employees. Those who run out of unemployment benets or drop completely out of the workforce are no

longer counted as unemployed, but they are most denitely lost employees. Real construction employment

is far worse than the unemployment gures would lead you to believe.

The industry had been losing construction employees for 5 years, but we may have hit the low point in

January 2011. Still, we are not far above a 15-year low.

We were at a peak of 7,726,000 jobs in April 2006. Over 5 years we lost 2,250,000 jobs, or 29% of allconstruction jobs. In 13 months, through March 2012, we’ve gained only 100,000 jobs and are still 28%

below the peak number of jobs. However, the construction unemployment rate has gone down from 25%

in February 2010 to 17% in March 2012. How does that make sense? If the unemployment rate goes down

but there are no gains in the number of jobs, that can only mean one thing: the number of people reported

as still in the workforce has gone down. Since we’ve gained back only 1% of the jobs lost, this drop in the

unemployment rate is almost entirely due to people dropping out of the workforce.

Non-residential buildings has barely moved off

of the 2011 bottom.

Non-buildings heavy engineering peaked in 2010

but has been on the decline for 2 years.

Residential construction has been rebounding

since late 2010.



13



While many workers are lost, the rst workers to be lost are typically those that represent the least value

to an organization, however, not all of the lost workers are “wanted turnover”. As the workload dwindled,

some of the workers that were let go or dropped out of the workforce had many years experience and were

highly trained. As a result, when work volume picks up there are going to be both general worker shortages

and as well as at least some shortage of these more valuable skilled workers. Over the next few years, when

work volume does pick up, this industry is going to be faced with a lack of available workers and shortage

of skilled, experienced workers. Both of those issues are going to DRIVE COSTS UP and QUALITY

DOWN due to the need to pay a premium for skilled workers and the necessity of training new workers in

their job and company procedures.

Table 6 BLS 2012 April Construction Employment All Employees

Industry: Construction Employment DataType:

ALL EMPLOYEES, THOU.S.ANDS

Year Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec

2006 7601 7664 7689 7726 7713 7699 7712 7720 7718 7682 7666 7685

2007 7725 7626 7706 7686 7673 7687 7660 7610 7577 7565 7523 7490

2008 7481 7435 7401 7331 7282 7216 7161 7115 7042 6965 6810 6705

2009 6558 6448 6295 6151 6094 6007 5925 5846 5775 5717 5687 5654

2010 5593 5529 5552 5559 5518 5507 5491 5511 5492 5499 5488 5477

2011 5456 5489 5496 5495 5498 5495 5508 5498 5528 5519 5520 5546

2012 5564 5563 5560 5558

U.S. Bureau of labor Statistics

The table “Construction Employment - ALL EMPLOYEES” includes both residential and non-residential

construction, and includes all trades and management personnel.

Total of All Employees in construction reached a peak in April 2006 at 7,726,000, then held fairly steady

between April 2006 and September 2006, averaging over 7,700,000. By July 2010, the total number of

all employees dropped to 5,500,000. Tenuous monthly gains throughout 2010 did not hold. Employment

reached a 15-year low of 5,456,000 in January 2011 and has seen only little gains since.

Since January 2011, construction employment increases have been minimal. The major construction states

actually lost jobs in the 4th quarter.

We cannot expect to see increases in the construction workforce until we see increases in construction

spending. While month to month changes are variable, it is a good sign that non-residential spending has

been on an overall upward trend since the start of 2011.Manpower report released March 2011:

Manpower gures measure the percentage of rms planning to hire minus the percentage of rms planning

to lay off and report the “net” percentage hiring outlook. The overall national employment (all jobs) picture

is slightly positive for the Q2 2012 with a projected net +10% of rms planning to hire.

Manpower reports hiring in the construction industry for Q2 2012 anticipated at a net +9% compared to a

net -4% in Q4 2011 and -7% in Q1 2012.



14



Manpower survey gures released in September 2011 indicated construction employment would decrease in

the fourth quarter That prediction was on target, with the top 9 states losing over 150,000 during the fourth

quarter.

Table 7 Construction Employees Major States

State Construction Employment # of Jobs

Four states account for 33% of ALL construction jobs.

current 12 mo last 4 mo

Texas 563,000 3,000 (41,000)

California 567,000 (3,000) (18,000)

Florida 319,000 (22,000) (15,000)

New York 301,000 (1,000) (25,000)

1,750,000 (23,000) (99,000)

Only ve other states have more than 150,000 construction jobs:current 12 mo last 4 mo

Pennsylvania 231,000 13,000 -

Illinios 190,000 (9,000) (29,000)

Virginia 182,000 500 (1,000)

North Carolina 177,000 6,000 1,000

Ohio 177,000 5,000 (9,000)

957,000 15,500 (38,000)

Where are the jobs?

Together these top 9 states make up 50%

of the national construction workforce.

The last (winter) report showed these

nine states combined had 39,000 more

jobs than a year ago. That has reversed

dramatically, showing the weakness in

jobs growth. Now they have 8,000 LESS

jobs than a year ago. And one year ago

total construction jobs had reached a 15

year low. The bad news is this group of

9 states lost 137,000 jobs in the 4 months

from Sep 2011 through Jan 2012. The

good news is the losses appear to have

been stemmed with the addition of 20,000

jobs in January.The big drop most probably reects the expected downturn

that was previously signaled by the falling ABI “work on the

boards” and construction Starts, among other indicators inthe middle of last year. National construction employment

totals increased by only 100,000 jobs during the same one year

period. Texas, which had been a jobs leader for the later half

of 2011, took the biggest drop.



15



JOBS /PRODUCTIVITY

A long-term trend in productivity can be found by comparing the annual spending to the annual average

workforce. For this purpose we must use the ination adjusted spending, which will eliminate material,wage and margin ination/deation from the equation. Productivity is a measure of units per worker, not $

put in place per worker. This adjustment gives total spending in constant dollars and allows a comparison

to equal units. Therefore the following productivity analysis is based on put-in-place revenues, ination

adjusted to 2012 dollars, compared to actual manpower.

Table 8 Productivity Inflation Adjusted

Productivity Infation Adjusted 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012

Total Unadjusted $ Spending

848891 991 1,104 1,167 1,152 1,068 903 804 789 832

5.1% 11.2% 11.4% 5.7% -1.3% -7.4% -15% -11% -1.8% 5.4%

Total Spending 2012 $ 1,071 1,080 1,077 1,083 1,091 1,060 1,001 915 836 810 832

0.8% -0.2% 0.5% 0.7% -2.8% -5.6% -8.6% -8.6% -3.2% 2.8%

# jobs avg / yr mil lions 6,715 6,736 6,973 7,333 7,690 7,627 7,162 6,013 5,518 5,504 5,666

# jobs per billion$ unadjusted 7,919 7,558 7,033 6,641 6,588 6,619 6,709 6,658 6,867 6,974 6,808

# jobs per billion 2012 $ 6,268 6,238 6,472 6,774 7,051 7,194 7,158 6,572 6,599 6,797 6,808

productivity change 0.5% -3.6% -4.5% -3.9% -2.0% 0.5% 8.9% -0.4% -2.9% -0.2%

At rst glance, Figure 5 seems to indicate the number of jobs supported by $1 billion dollars of spending

declined from 2002 to 2006 (the thin black line). Fewer workers to perform the same unit volume of work

would indicate an increase in productivity. If productivity was increasing, then each succeeding year it

would take fewer workers to produce the same work volume and the number of jobs would be declining.But you can see that line would go counter to expectations. It shows increasing productivity in times

of increasing workload. What’s missing in that analysis is the dollar volume of work put in place is not

ination adjusted, so it indicates work $ value, but not true work unit volume.

Figure 5 Jobs per billion dollars spending adjusted

JOBS per $bil ajusted to 2012$

#jobs per$bi

unadjustedl #jobs per $bil

in 2012$

5,500

6,000

6,500

7,000

7,500

8,000

2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012

# of Jobs needed to support $1 billion spending

To get the real picture of

productivity changes we must

adjust all dollars to the same

point in time, here adjusted to

2012$. Once we’ve done that,we see the adjusted data in Figure

5 (the thicker blue line) shows

productivity declining in lock-step

with rapid volume growth and

improving as work volume drops.



