VERTEX's CEO, Bill McConnell, PE, JD, MSCE, CDT, provides his annual outlook on the state of the Construction industry. The US economy has expanded, albeit slowly, for the past 8+ years. The construction industry, which over-corrected during the Great Recession, has rebounded with vengeance on the heels of record private construction spending. On the other hand, public construction spending was considerably less in 2017 than it was in 2006. Moving forward, all indicators suggest that private construction will slow while public construction spending will soon pick up steam. Also, all good things come to an end, and the current economic expansion will be no different—it is likely the US will enter into a mild recessionary cycle in late 2019 or 2020.

1. William J. McConnell, PE, JD, MSCE, CDT
Chief Executive Officer
THE VERTEX COMPANIES, INC.
Forensic Consulting | Design Engineering | Construction | Environmental
2018
State of the Construction Industry
1
March-2018

2. Executive Summary – Page 1
The US economy continues its low growth / low inflation expansion cycle
that started nearly 9 years ago, which makes it the third longest economic
expansion on record. The Trump administration has implemented several stimulus
measures and the headwinds that faced the energy industry have recently turned
due to the robust global economy, which have both led to a recent spike in
inflationary pressures and associated Fed rate hikes. In addition, the unemployment
rate has been below the 5-percent “full employment” mark for the past 2.5 years.
Should inflationary pressures and low unemployment persist, the Fed will likely
implement three or four additional rate hikes in 2018. Accordingly, continued
growth with higher prices and a lack of available workforce will be difficult. Hence,
the US economy is poised for a recession in late 2019 or 2020.
Overall put in place construction revenue is now in record territory, as it
surpassed the $1.25 trillion mark in 2017. Construction growth has outpaced GDP
growth for the past several years due to booming private sectors. In 2006, private
construction was over-weighted with residential construction revenue—this is no
longer the case. Private construction is much more balanced but growth of late is
starting to flatten due to a shortage of qualified construction workers and
construction-related inflation—this will cool overall construction growth for the
next several years.

3. Executive Summary – Page 2
Contrary to the heated private construction marketplace, public construction has
declined over the past decade. The Trump infrastructure proposal, if approved by
Congress, will certainly help reverse this trend. However, despite low
unemployment, federal deficits continue to rise, which leaves less money for
infrastructure spending. The American Society of Civil Engineering recently gave
America’s infrastructure a D+ grade, so demand for upgrades is pent up, to put it
mildly. Because of the shortage of public funding, private funding through PPPs will
likely be necessary to address many long-awaited improvements.
In sum, the US economy has expanded, albeit slowly, for the past 8+
years. The construction industry, which overcorrected during the Great Recession,
has rebounded with vengeance on the heels of record private construction
spending. On the other hand, public construction spending was considerably less
in 2017 than it was in 2006. Moving forward, all indicators suggest that private
construction will slow while public construction spending will soon pick up steam.
Also, all good things come to an end, and the current economic expansion will be
no different—it is likely the US will enter into a mild recessionary cycle in late 2019
or 2020.
Bill McConnell, CEO
The Vertex Companies, Inc.

4. Table of Contents
Part 1. State of the US Economy
Part 2. State of the US Construction Industry

5. Part 1. State of the US Economy
The Good
• Booming but recently volatile equities market
• Historically low unemployment
The Bad
• Moderate economic growth
• Inflationary pressures are creeping back
The Ugly
• US debt/deficit issues continue despite low employment
Bottom Line: The US economy is overdue for a minor correction,
which will likely manifest in 2019 if not sooner.

6. The following are the longest periods of
growth in US history:
1. 1991 to 2001: 10 years, 0 months
2. 1961 to 1969: 8 years, 10 months
3. 2009 to Feb ’18: 8 years, 8 months (and counting)
4. 1982 to 1990: 7 years, 8 months
5. 1938 to 1945: 6 years, 8 months
6. 2001 to 2007: 6 years, 1 month
It is likely that the current expansion will continue through the
summer of 2019, which will make it the longest economic
expansion on record. It should also be noted that this expansion
is the slowest expansion in terms of GDP growth since 1949.

