An Interesting Warning Sign

This may be looking for the dark cloud in the silver lining, but there’s an interesting economic indicator that appears to be a warning about the economy. It’s called the “output gap” and it’s an indicator of how close the economy is to the full potential GDP output. In other words, how close are we to having no more capacity to grow, either because there are no more workers or no more capacity to make things. That’s a pretty accurate description of today’s conditions. The thing that makes this measure worth noting is that a recession has followed the peak of the output gap every business cycle for almost 50 years. The question is: how close are we to peak?

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There is no reason that the economy has to go backwards just because it has when conditions were similar in the past. The most practical and urgent conclusion to draw from the current output gap is that the shortage of skilled workers and capacity could limit the ability of businesses to expand, even if their sales are growing. Adding a new plant or new equipment won’t help you grow if there is no one to occupy or operate it.

A few of the projects that have been in the news lately are either bidding or getting ready to bid. Packages are bidding and have been let by Forest City Enterprises for the $20 million conversion of the Freight House Shops to the UPMC training center. The $45 million Produce Terminal/1600 Smallman Street mixed-use development, being built by PJ Dick, is getting close to construction. Al. Neyer Inc. is preparing to start work on two new buildings, totaling 267,000 square feet at the Clinton Commerce Park in Findlay. There is a $6 million UPMC/Indiana Hospital joint venture cancer center out to bid to AIM, Landau, Massaro, MBM, Mosites, Shannon and Volpatt. New-Belle Construction has started work on a 67,000 square foot warehouse/office in the Technology Drive industrial park in New Stanton.

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Keeping an Eye on the Big Projects

Bidding activity is very slow as the kids get back to school. The $100 million Section 55A2 piece of the Southern Beltway is out to bid, due Sept. 26. Pitt’s $40 million Salk Hall has been extended again to Sept. 11. The activity after Labor Day will be a good indicator of how the year finishes out. If the pipeline is any indication, there should be a lot to bid in October/November.

Regardless of what projects owners put out after Labor Day, there will be bidding for some of the big projects that have been tracking for the past year or so.

AHN’s new $260 million Wexford hospital broke ground last week and additional bid packages from Massaro/Gilbane should bid through the fall. Likewise, packages for bid on the $190 million UPMC South Hills and $350 million UPMCY Mercy projects will be out. PJ Dick is bidding the 320,000 square foot, $40 million-plus Bakery Square 3.0 office building. CCAC’s new $60 million classroom at the Allegheny campus is expected to be ready to bid in November. The 90,000 square foot building will be bid in five prime packages.

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The Airport Authority’s $1.1 billion Terminal Modernization Program continues to quietly progress. The authority will issue an RFP for construction management services for the project in September, with the expectation of signing a contract in Feb. 2019. An RFP for additional A/E services specific to the $250 million-plus parking garage/lots and ground transportation center will also go out in Sept.

Opportunities

Thursday I attended a seminar on the Opportunity Zones that were created as part of the Tax Cuts and Jobs Act at the end of 2017.  The overlooked provision of the law has the potential to attract a lot of investment in poorer communities. The short explanation is that investing in Opportunity Zone projects or businesses allows you to defer capital gains as much as ten years, and then increase the cost basis of the investments made in the Opportunity Zones by up to 15%. If you hold the investment for ten years, the gains on the investment are tax-free.

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There are 86 such zones in SW PA, some 300 statewide. Some of them are places where there is already redevelopment buzz or projects, like the Hill District, Hazelwood and Homewood. The bad news is there are still no regulations published by the IRS yet, meaning that investors are still waiting out to see what the rules will be. By year’s end (at worst) this should be accomplished. You can read more about the zones at the DCED web site.

Project news is quite lean. The economic news of the week was Friday’s jobs report, which showed the US employers adding 157,000 jobs in July. That’s a decline from June’s total but still brisk enough to keep the average monthly gain for 2018 above 200,000 jobs. Economists believe the hiring pace would have been better but for the lack of applicants in the job market.

Miscellaneous…

Pittsburgh Homebuilding Report issued its research on the housing market in the six-county metro area this week. The report was unsurprising in that year-over-year growth in single-family detached homes was muted by lot inventory to 4.4%. There was a steep decline in multi-family starts but that is more a matter of timing than a change in direction of the market. With what is in the pipeline, it is expected that permits for apartments/condos will reach the 2,000 units mark again in 2018. The surprise was the 36.1% drop in attached single-family permits. This segment of the market has grown steadily over the past decade, as demographics and topography made townhouses and quads more desirable. This category has produced roughly 900-1,000 units during recent years. It’s unlikely that there will be a two-fold jump in townhouse construction during the last six months. Overall, the market was off by almost 800 units, or more than 30%.

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One of the major projects in the apartment pipeline, the second phase of the Riverfront development being built by NRP, is out to bid for subcontractors, due July 27. According to the description at the NRP Construction website this phase will include 442 apartments in two buildings, plus a 544-space garage. In today’s market, that should be in the $55 million range.

Turner Construction was selected as construction manager for the $240 million UPMC Hillman/Shadyside Hospital expansion. That wraps up the CM selections for the major UPMC capitol program. To recap: PJ Dick/Whiting Turner will build the Transplant and Heart Hospital at Presbyterian. Mascaro/Barton Malow is CM for the Vision and Rehabilitation Hospital at Mercy. Rycon/Skanska will build the UPMC South Hills Hospital.