16



From 2003 through 2007, the number of workers needed to put in place $1 billion of spending

increased. In other words, productivity decreased during that period when spending and jobs were on

the rapid growth trend. That result is perfectly in line with expectations during rapid growth. As we

approached peak employment in 2006-2007 we also approached peak spending, but the number of jobs

supported by $1 billion of spending was increasing. In 2002 through 2004, $1 billion of spending supported

just under 6,500 jobs. By the peak activity in 2006-2007, it required 7,300 jobs to put-in-place $1 billion

in spending, (less work value per employee). Productivity declined to its lowest point in 2005. But work

volume reversed and by the end of 2009, productivity increases were so signicant that $1 billion of

spending supported only 6,600 jobs. Today $1 billion in spending supports 6,800 jobs.

Figure 6 Productivity Changes 2003-2012

Productivity Changes

annual change

cum since 2007

since 2005

since 2006

-7.0%

-5.0%

-3.0%

-1.0%

1.0%

3.0%

5.0%

7.0%

9.0%

2003 2004 2005 2006 2007 2008 2009 2010 2011 2012

values above 0% = productivity gains

values below 0% = productivity declines

From 2007 through 2010, the number of workers needed to put in place $1 billion of spending

declined. This indicates each worker accomplished more work. In other words, productivity increased

during that entire period when spending and jobs were on the decline. Those are clear indications that

productivity will be increasing. Out of necessity, and with diminished workload providing no other options,

workers and management nd ways to improve. But that can and always does reach a limit. At some point,

longer hours and additional work burden causes productivity to decline. Also, a return to volume growth

results in an easing of performance. It appears the trend reversed in 2011. After 4 years of mostly work

output increases, the work output declined dramatically in 2011.

Over a period of 5 years (since 2006) the net gain in productivity is 4%. That means that it would take 4%

less workforce to put in place the equivalent volume of work today as it would have taken in 2006. That

also means if we were to maintain that 4% productivity advantage, then at some point in the future, when

work volume does return to previous peak levels, it would require 4% less total workforce to accomplish

that workload.

It is well known that productivity

decreases in times of increasing

activity,. Productivity generally

increases as available work declines.

(Applied Cost Engineering, Chapter

5, Clark and Lorenzoni, Marcel

Dekker, Inc., 1985). This graphic,

Productivity Changes, portrays this

concept almost perfectly.



17



As workload begins to increase in coming years, net productivity gains will decline somewhat. This net

affect cannot go unaddressed. The results of productivity declines are either decreased total output (if

workforce remains constant) or increased workforce needed (if total workload remains constant). Even with

the drop in 2011, fewer workers are needed currently to accomplish the same work volume as compared to

any time since 2005. However, that is already changing.

Realistically, I would expect that over the next few years, each year work volume increases we will

experience some slight erosion from the productivity gains. That means when we do once again recover to

the spending levels of years past, we will not recover to the number of jobs in years past. This erosion can

be offset by signicant technological and process advancements. I expect some of what we saw in 2009 can

be attributed to those two issues.

Earlier I asked, Why is it significant to analyze both revenue and volume?

Contractor fees are often determined as a percentage of revenue. However, workload volume is used for

planning the size of the workforce needed to accommodate the annual workload. It is valuable to know

from the past several years of data how many employees were required to accomplish the workload volume.

From the viewpoint of workforce determination, we should not be concerned with the value of the revenue,

only the volume of the work.

A S AN EXAMPLE:

At the peak of construction, a building cost $12 million and took 100 men/yr to build. Today that samebuilding could potentially cost as little as $10 million to build. Does it take 20% less men/yr to build it? No,certainly not. That would be the fallacy of trying to determine jobs needed based on revenue.

The building has not changed, only its cost changed. It still has the same amount of steel and concrete and

brick and windows. The only thing we can say is we’ve had an improvement of 4% in productivity. Therefore the workforce today will be 4% lower. Using revenue as a basis we might be led to think we need 20% fewerworkers. That points to the value to base workers needed on inflation adjusted volume, not direct annualrevenue.

How quickly can we recover from a 30% decline in the workforce?

The most rapid expansion in the workforce during the last 10 years was the period from mid-2003 to

mid-2006. In that 36-month period, the construction labor workforce expanded by 1,000,000 jobs, 15%.

Therefore, during the strongest period of expansion in the last 10 years, the workforce expanded by only

15% over 3 years, or an average of 28,000 jobs per month. What’s signicant is that ination adjusted

volume increased by only 10%. Such a signicant workforce expansion led to measurable lost productivity.Even if we could realize a similar rate of growth, which was associated with a high rate of economic

expansion, it would take 6 years to recover more than 2 million lost jobs. At this accelerated rate the

workforce would not return to previous levels before 2017. That is a very unlikely scenario, since it would

require uninterrupted elevated economic expansion. It is highly unlikely we will see the workforce return

to previous levels within 6 years. Furthermore, if we experience uninterrupted economic expansion at this

level for the next 6 years, productivity is going to plummet erasing all of the gains realized in the last few

years and more.



18



The rate of employment growth may be a valid concern for the following reason; if spending and jobs are

to remain balanced and return to normal, then both the rate of expansion in construction spending and the

rate of growth in the workforce needs to be approximately equal in the coming years. If the rate of spending

growth exceeds a normal the rate of growth, it will produce an extremely active market, there will be worker

shortages and productivity will drop. Also, when that occurs, it leads to rapidly increasing prices and

elevated margins.

CONSTRUCTION COSTS GENERAL

Industrial production related to construction is up 5 months in a row and is up over 7.5% in 12 months since

February 2011.

Fabricated metal products industry reported production is up, prices paid are lower and Backlog of

Orders is up.

Of items used in construction, copper, copper wire, copper pipe, aluminum, diesel fuel and plastics are all

still UP in price over the last 3 months. Structural shapes are down in price over 3 months.

Concrete and steel, the major drivers of building structure cost, are both experiencing low cost increases.

Concrete contractor pricing is up less than 1.5% over the year and more recently is down. Fabricated

structural products are up less than 2.5% over the year.

In March, Ken Simonson, AGC Chief Economist, said he expects materials prices to range from 4% to 9%

during the year, but to end at 5% to 6% increases for the year 2012. Labor is expected to nish the year up

1.5% to 2.5%.

Manufacturing capacity utilization had been uctuating between 76% and 77% since November 2010. In

July it increased just above 77%, by October it was approaching 78% and since December it has been near

79%. Typically, the capacity utilization index needs to be consistently above 80 before we see an expansion

of construction spending in the manufacturing sector. Spending in this sector is still down 23% from last

year. That will keep prices in that sector depressed.

M ATERIAL PRICE MOVEMENT

The overall Producer Price Index (PPI) for February 2012 shows cost for construction materials are up 4.4%

in the last 12 months. Costs for material inputs to non-residential construction are up 4.6% in the last 12months. Prices for completed buildings are up on average 4.0%.



19



Table 9 BLS PPI Markets

U.S. Construction Producer Price Indexes - February 2012

MarketsPercent Change Versus annual for

Inputs PPI to February 2012 from12

months12

months Jan-12 Nov-11 Feb-11 2011 2010

1 month 3 months 12 month last yr prev yr

Inputs to ALL Construction 0.9 1.1 4.4 5.3 5.3

Inputs to Non-residential 0.8 0.8 4.6 5.8 NA

Inputs to Commercial 0.7 0.7 3.9 5.0 NA

Inputs to Industrial 0.5 0.5 4.3 5.4 NA

Inputs to Hghwy/Hvy Engr 1.0 1.1 5.1 6.2 NA

Inputs to Residential 0.8 1.3 4.4 4.8 4.3

All data not seasonally adjusted

Data Source: Producer Price Index. Bureau of Labor Statistics

Compare the cost inputs in Table 9 to the completed costs for buildings in Table 10. From the latest data we

can see contractor actual costs are getting closer this past year to actual material cost inputs. That means

more cost is being passed along. It is reasonable to expect this gap to continue to narrow.