7. Economic Growth
While long in duration, this economic recovery has not yielded high GDP growth;
however, higher growth is projected for 2018.

8. Historical Expansion
[Trough to Peak in GDP]
Current Expansion: June ‘09 to Present
The trough of the current expansion took place in 2009; we have yet to
record the peak of this expansion cycle.

9. Equities Market Boom
The DJIA has increased by approximately 20,000 points over the last
decade (~6k to ~26k).

10. Equities Market Boom
[Outpacing GDP]

11. P/E Ratio for S&P 500 Companies
February 16, 2018: 25.52
Historical Average: 15.69
Source Data: www.multpl.com
The P/E ratio for the S&P 500 is historically high, which is resultant from
the exuberance of the equities market.

12. In Jan-2018, the FOMC noted that is it holding back the frequency of rate
hikes until inflation tips the 2-percent mark. Because the CPI eclipsed 2-
percent in early Mar-2018; further rate hikes are expected in the near
future.

13. Inflation is important to the FOMC as it drives wage increases – without
inflation, wages remain stagnant, as they have for the past decade.
However, the Employment Cost Index has recently trended upwards, as
shown on the following slide.

14. Employment Cost Index
Due to the booming equities markets, record corporate profits, and recent stimulus
measures (tax cuts, etc.), the ECI is trending upwards, which will likely cause a
continued spike in interest rates.

15. Inflation (CPI)
The CPI is trending upwards, and this will likely continue for the next year or two as
the FOMC tries to prevent the economy from getting overheated. An overheated
economy swiftly leads to a recessionary cycle.

16. Between January-2018
and February-2018, the
FOMC, under the new
direction of Jerome
Powell, is alerting the
public of looming rate
hikes to prevent the
economy from
overheating.

17. Unemployment Rate
Over the past two economic cycles, the unemployment rate bottomed out around 4
to 5-percent. Once unemployment bottoms out, a recessionary cycle typically
follows approximately one year thereafter.

18. Energy Inflation
After years of deflation due to a glut of supply, the global economy is heated
and increased demand has caused a spike in energy prices.

19. Interest Rates
To prevent a sharp spike in inflation, the FOMC has been ticking up the Federal
Funds Rate for the past year, after approximately 8 years of a near-zero interest
rate.

20. Recent Federal Funds Rate Changes:
06/20/06 5.25
09/18/07 4.75
10/31/07 4.50
12/11/07 4.25
01/22/08 3.50 11 changes in ~2 years
01/30/08 3.00
03/18/08 2.25
04/30/08 2.00
10/08/08 1.50
10/29/08 1.00
12/16/08 0 - 0.25
12/16/15 0.5
12/14/16 0.75 4 changes in ~9 years
03/15/17 1.00
06/14/17 1.25

21. Federal Deficit
The federal deficit typically shrinks during periods of low unemployment because of the
associated rise in tax revenue; however, this is not the case in 2018 due to the tax cuts and
additional federal spending.

22. Federal Debt
Federal Debt is now over 100% of the US GDP. The rising debt level has caused a
decrease in federal infrastructure spending.

23. Part 2. State of the US Construction Industry
The Good
• Booming private sectors
The Bad
• Flat public sectors
The Ugly
• Lack of skilled workers
• Construction cost escalation / thin margins
Bottom Line: Private sectors continue to boom while public
construction remains flat. This trend will likely reverse within the
next 24 months.

24. Overall Construction Spending
Put in place construction hit a record (~$1.25T) in 2017. The industry has
recovered all lost ground (and then some) since the Great Recession.

