HVAC Market Forecast: From Almost Heaven in 07 to Not So Great in 08

by Ken Simonson

What does the future hold? Of course no one knows, but we can analyze a number of factors to give us an idea how 2008 might treat the contractors who are the backbone of the U.S. HVAC industry. Nonresidential construction is winding up 2007 with nearly every spending category in the plus column, most with double-digits after the plus sign. But 2008 will be much more of a mixed bag.

Although many people seem to believe nonresidential construction inevitably follows a drop in home building with a 12 to 18 month lag, that view is too simplistic. It is true that both residential and nonresidential construction fell in the early 1980s and early 1990s. But the drop in the latter was attributable to a host of factors — recession, very high interest, unemployment and inflation rates — that are absent this time around.

The Census Bureau divides nonresidential construction spending into 16 categories. In the first 10 months of 2007, all but religious structures (the construction type most closely tied to home building) were higher than in the same period of 2006.

Residential construction is likely to continue declining in the first several months of 2008, particularly as large condo projects that started in the last wave of exuberance in early 2006 are completed. Even purpose-built rental housing, which benefited early in 2007 from demand from people who were not able to buy a home, will be under pressure in 2008 from unsold houses and condos that are offered for rent.

Home sales will remain weak until qualified buyers decide prices are not likely to sink any further. That could happen by mid-2008. But it will take at least until the end of the year before inventories fall enough to convince home builders to pick up their tools again. At best, housing starts will flatten out in late 2008 and begin to pick up in early 2009.

The continuing downturns in home building, sales and prices have several spillover effects for nonresidential construction. The dearth of new subdivisions will subtract incrementally from demand for local retail, schools and other public facilities, streets and utilities, as well as more substantially from demand for religious structures. Flat or falling property values and the lack of additions to the property tax base mean local governments and school districts are already starting to defer or cancel construction plans. Lower home sales mean fewer trips to home building supply, yard and garden, furniture and furnishings, and consumer electronics and appliance stores, adding to the drag on retail construction.

But, for the most part, nonresidential construction is driven by such factors as overall production, employment and personal income. All of those macroeconomic variables should continue to rise, at least modestly, in 2008.

In fact, several nonresidential categories look set to maintain or accelerate their growth. Some of these are especially important to heating and air conditioning contractors.

For instance, hospital construction, which has expanded at a 15 to 25% rate for the past two years, is showing no signs of letup. Hospitals are modernizing to accommodate new technology and patient care standards, including greater sensitivity to prevention of airborne pathogens. In California, hospitals also face tough seismic standards that add to the cost of HVAC and other systems. Hospitals are also moving into new neighborhoods where populations are underserved.

Ever-growing use of cellphones, personal digital assistants and computer networks is triggering a new round of communication construction, including more cell towers and data centers or “server farms.” These “must not fail” buildings have particularly intense air-conditioning requirements.

Higher education construction is benefiting from rising demand as record numbers of students reach college age. Also, swelling endowments and successful capital campaigns that tap donors whose portfolios have risen with the stock market, are enabling universities to go on a building binge. The mix of different vintages of dormitories, classrooms, offices, laboratories and specialized facilities, sometimes spread over a large campus served from a central heating plant, presents special challenges — and opportunities — for HVAC contractors.

Two other types of construction that should do well in 2008 are energy- and power-related projects. These include retrofits, upgrades and new capacity for refineries and power plants, new transmission lines, and a host of alternatives: wind farms, biodiesel and renewable diesel, and experimental projects.

However, three large categories of building construction will slow their rapid growth and perhaps turn down as lenders get more skittish. Lodging construction was up 42% in 2006 and another 65% in the first 10 months of 2007. But it may be hard to find financing for more hotels in markets that have already added thousands of rooms, if the economy is slowing.

Office construction, up 20% through October 2007, will run into higher vacancy rates, especially in suburban markets previously occupied by real estate agents, mortgage brokers and title companies. And several national retail chains have already trimmed their expansion plans after the triple whammy of fewer new communities, fewer visits by home buyers or sellers, and tougher lending standards.

Costs will be a headache again in 2008. After the extreme price increases of 2004 through mid-2006, the last year and a half has been tame by comparison. But recent record prices for crude oil and diesel fuel mean that many products that have a high energy content or transportation cost are probably going to cost more in 2008.

In addition, the drop in the value of the dollar relative to other currencies makes imports more expensive and gives domestic producers a chance to raise prices. Steel is a prominent example. Overall, materials costs are likely to rise 6 to 8% in 2008, compared with a 3 to 4% increase in 2007.

Labor costs may accelerate as well, but not uniformly. The ongoing housing slump means that many residential specialty trade contractors will be competing for nonresidential work.

But the continuing expansion of some nonresidential categories will push up salaries, wages and benefits for estimators, project managers, supervisors and skilled craft workers for projects that bear little resemblance to single-family homebuilding.

Thus, wages in energy, power and communications may rise even more than the 5 to 6% increase that looks likely for construction overall.

Thus, residential heating and air conditioning contractors will face another lean year, while nonresidential contractors will have to be much more selective about where to hunt for business than in 2007. Meanwhile, materials costs will be trending higher, as will labor costs for some segments and specialties.

Ken Simonson is chief economist for the Associated General Contractors of America, Arlington, VA. He can be reached at 703-837-5313, e-mail [email protected]
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