Table 10 BLS Actual Cost Buildings


Buildings Percent Change Versus annual for

Completed to February 2012 from12

months12

monthswhole building cost Jan-12 Nov-11 Feb-11 2011 2010



New Industrial Bldg -0.2 0.0 3.6 3.3 0.4

New Warehouse Bldg 0.0 0.5 4.2 3.8 0.4

New School Bldg 0.0 0.7 4.6 4.7 1.3

New Ofce Bldg 0.0 0.8 3.8 3.9 -0.3

except inputs, includes labor, material overhead and prot


Source: Producer Price Index. Bureau of Labor Statistics

For the past 3 years, the trend has been increasing materials costs that have been difcult to pass on to the

consumer. From the client’s perspective building costs were not been increasing as much as material

costs. From the perspective of manufacturers, suppliers and constructors, costs were increasing butwere being absorbed by a reduction to margins. In effect, this kept selling price to end users well below

the level of material cost ination, but also considerably reduced the protability of all producers, suppliers

and builders. That is now starting to change.

As construction spending slowly grows from depressed levels, selling prices will begin to approach the

normal cost line at which more, if not most, material cost ination will be passed along to the end consumer

in this environment. Manufacturers, suppliers and contractors will begin to recover from depressed margins

as this trend increases.



20



Table 11 BLS Actual Cost Trades


TradesPercent Change Versus annual for

Non-residential to February 2012 from12

months12

monthswhole trade bid cost Jan-12 Nov-11 Feb-11 2011 2010



Concrete -0.2 -0.5 1.1 1.3 0.4

Roong 0.0 0.7 4.2 4.3 -1.9

Electrical 0.8 1.2 4.1 3.8 1.1

Plumbing / HVAC -0.1 0.8 4.3 3.6 1.7




I expect whole building costs to rise, but a bit slower than material/labor ination.

Indicators are pointing to growth signs and that will eventually lead to a more normal bidding environment.

That in turn will allow builders to pass along ever greater percentages of cost increases. Concrete trades

over the last year increased prices only about 1%, but Roong Electrical and Plumbing / HVAC trades all

increased prices on average 4%.

NOTABLE MATERIALS CHANGES OVER THE LAST 12 MONTHS THROUGH FEBRUARY :

diesel fuel +14%

gypsum products +15%

copper and brass shapes -11%

steel pipe +10%

asphalt paving +11%

CEMENT / CONCRETE

Portland Cement Association (PCA) reports the volume of cement demand as an indicator of economic

activity. It is a reliable coincident indicator.

Nearly two-thirds of U.S. cement consumption occurs in the six months between May and October. Rising

consumption and prices leading into summer can lead to large shifts in demand and seasonal pricing andis not an indicator of long term growth but only reects periodic seasonal uc0tuating consumption rates.

Look at total annual volumes for trends.

Cement ProductionIn 2008 U.S. cement plants were operating at a capacity utilization of 82%. In Fall 2011, cement plant

capacity utilization, considered depressed, was 60%. The rate of decline in consumption helps explain the

60% capacity utilization. In 2010, cement production and consumption hit a 28-year low.



21



Figure 7 PCA Cement Consumption

millions

metric tons

2010 = 28yr

low

0

20

40

60

80

100

120

140

2005 2007 2009 2011 2013

Cement Consumption

Cement prices increased only 1% in 2011 after dropping 3 years in a row. Cement prices are 10% below2007. Ready Mix Concrete prices are currently only 2% higher than 2007.

Cement Imports accounted for 25%-30% of consumption in 2006. For 2008, imports accounted for only

12% of consumption. Imports have averaged about 10% since then. Imports grow when U.S. plant capacity

utilization is greater than 80%. Half of all imported cement comes from Canada and most of that enters

through the Great Lakes ports of Detroit, Cleveland and Buffalo.

Texas is by far the leading consumer of cement, using 50% more than California and nearly 300%

more than third place Florida. Together these 3 states account for 30% of U.S. cement consumption.

(Correspondingly, these 3 states together account for 27% of the U.S. construction workforce).

STRUCTURAL STEEL

The construction industry represents the largest consumer of steel products worldwide. Approximately

100 million tons of steel is produced annually in the United States. More than 40 million tons of that is

delivered to the construction industry. The next largest industries, automotive, equipment and machinery,

combined do not consume as much steel as construction.

The American Iron and Steel Institute reports steel production in March 2012 reached a post-recession

capacity utilization of 79%. It has since fallen to 76%. During the same period last year capacity utilization

was ranging between 74%-75%. Through the rst 3 months this year production is UP 6.6% over the

same 3 months last year. Capacity utilization is increasing but still with some excess production capacityavailable for steel.

Late last year we had steel production tonnage up, excess production capacity available andconstruction spending (demand) down. That combination kept steel prices in check. Now we seeincreased production, less available additional capacity and demand volume on the increase. Thiswill soon lead to increasing prices.

For 2010 and 2011, consumption wasdown 46% from peak 2008. PCA

recently released 2011 data predicting

consumption to have grown by only

1.1%. Consumption is expected to grow

only 0.5% in 2012, but then grow a bit

greater by 7.4% in 2013.





23



COPPER

Copper material prices hit an all-time high of $4.60/lb in February 2011, up 25% from October 2010. By

September 2011 the price dropped back to $3.10/lb. The price as of April 4, 2012 was just under $3.85/lb,15% below where it was a year ago.

WHAT MAKES COPPER SO IMPORTANT TO WATCH?

Copper is a leading economic indicator that has rarely (if ever) failed to indicate the direction of world

economies. When copper rises in price, world economies are leading into expansion. When copper drops

in price, a decline in world economies very quickly follows. Copper prices and the U.S. workforce move

almost perfectly together. Also, because copper is so widely used in buildings, and manufacturing facilities

must be built to see a big increase in production, copper demand precedes and is an excellent predictor of

industrial production 12 months out.

For a visual representation of the copper prices, visit:

http://metalprices.com/PubCharts/PublicCharts.aspx?metal=cu&type=L&weight=LB&days=60&size=M&bg=&cs=1011&cid=0

What drives copper prices up or down? Unlike some other metals, it is not speculation. Quite often it is

demand. Increasing demand = increasing prices. When demand wanes, prices drop. Analysts predict

copper will average $4.00/lb in 2012.

WHAT AFFECT DO COPPER PRICE CHANGES HAVE ON THE COST OF OUR PROJECTS?

ROUGHLY SPEAKING, COPPER MATERIAL IS ABOUT:

10% of an Electrical contract or 1% of cost of project

5% of an HVAC contract or 0.6% of cost of project

10% of a Plumbing contract or 0.3% of cost of project

So, for an average project, copper material can represent approximately 2% of the total cost of the project.

Therefore, a 25% increase in the cost of copper will increase the cost of a project by 0.5%.

There may be exceptions. For example, if copper is 2% of the total cost of the typical project, it is probably

4% to 5% of total cost on a heavy mechanical/electrical project, like a data center. So a 25% increase in the

cost of copper increases the total cost of a data center by 1% to 1.5%. For a copper roof, material is 65% of

total cost and can represent ~1% of typical project cost.





24



PRODUCER PRICE INDEX

The February 2012 2011 Producer Price Index for Material Inputs to Construction increased 1.1% over the

last 3 months and is up 4.4% over the past 12 months.

The February 2012 PPI for Material Inputs to Non-residential Construction decreased 0.8% over the last 3months and is up 4.6% over the past 12 months.

PPI for Trade Contractors nal costs and Whole Building nal costs is UP, but up only about 4% in 12

months. See Materials Price Movement for Contractor Installed Prices and Finished Building Prices.