Construction Inflation Becomes a Problem

Prices for construction materials and products have been creeping up steadily for more than a year. Higher demand pushed supply lines to the limit of current capacity, giving manufacturers the opportunity to raise prices and regain some long-lost profits. Wages likewise have been creeping higher, outstripping the wage gains of the overall workforce. Creeping became “leaping” during the past two months. The first signs of sticker shock are beginning to appear.

All of the gradual price increases have been given a boost by the tariffs levied by the Trump Administration. While it’s worth noting that virtually all of the documented increases happened before the tariffs went into effect, the threat of tariffs gave manufacturers the room to push price increases into the market. That has applied to products that won’t be affected by the tariffs too. Surcharges were beginning to hit the market for tariff-affected items in June, and the impact on producer prices was immediate.

Analyzing the Department of Labor Statistics’ data for May, AGC Chief Economist Kenneth Simonson noted that “the producer price index jumped by 20.0 percent for aluminum mill shapes, 17.4 percent for copper and brass mill shapes and 12.3 percent for steel mill products between June 2017 and June 2018. Other construction inputs that rose sharply in price from May 2017 to May 2018 include diesel fuel, 52.8 percent; lumber and plywood, 18.3 percent; asphalt felts and coatings, 7.5 percent; ready-mixed concrete, 5.5 percent; and paving mixtures and blocks, 5.0 percent.”

The producer price index for inputs to construction industries, goods—a measure of all materials used in construction projects including items consumed by contractors, such as diesel fuel—rose 9.6 percent over 12 months. The year-over-year increase was the steepest since October 2008, Simonson noted.

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This kind of hyperinflation couldn’t come at a worse time for construction in Pittsburgh. Most of the anticipated boom in construction lies ahead. With labor nearly tapped out this summer, specialty contractors are beginning to price projects more cautiously and the result is stressing budgets. The upward pressure comes from several factors. Specialty contractors’ costs are roughly 50 percent labor. With the construction workforce at full employment in Pittsburgh, future work will be done with less people than necessary. Premium time and pay will be used to meet schedules. Contractors will be less certain about the productivity of the labor force. Uncertainty adds risk – and cost. Contractors will also begin to be maxed out on backlog (many already are), meaning that the projects they bid will have higher profit margins on their work. This isn’t greed; it’s simply the response to a shift to a seller’s market.

The results of this unexpected and steep jump in prices for owners will be higher costs for less program and the deferral of some projects for a time. That will chill the boom somewhat. The worse impact will be for contractors – and owners – that are locked into agreements before prices spiked and before projects were bought. If costs rise beyond what the contractors bid, disputes will increase and firms will do what is necessary to survive the inflation. None of those kinds of measures will make for better projects.

The many large private projects that will be built in Pittsburgh over the next 12-18 months have already begun to feel the impact on budgets. That hasn’t been the case in the public market, where bidding remains competitive. God bless the school district that signed big contracts based on bids taken in the past 90 days. They may want to wait until the punch list is complete to celebrate the great bids they received.

The Cracker is Booming

If you haven’t driven by the Shell Franklin site in Monaca lately, you should. The beehive of activity is impressive. Maybe more impressive is the fact that 1,700 workers are on site at the moment but that will more than triple by this time next year.

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Count the cranes from the Ohio River.

In project news, Allegheny County Airport Authority selected Jacobs as program manager for the $1.5 billion Terminal Modernization Program. The A/E team is expected to be selected at the July board meeting. University of Pittsburgh selected PJ Dick for its $80 million addition and renovation to Scaife Hall. UPMC short-listed Turner Construction and the Mascaro/Barton Malow team for the $280 million Hillman/Shadyside expansion. PJ Dick’s Special Projects Group was awarded the $9 million CM-at-risk contract for the Botanical Gardens in North Fayette. St. Clair Hospital awarded Mascaro the contract for the new $16 million central utility building. Phipps Conservatory is taking proposals from Jendoco, Massaro, PJ Dick, Rycon and Sota on its $10 million garden center project.

PA Budget Passes: Not So Great for Construction

As expected, the Commonwealth’s legislature passed a 2018-2019 budget yesterday, sending to the governor a spending bill that creates a surplus for the Rainy Day Fund without raising taxes. The budget also increases funding for education and, specifically, props up the ailing PASSHE system schools. In a gubernatorial election year such cooperation was expected, but the healthy bump in revenues through five months (that is expected to continue into 2019) made the budgeting process smoother.

For the construction industry, however, the budget is a continuation of the under-investment that has marked the Corbett and Wolf administrations, which saw Republican majorities in the state houses. The new budget does nothing to fix PlanCon, contrary to promises made by members of the advisory committee for the reform of the K-12 reimbursement mechanism. There is also less funding for capital projects statewide. And nothing was done to address the looting of the funds generated by the gas tax increase in Act 89 of 2013. That highway bill was designed to add $3.5 billion to annual bridge and highway funding by 2019 but more than $700 million has been “appropriated” to make up a gap in state police funding. The gap is due to PA State Police patrols of communities that cannot afford local police forces.

The PlanCon situation is particularly troublesome for the industry, because the system has been under a moratorium since mid-2015. Projects not already well along with the design process at that point have been stuck in PlanCon purgatory since. Some districts have found ways to deliver projects without the additional funding that PA would provide by reimbursement, but some unknown number of capital programs will remain stuck through at least mid-2019.

New Castle School 005Funding for projects already in the process has been allocated, which is some good news. Firms involved in public construction hoping for improvement in the coming year got little other good news yesterday.