25. Construction is Outpacing the US Economy
by a Wide Margin
US Construction Industry Growth Rate Since 2011:
9%
US Nominal GDP Growth Rate Since 2011:
3.5%

26. GDP v. Put-In-Place Construction
The construction industry outpaced the overall US economy in the early 2000s
before the industry overcorrected and put in place construction trended well
below GDP growth in the early 2010s. The construction industry is now trending
with GDP, which is a good sign—the construction industry is right-sized for the first
time since 1996.

27. The Dodge Index is flattening out in large part due to construction
inflation, slowing demand, and a lack of skilled craftsman.

28. Private Construction
Private construction is back to $950B in revenue, its pre-recession high.
However, it is more balanced now, and not over-weighted with residential
work, as was the case in 2006.

29. Residential Construction
Residential construction peaked in 2006 at nearly $700B. At the end of the Great
Recession, residential revenue was down to approximately $200B. This sector has
rebounded since 2012 and it now hovers around $500B, which is a reasonable
figure.

30. Average home prices are soaring much faster than GDP growth. When
this happens for an extended period, it generally leads to flat growth
followed by compression.

31. Home value growth is most notable in the south and northwest. Certain areas
of the northeast have seen significant growth as well (Boston/New York).

32. Apartment Vacancy Rates
Apartment vacancy rates have flattened out for the past two years,
which signals that ample supply exists.

33. Office Construction
Office construction dipped after the presidential election, and the sector
reheated approximately six months thereafter. Overall this sector has
doubled in size over the past four years (~$36B to ~$72B).

34. Like apartment vacancies, office vacancies are flattening out, which will
likely cause office construction spending to slow over the next several
years.

35. Lodging Construction
Hotel construction has grown from ~$8B in 2011 to ~$28B in 2017;
however, construction revenue is flattening out as occupancy rates are
no longer on the rise.

36. Hotel occupancy has remained at approximately 65% for the past four
years, which has led to flat growth in this sector of late.

37. Retail Construction
Despite fears that Amazon will eliminate the need for retail centers, retail
construction has grown from ~$40B in 2011 to over ~$80B in 2017.
However, like many other sectors, occupancy rates have flattened out
and, consequently, the demand for new retail product has slowed.

38. Manufacturing Construction
Between 2011 and 2015, the US dollar strengthened against most other
currencies. As a result, exports started to slow, which led to a notable decrease in
this sector. Now that the US dollar is on the decline, the manufacturing sector
should rebound significantly over the next several years, particularly when
coupled with the stimulus measures by the federal government (tax cuts, tax
incentives, etc.).

39. US Dollar Index
source: www.macrotrends.net

40. Health Care Construction
Spending in the Health Care sector has remained flat for the past decade
despite the aging population. Experts attribute this to a lack of demand for
hospital beds, and extreme consolidation in this industry. In addition,
technological advances are likely going to lead to less demand as doctors will
be able to evaluate vitals signs remotely, etc.

42. Power Construction
The flat demand for electricity has led to flat construction spending in
the Power sector. This trend will likely continue for some time.

43. Public Construction Spending
[21% of overall construction spending]
Public construction spending has steadily declined for the past decade even
though demand is pent up (to put it mildly). The decline is due to the
increase in deficits and federal debt level. In the near future this will become
an emergency situation and the federal government and states will have no
other choice than to prioritize infrastructure spending. Due to the shortage
of governmental funds, PPPs will likely become a large part of the solution.

44. In 2017 the American Society of Civil Engineering graded the US
infrastructure at D+, which evidences the pent up demand for spending.

45. Takeaways from the Trump
Infrastructure Plan:
• Federal Government would
commit up to $200B over the
next decade so long as…
• State/Localities/PPPs put up
approximately 85% of the funds
for individual projects, or $1.3T
• Total plan is for $1.5T in
infrastructure spending ($200B
+ $1.3T = $1.5T)
• Congress will address this plan
over the next couple of months
• The 53 page plan includes
permit streamlining elements

46. Public Construction as a Percent of GDP
Public construction as a percent of the GDP has been on a steep decline
for the past decade.