Table 12 BLS PPI Construction Related Materials


Materials Percent Change Versus annual for

to February 2012 from12

months

12



Summary



Commodities

Cement -2.4 1.3 2.2 1.1 -6.0

Iron & Steel Scrap -6.2 3.5 -4.5 11.1 38.9

Manufactured Materials

Diesel Fuel 3.0 -2.0 14.5 20.2 26.4

Asphalt Paving 2.5 4.3 11.3 8.4 4.4

Asphalt Roong -0.5 -2.4 -1.9 2.6 1.9

Ready Mix Concrete -0.2 1.0 1.5 0.6 -1.2

Concrete Block & Brick -0.1 0.3 1.8 1.1 -1.1

Precast Conc Products 0.1 0.2 0.1 2.6 1.0

Building Brick 0.2 -3.4 -2.9 -2.6 -0.3

Copper / Brass Mill Shapes 5.9 4.7 -11.2 -9.3 11.8

Aluminum Mill Shapes 1.9 -0.8 -0.8 0.1 11.6

Steel Mill Products 0.6 1.3 4.0 11.3 12.5

Steel Pipe and Tube -0.8 4.9 10.0 12.1 19.6

Fab. Structural Steel 1.9 1.2 2.5 4.4 1.9

Fab. Bar Joists and Rebar 2.4 0.7 1.4 2.8 -0.3

Gypsum Products 5.1 12.0 15.2 -1.5 3.2

Insulation Materials 0.4 3.3 5.0 5.4 4.6Lumber and Plywood 1.7 2.3 -0.7 -0.8 5.7

Sheet Metal Products -0.5 -2.1 2.4 5.8 4.0



The primary factor keeping total costs down right now is high level of competition for a slowly increasing

volume of new work. The price asked for subcontract work and for nished buildings is slowly starting to

catch up with the rate of material cost increases.



25



THE PPI FOR ITEMS THAT CONTRIBUTED THE MOST TO THE 3 MONTH AND YEARLY CHANGE INCLUDED:

Diesel fuel prices dropped 2% recently but climbed 14% over the last year Asphalt paving is up 4% in 3 months and up 11% over the year

Gypsum products rose 12% in 3 months and 15% over the year

Steel pipe and tube rose 5% in 3 months and but rose 10% over the year

Is the PPI for Construction Materials = Escalation? NO!

IS THE MOVEMENT OF THE PPI A GOOD INDICATOR OF FUTURE ESCALATION? NO!

Indexes like the PPI MTRLS deal ONLY with materials costs or prices charged at the producer level. They

do not include delivery, equipment, installation, or markups. In fact, they do not even reect the retail pricecharged to contractors. Nor do they reect the cost of services provided by the GC or CM.

Total project cost encompasses all of these other costs. Trade Contractor PPI and Whole Building PPI

doesn’t give us any details about the retail price of the materials used, but it does include all of the

contractors costs incurred for delivery, equipment for installation, labor for installation and markups on the

nal product delivered to the consumer, the building.

The PPI for construction materials IS NOT an indicator of construction ination. It is missing the selling

price. In 2010, the PPI for construction inputs was up 5.3% but the selling price was at. In 2009 PPI for

Inputs was at but construction ination as measured by cost of buildings was down 8%-10%.

Construction Starts and construction spending are still near 10-year lows, and therefore there is little workavailable out for bid, forcing contractors to remain extremely competitive. As a result, they areunable

to pass on all cost increases to clients. This has the effect of keeping selling price low, reducing both

contractors and producers margins. In some cases margins may be reduced to a loss just to get work.

Construction cost escalation is moving closer to track in line with the PPI for construction materials. But it

will take continued increases in the levels of activity to enforce the narrowing of the gap between the two.

I do not expect cost escalation to track in-line with PPI for at least 1 to 2 years. Until then, do notbase building cost growth on the increase in construction materials PPI.

http://portal.gilbaneco.com/whatitsworth/Lists/Posts/Post.aspx?ID=47

http://portal.gilbaneco.com/whatitsworth/Lists/Posts/Post.aspx?ID=47



26



THE B ALTIC DRY INDEX

The Baltic Dry Index (BDI) provides an assessment of the price of moving major raw materials by sea. It

indirectly measures global supply and demand for the commodities shipped aboard dry bulk carriers, suchas building materials, coal, metallic ores, and grains. Because dry bulk primarily consists of materials

that function as raw material inputs to the production of intermediate or nished goods, such as concrete,

electricity, steel, and food, the index is also seen as an efcient economic indicator of future economic

growth and production.

Figure 10 Baltic Dry Index BDI

Baltic Dry Index monthly

0

1000

2000

3000

4000

5000

Jan-

09

Apr Jul Oct Jan-

10

Apr Jul Oct Jan-

11

Apr Jul Oct Jan-

12

Apr

The BDI is termed a pure leading economic indicator because it predicts future economic activity andis not influenced by speculators.

More iron ore is shipped by seagoing dry bulk carriers than any other dry bulk commodity. Demand for

iron ore has a dramatic effect on the BDI and further then on the price of iron ore and ultimately on the price

of steel. Steel products, iron ore, billet steel, nish steel pipe and steel shapes account for more than 50% of

all the world-wide dry product shipped in large cargo ships. The construction industry is the largest user of

steel worldwide.

The BDI does not yet provide strong support for a pickup in future economic activity.

As demand increases, the BDI goes up. A rising BDI indicates an increase in future economic activity but also future rising prices for commodities and nally, materials. However as demand wanes, the BDI

decreases and so eventually does the cost of raw materials.

In May 2008 the BDI was near 12,000. By

December of 2008 it had dropped to 700.

The index saw a few peaks throughout 2009

and 2010, but did not hold. The current

index is lower than at any time in 2010 or

2011, now 11,000 points below the Q2 2008

peak.

http://en.wikipedia.org/wiki/Building_materials


http://en.wikipedia.org/wiki/Ore

http://en.wikipedia.org/wiki/Grain

http://en.wikipedia.org/wiki/Raw_material

http://en.wikipedia.org/wiki/Intermediate_goods

http://en.wikipedia.org/wiki/Finished_goods

http://en.wikipedia.org/wiki/Concrete

http://en.wikipedia.org/wiki/Electricity

http://en.wikipedia.org/wiki/Steel

http://en.wikipedia.org/wiki/Food

http://en.wikipedia.org/wiki/Economic_indicator

http://en.wikipedia.org/wiki/Leading_economic_indicator

http://en.wikipedia.org/wiki/Leading_economic_indicator

http://en.wikipedia.org/wiki/Economic_indicator

http://en.wikipedia.org/wiki/Food

http://en.wikipedia.org/wiki/Steel

http://en.wikipedia.org/wiki/Electricity

http://en.wikipedia.org/wiki/Concrete

http://en.wikipedia.org/wiki/Finished_goods

http://en.wikipedia.org/wiki/Intermediate_goods

http://en.wikipedia.org/wiki/Raw_material

http://en.wikipedia.org/wiki/Grain

http://en.wikipedia.org/wiki/Ore


http://en.wikipedia.org/wiki/Building_materials



27



A RCHITECTURAL B ILLINGS INDEX

For February 2012 the Architectural Billings Index (ABI) has remained above 50 for the third consecutive

month. In March we experienced the drop. Through February, with the exception of September 2011, theindex has been climbing since July 2011. Index readings above 50 indicate more rms reporting increasing

billings than rms reporting decreasing billings.

Residential design projects account for about 15 percent of the total index. Ofce buildings, hotels,

shopping centers, banks, warehouses, manufacturing plants and other commercial properties represent 35 to

40 percent of the index. Institutional buildings account for 45 to 50 percent of the index.

The strongest growth is in the Midwest with modest growth at rms in the Northeast and South. These three

regions are expected to show continued momentum in design activity over the next few months. Firms in

the West are still reporting declining levels of billings.

Since July 2011, all the indices have been climbing. The commercial index has been above 50 sinceSeptember, the overall non-residential ABI since October and the Institutional index is above 50 since

December. Typically, institutional facilities are usually the last non-residential building sector to recover

from a downturn. This bodes very well for newly anticipated work growth in Q2-Q3 2012.

Figure 11 Architectural Billings Index ABI

Architectural Billings Index

ABI

Inst

Com

44.0

46.0

48.0

50.0

52.0

54.0

56.0

1 1 - J a n

F e b

M a r

A p r

M a y

J u n

J u l

A u g

S e p

O c t

N o v

D e c

1 2 - J a n

F e b

M a r

above 50 =billings increasing, below 50 =billings decreasing

ABI Institutnl Outlook Commercl

The ABI is a leading indicator of

construction spending 9 to 12 months out.

