January 2016 Economic Overview

Residential Industry Summary

A new year is upon us, and so are the predictions. Housing starts are expected to come in north of 1.1 million in 2015, decent growth from the previous year. Despite a minor slippage in the closing months, builder confidence is high. So what will the experts predict for our industry in 2016? It is reasonable to expect continued improvement. The economy is strengthening, cosumers are feeling better. Unemployment continues to fall, potentially dropping below 5% for the first time in over 8 years. Inflaton remains low, helping the dollar in your pocket buy more. So why not predict 1.3 million starts in 2016? Why not 1.4? Some people will. But with labor and land shortages still at the top of every builders’ list of challenges, and appreciating home prices keeping some buyers on the fence, growth in ’16 could be underwhelming. From an economic standpoint, the recent rate increase is too small to have an impact. But the stigma around rate hikes packs a stronger punch. Wage growth remains an underlying concern, which is critical to addressing price appreciation. And is anyone concerned about the mild winter? To be sure Mother Nature has something in store for us in Q1. Starts will increase in 2016, but expect single digit growth.

General Economy

• 2015 GDP of 2.5% is highest since 2006; still below 3.0+% which is need for robust growth post recession.
• Consumer confidence high, housing growth strong, consumer spending robust in 2016; Strong dollar and lower manufacturing exports will restrain growth and encourage Fed to hold rates steady in1Q 2016; expect rate increase in mid-year meeting.

2016 Forecast: Slow exports, strong dollar restrain GDP to maximum of 3.0%, with likely result of 2-5%-2.7%.

Unemployment

• 2015 jobs market continues to improve with 292K jobs added in December, and upward revision of both October and November.
• Mild winter sparking construction activity; Housing growth driving residential specialty trade contractor employment figures.
• Participation rate is low, falling, and is driven by early retirees, 35-50 age workers’ pursuing graduate ed., and misaligned skill sets.

2016 Forecast: Slow and steady improvement; modest wage pressures; unemployment below 5% for first time since 2007.

Political Environment

• Conflict…no change in status until November 2016 Presidential election.
• Republican primaries continue to entertain; Eventually Republicans and Democratic alike will have to select someone to govern.

2016 Forecast: Trump driven Republican convention turmoil splits electorate, hands White House to Hillary Clinton.

Finance & Banking

• Dec. ’15 rate increase yielded moderate impact; Strong dollar makes a 1st Q rate increase unlikely; expect mid-year action.
• EU QE policy ongoing and is unlocking some growth; European and Global focus, however, is on terrorism and refugee crisis.
• Strong US dollar hurts US exports; helps US imports, drives oil price down, and may eventually support faster global growth.

2016 Forecast: Interest rates remain low; mid-year and end of year Fed rate increases; markets largely unchanged.

Surety

• 2015 estimated losses slightly up; Multi-year results are unprecedented and highly positive attracting new surety companies to market.
• Market softening, underwriting loosening, higher capacity, and competition on indemnity or terms are accelerating for surety providers; Easier for contractors to obtain bonding support…Is this reminiscent of 1990’s?

2016 Forecast: Loss activity up but no spike; surety executives are nervous “like a long-tail cat in a room full of rockers.”

Inflation

• Slow global growth, strong dollar, falling oil and gas prices, and modest wage pressure all tamed inflation.
• Low energy prices are net beneficial to GDP; If prices continue to fall, potential to destabilize US and global financial markets.

2016 Forecast: Inflation remains very low throughout 2016; Energy prices remain low with oil not above $60 until 2017/2018.

State & Municipal
Agencies

• State/Muni performance improving; FAST Act and federal support for water and sewer yeild spending growth through 2016 & 2017.
• High profiles budget, spending, pension, and debt issues in IL, NJ, KY, and CT present both short and long-term challenges.

2016 Forecast: Continued improvement sees more funding to state & municipal priorities and infrastructure replacement.

Global Competition

• Outside of the US, the globe is a mess…Issues include Euro crisis, Domestic and International Terrisiom, Iran Proxies, Iraq, Syria, ISIS, Yeman, Saudia Aribia, North Korea, Boko Haram…all present unique challenges and constraints to stability.
• High flying BRIC countries undone: Brazil is in reverse; Russia is unrecognizable; India has stalled; and China’s growth has slowed dramatically…Is it time to look in a new direction for global growth?..Perhaps MIST – Mexico, India, South Korea, and Turkey.

2016 Forecast: Global growth will not return until 2017 keeping commodities low priced and constrain US exports.

Residential
Building

• Land and labor supply hindered 2015 growth for mid-sized private builders; Workforce trending back to 2:1 starts:employees.
• Permits (+11%) and single-family starts (+7%) for October to November with full year figures at 1.1 million starts, highest since 2007.

2016 Forecast: Growth <10% in starts due to labor shortages, rate hike stigma, and stubborn wages in 2016.

Construction Economy

• 2015 $1.1 trillion (+10%) construction spending, highest in 7 years; Growth from: Manufacturing, Lodging, Office, Residential, Conservation and development, and Telecom….Power construction fed growth for the last 7 years fell by more than 10%.

2016 Forecast: After 7 years, health and widespread construction spending growth has returned and will continue in 2016.

Residential Construction M&A

• Standard Pacific and Ryland merge forming the the nation’s fourth largest builder, The CalAtlantic Group, Inc.
• PulteGroup purchases 7,400 lots from John Weiland Homes, a leading move-up and luxury builder in the southeast.
• Builders FirstSource acquires ProBuild for $1.6B, making them the industry’s premier supplier.

2016 Forecast: Mid-size private builders will continue to feel the pressure from the publics in their local markets, leading to further acquisition activity within the top 100 in the first half of 2016.

Power
Construction

• 7 years of growth has met its match in low energy prices; spending slowed in late 2014 and is shrinking during 2015.
• Long-term prospects very good: Power Gen market will see renewable and gas growth along with decommissioning; Electric T&D focused on reliability, undergrounding, and asset replacement; Gas/liquid T&D focused on integrity and asset replacement.

2016 Forecast: Low energy prices will constrain growth throughout 2016 with return to faster capital spending in 2017.

Homebuilder
Financial
Performance

• Public builders 2015 revenues up due to sales price appreciation (Avg. sale price up to $470k), however gross margins were down due to cost increases (Cost up from $95 to $103 per square foot).
• NVR and Toll Brothers, only 2 top 10 builders reporting margin improvements over the last twelve months.
• Operating efficiency is down due in part to labor shortages causing public builders to end the year at less than 1 inventory turn.

2016 Forecast: Avg. sales price slowly rising but not as fast as land and labor costs, builders continue to face significant margin pressure.

Construction Raw
Materials

• Construction material prices flat in 2015 due to the strong dollar and low global demand.
• Lumber fell dramatically in 2015 as a result of the U.S.’s import of less expensive Canadian lumber and more sawmill capacity.

2016 Forecast: Flat until global growth returns, some modest upward pressure from improving US construction markets.