47. Sewage & Waste Disposal Construction
Water Supply Construction
Public Safety Construction
Educational Construction
Most public sectors have seen a steady decline in spending since the
Great Recession.

48. Highway & Street Construction
Transportation Construction
The two sectors that have bucked this trend is Highway & Street and
Transportation, likely because these demands are patently evident
(traffic, dilapidation, etc.).

49. Construction Workforce
The construction workforce peaked in 2006 at ~7.6M; the workforce
dropped to ~5.6M in 2010—thus, the workforce lost ~2M people. Over
the past 8 years, however, the workforce has increased by ~1.5M but it
remains 500k workers short of its peak, even though the same amount of
work is being installed (~$1.2T in 2006; ~$1.2T in 2017).

50. Average Hours Per Week
Due to the shortage of workers, the workforce is working longer hours.
This trend causes safety issues, quality issues, and schedule issues.

51. Unemployment Rate - Construction
Construction unemployment historically never gets far below 5%, which
it has been at for the past three years. Hence, if the workforce does not
grow, it will be difficult if not impossible for the construction industry to
grow, save for increases due to inflation.

52. Construction Establishments
Source: Bureau of Labor Statistics
Reduction
of 120k
companies
Over the past decade the number of construction establishments has
reduced by 120k. Therefore, less companies and less workers exist to
perform the same amount of work. Again, this trend will likely restrain
industry growth.

57. $127/SF
One example of construction inflation is on multi-family projects, where
the average cost per square foot has increased from $127/SF in 2010 to
$187/SF in 2018, or growth of 8%/year.

58. Construction Escalation
8%/year since 2010

59. Inflation in the construction industry is trending well above the CPI.

60. Even though the construction market is booming and there are less companies
and workers to complete the work, net profit margins remain low. In fact, over
the past five years, the net profit margin of publicly traded general contractors
has gone down. The same holds true for heavy contractors, which is not
surprising due to the lack of public construction spending. Net profit margins
for engineering companies have increased, but not to 2006 levels. The most
profitable sector remains residential construction, but most public residential
contractors also serve as developers, so the higher margins make sense.

61. Construction Trends:
• A/E Companies are entering the construction marketplace
and taking substantial market share.
• The Construction Industry, after 40+ years, is at a tipping
point for efficiency gains due to technological advances
(self driving equipment, 4D technology, etc.).
• Smart Cities and the Internet of Things (“IOT”) will have a
drastic effect (positive) on the way buildings/infrastructure
is built and the way facilities are managed in the future.

62. One interesting trend in the construction industry is the addition of AE firms
that recently acquired construction companies to ENR’s Top Contractor list,
such as AECOM and Jacobs. This trend will likely continue as publicly traded
AE firms will need to find ways to promote revenue growth.

64. Market Share of the Top 100 Contractors:
2004: 18%
2009: 26%
2016: 30%
The market share of the Top 100 contractors in the US has
nearly doubled in the past two decades. This trend will likely
continue as AE firms enter the construction space.

65. Construction is one of the few industry that has seen little to no efficiency gains
over the past 100 years. In fact, McKinsey recently reported that construction
workers are actually less efficient now than they were 50 years ago. However,
recent trends indicate that this is about to change over the next decade.

67. Several large heavy contractors are now using drones (UAVs) to complete
aerial surveying and geo-mapping on a daily or weekly basis. In addition,
many large heavy contractors are using self-driving earth moving
equipment on grading projects (most equipment continues to have
operating engineers on them for safety purposes). These advances will
greatly improve the efficiency of earthwork construction in years to
come.

68. Large building contractors are now leveraging 4D technology to improve the
efficiency of construction as 3D models are plotted against CPM schedules so
the workforce can understand the proper sequence of work, and the proper
integration of various divisions of work. This trend is in large part attributable
to design subconsultants embracing Revit software, so each subconsultant
can work on the same software platform.

69. The trend towards smart cities will create massive demand for the installation of
new smart technologies, a sample of which is shown above. This is referred to as
the “Internet of Things.”

70. End