Index values consistently below 50 indicate

there will be a decrease in construction

spending 9 to 12 months later. The 2011drop from March through July accurately

predicted the current slow-down in new

Starts and spending. Financing is still the

most common reason for a delay in projects

moving forward.



28



CONSUMER INFLATION / DEFLATION

The Moore Ination Predictor© (MIP) is a highly accurate graphical representation of the future direction of

the ination rate. It has a 97%+ accuracy rate forecasting ination rate direction & turning points. And over90% of the time the ination rate falls within the projected “likely” range.

Figure 12 Moore Inflation Predictor Consumer Inflation

Current Consumer Ination Rate Forecast for the next 12 months

(MIP chart used by permission, Tim McMahon, Editor, Financial Trend Forecaster www.ntrend.com)

Accelerating ination reached 4% by September 2011, but then a downward trend brought us back to 3%

by year end. In the short term, ination may move a bit lower. But the effects of the second round of

stimulus (QE2) are beginning to be felt. That may boost inationary pressures and may have already begun

to kick in. The monthly rates of ination for January and February were both over 0.4% which would be

over 5% if annualized. Originally, QE2 results were expected to show up around May 2012. That may be

showing up a bit earlier than predicted.

Over the long term (a year from now) we may see ination above 5% again. The expected temporary drop

could act as a false indicator about the longer term direction of ination.

Keep in mind, construction ination is historically much higher than consumer ination.

http://www.fintrend.com/

http://www.fintrend.com/

http://fintrend.com/wp-content/uploads/2011/11/Moore_Inflation_Predictor3.jpg



29



CONSTRUCTION INFLATION FORECAST

Construction ination, based on several decades of trends, is double consumer ination. Since mid-2009that long term trend has not held up. Recent construction ination continues to be inuenced primarily by

bid margins which have been low due to low work volume. If it holds true that long-term trends eventually

return to the norm, we may be headed for some serious construction ination down the road.

From January through April 2011 consumer ination shot up to 3%. At that time expectations were that

consumer ination would continue to climb through the year, potentially to a range just above 5% with a

drop back to 3% expected by May 2012. We see now that it reached near 4% by September and returned to

3% by year end and may go lower by May. But that short-term downward trend should then turn upwards

and move closer to 5% a year from now.

Normally we would expect construction ination to come in near double that range. Construction materials

currently are below that trend. However, keep in mind, because of current low demand, prices are being

held down. Construction materials ination is low year to date, but increased signicantly in the latest

month. As demand increases in coming months, construction ination may climb rapidly.

Until construction spending returns to normal, I expect total construction escalation cost passed on to

owners might be somewhat subdued, perhaps no more than 4%. Subdued nished building prices will be

inuenced by aggressive bidding. This will change quickly as bidding volume increases.

SOME S IGNS A HEAD

The Institute for Supply Management (ISM) report released April 2, 2012, shows the national Purchasing

Manager’s Index (PMI) is 53.4%. It is growing stronger. PMI values above 42.5 indicate overall economic

expansion. Index values above 50 indicate expansion in the manufacturing sector. Fabricated metal

products industry reported production is up, prices paid are lower and Backlog of Orders is up.

The ISM Non Manufacturing Index (NMI) measures economic activity in several industries (including

construction) not covered in the manufacturing sector. The NMI for March is 56.0, down from February,

but still growing, although at a slower rate. The New Orders and Backlog Indexes declined for the month.

A respondent from the construction industry commented, “We are starting to see the private sector building

again.”

Industrial production related to construction is up 5 months in a row and is up over 7.5% in 12 months since

February 2011.

The Conference Board Leading Economic Index (LEI) is up 5 months in a row through February. After 5

months of strong growth, the Employment Trend Index (ETI) turned down slightly in March.

The Economic Cycle Research Institute (ECRI) U.S. Weekly Leading Index of economic growth predicts



30



economic activity 2 to 3 quarters out. This index was positive from December 2010 through August 2011,

when it turned mildly negative. It turned stronger negative in October. But since November the WLI has

been on the increase and since January has been increasing strongly.

The Architectural Billings Index (ABI) is a leading indicator of construction spending 9 to 12 months out.

Since July 2011, all the ABI market indices have been climbing. The commercial index has been above 50

since September, the overall non-residential ABI since October and the Institutional index is above 50 since

December. Typically, institutional facilities are usually the last non-residential building sector to recover

from a downturn. This bodes very well for newly anticipated work growth in Q2-Q3 2012.

Manpower reports hiring in the construction industry for Q2 2012 anticipated at a net +9% compared to a

net -4% in Q4 2011 and -7% in Q1 2012.

Construction Starts hit a 12-month low in September, but hit an unusual high in October, likely reecting

volatility from month to month. Starts have trended downward since October hitting a 15 month low in

February. This may be strongly inuenced by a sharp drop in non-building Starts.

The FMI rst quarter Non-residential Construction Index Report (NRCI) is now 58.1, is up almost 8 points

from the previous quarter. FMI’s index of the overall economy provided the strongest improvement in the

overall index.

ENR INDEX

The March 2012 Engineering News Record Building Cost Index (ENR-BCI) is 5144, up 0.6% year to

date. However, the winter months historically show very low growth while the summer months show rapid

growth. In times of 4% annual escalation expect the winter rate to be -2% to +2%, while the summer rate

will be +6% to +7%. The ENR BCI index increased 3.7% in 2010 and 2.8% in 2011.

THE ENR-BCI IS ONE OF THE MOST WELL-KNOWN AND MOST WIDELY USED BUILDING COST INDICES.HOWEVER, ITS LONG-TERM STRENGTHS CAN ALSO BE WEAKNESSES, PARTICULARLY IN TIMES OF FLUCTUATING SELLING PRICES BECAUSE:

It is made up of a small shopping basket of labor and materials. Therefore it is not always the bestrepresentation of all building types, which can vary considerably in composition.

That shopping basket includes no representation for any Mechanical, Electrical or Plumbing items, whichcan comprise 30%-50% of the cost of the building. In many cases the shopping basket comprises less than 20% of the building cost.

Building materials differ widely in rate and timing of cost growth and can dramatically affect the costof projects. In 2009 while structural steel products declined in price by -10% to -15%, copper productsincreased in price by 40%+.

ENR-BCI does not take into consideration bid prices, so it often does not represent the final cost ofbuildings. Bid prices are referred to as Selling Price, and this is not included in the ENR-BCI. Sellingprices show increased or reduced margin bids due to market activity.



31



Table 13 ENR’s Building Cost Index History (2000-2012)

1913=100 JAN FEB MAR APR MAY JUN JUL AUG SEP OCT NOV DECANNUAL

AVERAGE2000 3503 3523 3536 3534 3558 3553 3545 3546 3539 3547 3541 3548 3539

2001 3545 3536 3541 3541 3547 3572 3625 3605 3597 3602 3596 3577 3574

2002 3581 3581 3597 3583 3612 3624 3652 3648 3655 3651 3654 3640 3623

2003 3648 3655 3649 3652 3660 3677 3683 3712 3717 3745 3765 3757 3693

2004 3767 3802 3859 3908 3956 3996 4013 4027 4102 4129 4128 4123 3984

2005 4112 4116 4127 4168 4189 4195 4197 4210 4242 4265 4312 4329 4205

2006 4335 4337 4330 4335 4331 4340 4356 4359 4375 4431 4462 4441 4369

2007 4432 4432 4411 4416 4475 4471 4493 4512 4533 4535 4558 4556 4485

2008 4557 4556 4571 4574* 4599 4640 4723 4733 4827 4867 4847 4797 4691

2009 4782 4765 4767 4761 4773 4771 4762 4768 4764 4762 4757 4795 4769

2010 4800 4812 4811 4816 4858 4888 4910 4905 4910 4947 4968 4974 4884

2011 4969 5007 5010 5028 5035 5059 5074 5091 5098 5104 5113 5115 5050

2012 5120 5122 5144

Data reprinted by permission Engineering News-Record - ENR.com

Using known historical projects to get an idea of cost of future projects is common practice. Time indices

give us the means to move project costs from some point in time in the past to current time. One method

of indexing project cost from some point in time in the past to the current time is by using the ENR-

BCI. Divide the current index value by the index value from the midpoint of construction of the historical

reference project. That factor allows us to move cost from the past to today.

The correct procedure for moving project cost over time is to move from the midpoint of construction to the

midpoint of construction. The total cost of any project is not arbitrarily located at the start of construction, but is correctly positioned at the centroid of the construction duration. The centroid of cost for most projec

types is almost always located at about 55%-60% into the construction schedule. However, often the

midpoint of the construction schedule is used as the centroid of cost.

Since the correct procedure requires that we move cost out to the midpoint of construction, we must

complete the process by applying anticipated ination factors on today’s cost to move that out to the future

project midpoint. Ination factors, referred to as escalation, are addressed elsewhere in this report.

There were several monthly declines in the ENR index from late 2008 through early 2010, but the annual

average has gone UP every year for 70 years. More importantly, from Q2 2008 through much of 2011,

during the only recent period of true deation, the ENR-BCI would indicate a 10% cost increase! The

actual nal cost of buildings, documented by several reliable measures, from Q2 2008 through Q4 2010went DOWN by anywhere from 8% to 13%. Since December 2010, while the ENR Index has increased by

less than 3%, cost of buildings has increased about 4%.

The ENR-BCI will give a good representation of growth when construction activity growth is fairly

constant without steep up and down swings. During constant growth periods contractors’ margins are

relatively even and the yearly change in the index values of even a small basket of materials and labor costs

can be representative of the growth in the cost of buildings.



32



Whenever we have very active periods or very depressed periods of construction activity, contractor

selling prices rise or fall accordingly and the ENR-BCI, since it does not track selling price, cannot reect

accurately what affect selling price had on the cost of buildings during those periods. Nonetheless, the

ENR-BCI is often relied upon as an indicator of cost movement over time.

We’ve just gone through a period of three to four years during which margins were rst inated and then

deeply depressed, transitioning dramatically from peak to trough. If you rely solely on the ENR-BCI to

index the cost of buildings from, during or across that period of time, you may end up with indexed cost

results that are grossly in error. If you were to select a time period between Q2 2008 and today, you could

be overstating the future cost of a building by approximately 15% to 20%. You must at the very least take

into consideration the selling price of buildings, past and present.

Selling prices are not captured in the ENR Index. For a procedure to adjust for actual selling prices see the

Indexing – Addressing the Fluctuation in Margins section of this report, and refer to the graph Escalation

Growth vs. Margin Cost. This is particularly important for those of you using cost modeling tools suchas Gilbane’s CostAdvisor.



33



INDEXING BY LOCATION – CITY INDICES

Equally important as indexing for time is the

process of indexing for location. The practice of

using historical projects, regardless of location,

to get an idea of cost of future projects is quite

common. Not only must we move project costs

over time, but also we must move location. City

indices provide the means to move project costs

from one location to another.

Suppose our historical project was built in Phoenix

and we wish to determine the cost of a similar project built in Boston.

A SSUME PROJECT COST AS BUILT = $10,000,000

Boston index = 120

Phoenix index = 90

MOVE COSTS TO BOSTON FROM PHOENIX;

DIVIDE “TO” CITY BY “FROM” CITY

MULTIPLY ORIGINAL COST BY FACTOR.Boston / Phoenix = 120/90 = 1.33x

$10,000,000 x 1.33 = $13,300,000.

You can see by this example the danger of simply

using unadjusted project costs from one location

to determine costs in another location. Without

adjusting for differences in cost due to location, it

is possible to over or understate project costs by

substantial amounts.

ENR provides city indices for 20 majormetropolitan cities. RS Means annually updates

tables for hundreds of cities. The chart here lists

30+ major cities from highest to lowest RS Means

index. The ENR index is shown for those available.

Figure 13 City Location Indexes



34



SELLING PRICE

Selling price is the total price at which a contractor is willing to bid to win a project, even if that selling

price eliminates all prot from the bid.

Few ination or material/labor cost predictors address the issue of bidders lowering margins to win work

and hence lowering what is known as Selling Price. Selling price is dramatically affected by economic

conditions such as market volume and contractor booked revenue. When market volume is low, contractor’s

margin, or Selling Price, comes down. As business volume picks up, and once contractors secure more work,

even if material prices stay low, contractors begin to increase their selling price.

Table 14 BLS PPI Markets


Markets Percent Change Versus annual for

Inputs PPI to February 2012 from12

months12





Inputs to Commercial 0.7 0.7 3.9 5.0 NA

Inputs to Industrial 0.5 0.5 4.3 5.4 NA

Inputs to Hghwy/Hvy Engr 1.0 1.1 5.1 6.2 NA

Inputs to Residential 0.8 1.3 4.4 4.8 4.3


Data Source: Producer Price Index. Bureau of Labor Statistics

We are currently in a slow period predicted by both the Construction Starts gures reported by McGraw Hill

and the Architectural Billings Index published by the AIA. Both indices in Q4 2011 indicated declining

construction activity for the next 6 to 9 months. However, monthly rate of spending is still well above

levels of the last 18 months. Although it may be several years before building markets return to pre-

recession levels, at least we can say the rate of activity is increasing.

Table 15 BLS Actual Cost Trades


Trades Percent Change Versus annual for

Non-residential to February 2012 from 12 months 12 months

whole trade bid cost Jan-12 Nov-11 Feb-11 2011 2010 1 month 3 months 12 month last yr prev yr


Concrete -0.2 -0.5 1.1 1.3 0.4

Roong 0.0 0.7 4.2 4.3 -1.9

Electrical 0.8 1.2 4.1 3.8 1.1

Plumbing / HVAC -0.1 0.8 4.3 3.6 1.7


All data not seasonally adjusted | Source: Producer Price Index. Bureau of Labor Statistics



35



The cost of buildings still lags normal labor and material ination cost indices and should continue to do so

for some time to come, but the gap is narrowing. Despite an average 5% increase in cost of material inputs

in 2010, prices for buildings remained virtually unchanged, still 10% to 15% below mid 2008. However, in

2011 building total cost growth nearly equaled labor and material cost growth.

The net change for 2010 and 2011 combined shows that on average, material price inputs increased 11%.

During that time labor costs increased by 2%-3%, for a net normal expected 6.5%-7% increase in building

costs. At the same time total building costs are up only 3.5% to 5%. The difference is absorbed in reduced

margins.

Table 16 BLS Actual Cost Buildings


Buildings Percent Change Versus annual for

Completedto February 2012 from

12

months

12

monthswhole building cost Jan-12 Nov-11 Feb-11 2011 2010



New Industrial Bldg -0.2 0.0 3.6 3.3 0.4

New Warehouse Bldg 0.0 0.5 4.2 3.8 0.4

New School Bldg 0.0 0.7 4.6 4.7 1.3

New Ofce Bldg 0.0 0.8 3.8 3.9 -0.3




The ow of projects coming to bid during the coming months will strongly inuence the cost movementof the bids. If the volume of projects coming to bid decreases, overall construction business will remain

depressed and bids will remain low, strongly inuenced by reduced margins. When we see a continued

increase in the volume of projects coming to bid, the need to keep margins reduced will diminish and

margins will begin a return to normal.Contractors’ margins are extremely variable over market sectors.

In general, depressed margins for non-residential building contractors will continue through 2012.

Specic specialty contractors may see margin increases prior to general market trends. Competition

will cause project bids to stay low well into 2012 but bid costs should begin to rise before year-end.



36



INDEXING – A DDRESSING THE FLUCTUATION IN M ARGINS

We often look at the cost of previously built buildings as a historical guide for what to expect in the future. Escalation indices allow us to move the cost of buildings over time. City indices allow us to move for

location. NOW we need also direct our attention to the baseline project cost upon which future escalation is

applied and where that baseline cost stands with respect to normal indices.

For all of 2009 and continuing through 2010, project bids came in at perhaps 10% to 20% under normal

budget estimating. Average costs of buildings from Q2 2008 through Q4’2010 fell by 13% to 15%. We

cannot account for all that drop with individual material cost, wages or productivity changes. It is in part

due to depressed margins.

In the last 6 years, material costs increased or remained constant (see BLS-PPI) and labor costs due to wage

freezes and lack of jobs in some cases decreased. In times of increasing activity, productivity decreased,

but as activity waned from 2006 to 2010, productivity increased. Materials resulted in no lowered costs tocontractors, but producers, suppliers and contractors absorbed some of the material cost increases. Wages

varied by trade, location and labor contractor requirements. Productivity changes, over and above wage

changes, may help account for approximately a 10% reduction in labor cost or about 4% reduction in project

costs. In 2011 productivity declined by 2%. Much of the remaining difference in cost was reduced margins.

A financial study of private companies in the construction industry, prepared by Sageworks, providesinformation on contractor margins. Margins declined from 2006 (5.2%) to 2010 (0.8%). The trendhas reversed and margins are starting to improve. Margins for non-residential contractors increased+1% in 2011 over 2010. 2011 shows average sales increases of about 10%, but more importantlyshows contractor margins reversed a 4 year decline and increased from the 2010 low of 0.8% to

1.8% in 2011. (source = Sageworks Financial report on construction industry)

Margins are now increasing and as workload continues to grow so will margins. In addition, out of

necessity, contractors need to include the normal cost of labor and material escalation. It will take several

years for contractor’s margins to complete the return to normal, but for the next several years escalation, due

to returning growth of margins, will outpace normal labor and material cost growth.

Standard labor and material index tables will not address the inection points in this unusual time period,

nor will standard labor and material ination factors address the return of margin growth. Figure 14 below,

Escalation Growth vs. Margin Cost, illustrates this unusual period and provides a means to properly account

for these unusual occurances

The Blue line = ENR BCI actual values through November 2011 and predicted escalation ranging from 3%to 6% over the next two years, increasing at a rate of 0.5% per quarter. The plotted values are three month

moving average to smooth out the line.

The Red line = Contractor Bid Price Movement or Reduced Margin Cost representative of bids received.

Very low margin cost in mid-2010 reects contractor bids at low cost to secure a dramatically reduced

amount of available work. Predicted future cost shows long term cost growth which accounts for both

normal labor/material escalation equal to escalation outlined above AND a very slow but steady 0.5% per

quarter recovery of margins over the next few years.



37



Figure 14 Escalation Growth vs. Margin Cost

Escalation Growth vs Margin Cost Illustration Only

Actual Cost =

Margin ReducedCost

ENR Index 3mo

move avg =

Escalation

G a p = n e e d e d

< - - - - - - - - - - - - - - - >

% a

d j u s t m e n t

90.0

95.0

100.0

105.0

110.0

115.0

120.0

125.0

130.0

135.0

2 0 0 6 Q 1

Q 2

Q 3

Q 4

2 0 0 7 Q 1

Q 2

Q 3

Q 4

2 0 0 8 Q 1

Q 2

Q 3

Q 4

2 0 0 9 Q 1

Q 2

Q 3

Q 4

2 0 1 0 Q 1

Q 2

Q 3

Q 4

2 0 1 1 Q 1

Q 2

Q 3

Q 4

2 0 1 2 Q 1

Q 2

Q 3

Q 4

2 0 1 3 Q 1

Q 2

Q 3

Q 4

2 0 1 4 Q 1

when margin cost is lower then index

then indexed cost must be adjusted downward

I n d e x v a l u e

HOW TO USE THE A BOVE GRAPH: Pick the date for midpoint of the historical reference project.

At that date, draw a vertical line so it passes through both curves.

Now pick today’s date.

At that date, draw a vertical line so it passes through both curves.

Record the ENR Index at the historical reference date and today

Record the Margin Cost Index at the historical reference date and today.

Subtract historical ENR index from today’s ENR index. Label that value A

Subtract historical Margin index from today’s Margin index. Label that value B Pay attention to sign (+ or -).

The difference between the movement due to the ENR index and the Margin Cost Index is the neededcorrection factor. Use the differences from the ENR Index (A) and the Margin Index (B) to develop anadjustment factor for your project. Since baseline is 100, all factors are the same as percentages.

B minus A = Margin Adjustment factor. Pay attention to signs (+ or -).

Cost Advisor users can record the Margin Adjustment value determined here into the Similarity Adjustment factor field. Treat all system indexing and future escalation as you would normally.



38



This will be a period of conceptual project budget preparation unlike any we have ever experienced. The

critical issue is consideration of project time-period being used as the baseline for a future projection.

A NY BASELINE PROJECT FROM EITHER THE INFLATED OR THE DEPRESSED MARGIN PRICING ERA WILL NEED SPECIAL ATTENTION TO REFLECT AN ACCURATE PREDICTION OF THAT PROJECT INTO FUTURE COST.

COSTADVISOR USERS MUST BE PARTICULARLY VIGILANT OF THIS POTENTIAL ESCALATION / INDEXING ISSUE.

EXAMPLE 1:

Historical project midpoint = Q2 2008 to today’s date = Q2 2012

ENR Index value at midpoint = 107, ENR Index value today = 122,


122 – 107 = 15 = A

Margin Cost at midpoint = 115, Margin Cost today = 108

Subtract historical Margin index from today’s Margin index. Label that value B

108 – 115 = (-)7 = B

Pay attention to signs (+ or -).

ENR Index would have moved cost up from 107 to 122 = +15 = A

But Real cost needs to move from 115 down to 108 = -7 = B

Adjustment Factor = B – A = (-7) – (+15) = -22

Adjustment factor of -22 corrects for indexing error

EXAMPLE 2:

Historical project midpoint = Q3 2010. Today’s date = Q2 2012

ENR Index value at midpoint = 113, ENR Index value today = 122,


122 – 113 = 9 = A

Margin Cost at midpoint = 102, Margin Cost today = 108



39



Subtract historical Margin index from today’s Margin index. Label that value B

108 – 102 = 6 = B

Pay attention to signs (+ or -).

ENR Index would have moved cost up from 113 to 122 = +9 = A

But Real cost needs to move up from 102 to 108 = +6 = B

Adjustment Factor = B – A = (6) – (9) = -3

Adjustment factor of -3 corrects for indexing error

If you are preparing an estimate using historical data input or you are using CostAdvisor to conceptualize

a future project budget several years out from now, AND if selecting any historical project with a cost

midpoint occurring where ever the Red MARGIN line VARIES FROM The Blue ENR INDEX line, you should consider applying a percentage adjustment to the baseline cost to adjust for the difference (or

some portion of the difference) between the two indices. The goal is to correct for any margin over/under

compared to how the ENR index would have moved the costs. Then carry a normal prediction for future

escalation.

ESCALATION – WHAT SHOULD WE C ARRY ?

We tend to think of Escalation as one simple value. An estimator typically prepares a budget in today’s

dollars, but then must escalate the total estimate to the midpoint of the project construction schedule.

Escalation must account for all anticipated differences from today’s cost to future cost. As explained in prior sections, there is more going on with determining escalation than just picking one simple value.

To move costs from today’s dollars into the future, the factor must account for the cumulative expected

changes in labor cost, material costs and selling price, each at its percentage of the total, and you must

escalate the cost out to the midpoint of future construction.

Labor represents on average approximately 40% of building cost.

Materials represent on average approximately 50% of building cost.

Margins are applied on all 100% of building costs.

Escalation factors need to account for all of the above, at the appropriate ratio and for the appropriate

amount of time.

L ABOR:

Anticipate labor cost of 2%-3% per year. For a period of time labor costs were being offset by

productivity increases. That is no longer the case. Recently (2011) productivity declined, actually pushing

labor cost higher than wage rate increases. Labor ratio is 40%. Escalation = 0.8% to 1.2%.

M ATERIALS:



40



Anticipate material costs passed along to only reach 5% to 6%, even though the PPI for construction

materials in 2012 may reach 6%-9%. Material ratio is 50%. Escalation = 2.5% to 3%.

For 2011, PPI for material inputs to non-residential construction increased 5.8%. For that same period totalcosts passed on to the owner were less than 3%, so only half of material cost was reaching the end consumer.

Current economic conditions lead to expectations of ination. However demand, or lack of it, will inuence

the cost of materials. Slow (but steady) growth in spending indicates continued slow demand growth.

Anticipate on average only moderate material price increases. As demand increases, costs passed on will

increase.

M ARGINS:

Anticipate 1% to 1.5%/yr increase to margins unless activity picks up dramatically, then increase rate

of margin growth to 2%/year. Margins are applied on all costs, therefore the ratio is 100%. Escalation =

1% to 2%.

Selling price represents contractor margins and is market activity dependent. Competition will cause project

bid margins to stay low in early 2012 but margins have already been on the increase. Bid costs will show

greater rate of increase before year-end. When we nally see substantial growth in the volume of projects

coming to bid, the need to keep margins reduced will diminish and margins will begin a return to normal.

There is no room left for depressed market activity to move margins lower. Expect margins to increase slowly

over time.

Selling prices are still depressed and it will take time before workload volumes increase to a point that

contractors see a return to normal margins. Nearly 75% of contractors lowered margins in 2010 bids. More

than 75% kept margins the same in 2011 or lowered them even more. Both the New Construction Starts

gures reported by McGraw Hill in the last several months and the March to July 2011 Architectural BillingsIndex published by the AIA are currently proving the delayed increase in construction activity. This should

turn stronger in Q2 2012. The FMI Q1 CIRT Sentiment report indicates 40% of rms anticipate modest

growth in 2012, however the recent AGC March Outlook report indicates only 12% of contractors expect

construction to improve in 2012. It may be several years before the construction workforce and building

markets return to pre-recession levels.

CUMULATIVE COSTS AFFECTING ESCALATION FACTOR:

Labor = 0.8% to 1.2%

Materials = 2.5% to 3%

Margins = 1% to 2%

Potential range of escalation (rounded off) from low of 4% to high of 6%. This could be considered a range

for escalation for the next few years. The 2012 baseline prediction noted here is using the low end of the

range.



41



TOTAL ESCALATION FOR 2012 = 4% MINIMUM

Assumes slow but continued growth in activity which allows passing along only some labor and material

costs and potentially increasing margins 1%.If construction activity increases rapidly, we would quickly reach the high end of 6%, but unlikely.

I anticipate growth accelerating in the second half and potentially pushing escalation to 5%.

Consider your market. If you are in a market area that has expectations of a huge volume of work that

may start within a narrow window of time, then market pricing can turn rapidly for you. In this specic

condition, it would reasonable to assume 6% annual escalation as a conservative approach in a rapidly

growing market. All labor and material cost will get passed along and margins will increase dramatically.

Let’s not forget that building construction real cost escalation was 8%-10% in 2006 and 7%-8% in 2008.

For 2013

There has been some discussion that immediately following this deationary period we could experience

hyper-ination. Contrary to what some economists think, I have read and share numerous opinions that

construction markets are so deeply depressed it will take more like 2 to 3 years to return to active markets

with normal margins and truly inated labor and material costs. If this does occur, I believe it will not

appear before the end of 2013. I expect there will still be some discount bidding well into next year. But

there is no room left to reduce margins further. Margins will not be reduced as much as they had been.

More of the labor and material cost increases will very likely be passed along.

Potential range of escalation from low of 5% to high of 7%. I believe the potential range of 5% to 6%

escalation may accompany a period of unusual ination in construction. The 2013 baseline prediction noted

here is using the low end of the range.

TOTAL ESCALATION FOR 2013 = 5%

Assumes moderately greater rate of growth in activity which allows passing along most labor andmaterial costs and increasing margins 1% to 1.5%.

If construction activity increases rapidly, we would quickly reach the high end of 7%, but unlikely.

Steady growth greater than anticipated could potentially push escalation to 6%.

TOTAL ESCALATION FOR 2014 = 6%

Assumes greater rate of growth in activity than 2013 which allows passing along all potentially

inflationary labor and material costs and increasing margins 1%-2%.

Looking out to 2014, normal construction activity growth and a path of return to normal margins indicate

we will probably approach the higher end of the escalated cost range. By this time contractors may

potentially increase margins 2%. Inationary pressures may push the rate of material costs increases higher

than the 2%-3% range. All material cost increases from the manufacturer through the supplier may be

passed along. It’s difcult to reach any conclusion that total costs within the year would not be escalated to

at least 6%-7% over the previous year. Any assumption that escalation growth would be less requires that



42



market activity does not continue to grow and that contractors will not be able to grow margins, even though

still only 60% of the way back from the margins lost since 2006.

Figure 15 Escalation Minimum and Potential

Inflation / Escalation

-9.0%

-6.0%

-3.0%

0.0%

3.0%

6.0%

9.0%

2000 2002 2004 2006 2008 2010 2012 2014

minimum and potential range

The ABI predicts activity 9 to 12 months

out and indicated a slight downturn which

we are currently going through. Indexes

above 50 indicate increasing billings. Since

July 2011, all the ABI market indices have

been climbing. This bodes well for newly

anticipated work growth in Q2-Q3 2012.



43



Gilbane Inc., is a full service construction and real estate development

company, composed of Gilbane Building Company, Gilbane Development

Company, and ITSI Gilbane. The company (www.gilbaneco. com) is one

of the nation’s largest construction and program managers providing a full

slate of facilities related services for clients in educational, healthcare, life

sciences, mission critical, corporate, sports and recreation, criminal justice,

public and aviation markets. Gilbane has ofces in ten regions of the

country, with corporate ofces located in Providence, Rhode Island. The

information in this report is not specic to any one region.

Author Ed Zarenski is a 40-year construction veteran and a member of the

Gilbane team for more than 30 years. Ed is an Estimating Executive who

has managed multimillion dollar project budgeting, owner capital plan

cost control, value engineering and life cycle cost analysis. He compiles

economic information and provides data analysis and opinion for this

quarterly report.

QUESTIONS REGARDING THIS REPORT CAN BE ADDRESSED TO:

Edward R. Zarenski

Estimating Executive - NENG


Providence, Rhode Island

[email protected]



44

D ATA SOURCES:

Among countless news articles, these sources are used for data in this report

American Institute of Architects – www.aia.org/practicing/economics/index.htmAmerican Iron and Steel Institute - steel.org

American Recycler - americanrecycler.com

Associated Builders and Contractors - abc.org

Associated General Contractors of America - agc.org

Bloomberg L.P. Financial News - Bloomberg.com

Bureau of Labor Statistics - Stats.BLS.gov

Census Bureau - census.gov

Construction Industry Round Table – www.cirt.org

Data Digest – agc.org/datadigest

Economic Cycle Research Institute businesscycle.comEnergy Information Administration - Eia.doe.gov

Engineering News Record - ENR.com

Financial Times - FT.com

Financial Trend Forecaster - Fintrend.com

FMI Management Consulting - FMINET.com

IHS Global Insight - ihs.com

Institute for Supply Management - ism.ws

International Iron and Steel Institute - Worldsteel.org

McGraw Hill – Dodge – construction.com/about-us/press

Metal Miner - agmetalminer.comMetal Prices – metalprices.com

Producer Price Indexes - bls.gov/ppi/

Reed Construction Data - reedconstructiondata.com

RS Means - rsmeans.reedconstructiondata.com

Sageworks – sageworksinc.com

Engineering News Record materials graphics and BCI table reprinted by permission

Financial Trend Forecaster Moore Ination Predictor graph reprinted by permission

U. S. Census Bureau data tables reprinted from public domain

U. S. Bureau of Labor Statistics data tables reprinted from public domainMetalprices material cost data charts from free metalprices.com

All other graphs and tables created by E Zarenski, Gilbane Building Company

Graphs and Tables reprinted by permission may not be reproduced outside this report.

Documents

GBCo Market Conditions Spring 2012