Balancing ACT

Aug. 1, 2007
Residential construction is down; non-residential is strong for now. That seems to be the weather forecast most of the rental industry is looking at for

Residential construction is down; non-residential is strong for now. That seems to be the weather forecast most of the rental industry is looking at for the remainder of 2007 going into 2008. But, after about three years of boom time in North America's rental industry, the outlook is far less robust in most geographic regions and customer sectors, with a slowdown in residential construction being the primary reason.

That said, non-residential construction continues to show strength. Speaking to rental people around the country, many say business is vibrant, customers are busy and utilization remains high. But a far more cautious approach to equipment purchases and a consensus that the days of double-digit growth have passed for awhile is the dominant outlook across most of North America.

Whichever way you look at the construction landscape, it's clearly a varied patchwork. One region might appear to be weakening, but a few big projects in a particular city tip the scales. As Ken Simonson, chief economist for the Arlington, Va.-based Associated General Contractors of America, says: “It's a big cake, with a lot of raisins in different spots.”

Simonson points to growth in the manufacturing sector as an illustration of the “raisin” concept. “Manufacturing plants are scattered here and there,” he says. “Obviously you don't have manufacturing everywhere in the country, or companies adding factories, but there is quite a variety of types of factories and locations. Recently a German steel maker announced it will spend $4 billion to put in a plant to make steel and stainless steel near Mobile, Ala. Toyota just completed a truck plant near San Antonio and is going to build a $1 billion-plus factory in Blue Springs, Mo. Honda is halfway through a $500 million plant in Indiana.”

So companies in the right market at the right time might find big jobs in their backyards. Other rental companies that have long targeted the industrial market are finding current conditions strong in that sector.

“Warehousing is good and industrial rehab jobs are very strong,” says Jim Dietz of Franklin Park, Ill.-based National Lift Truck.

“We have a good backlog of work for manufacturing-related rentals, road work and plant shutdowns,” adds David Griffith of Bristol, Pa.-based Modern Equipment.

Another construction bright spot is the hospital market, partly driven by the aging of North America's population. “Hospital construction seems to be strong everywhere,” Simonson says. “Particularly in California where you have seismic retrofit requirements forcing hospitals to spend billions of dollars in addition to the technological catch-up hospitals are facing to try to accommodate new equipment for diagnosing and treating, or operating on patients,” Simonson says.

Most geographic regions seem to have hot and cold spots. Cities such as Charlotte, N.C., Jacksonville, Fla., New York, Dallas and Houston are enjoying robust construction environments, while one might not have to drive too far away to find different circumstances. Chicago and Phoenix have a number of big projects going on, and big hotel-casino projects in Las Vegas seem to balance out the slowing housing. Recovery efforts have driven construction in the Gulfport-Biloxi area in south Mississippi and in and around New Orleans. Cities such as Slidell and Baton Rouge, La., where populations swelled post-Katrina have seen considerable construction activity.

“We've had a big influx since the hurricane,” says Ralph Kastner of Tuff Equipment Rentals, Slidell, La. “A lot of the people from suburbs like St. Bernard where there was major flooding moved up here. It seems like every time you turn around they are putting up something new.”

In some regions, growth is more vital away from the big cities. “In California, for example, smaller cities such as Merced, Bakersfield and Riverside, outside of major metro areas are growing more than the major metropolitan areas are,” says Nick Mavrick, vice president of global strategy and marketing for Volvo Rents.

We'll leave the light on for you

The Motel 6 may not be the hotel of choice for most people in the rental industry, but few would mind renting equipment for its construction. And hotel construction is a strong market now and is likely to remain so for a while.

“The vacancy rate at hotels has been declining for years since 9/11 and the average room rates have been rising, so the expected return on hotels is very favorable,” says Ed Sullivan, chief economist and staff vice president for the Skokie, Ill.-based Portland Cement Association. “You have other conditions contributing: the economy is still growing, a weak dollar attracts foreigners into the U.S., and prevents Americans from going overseas in favor of vacations at home because they will be cheaper. Hotels grew by 45 percent last year and we expect a 36-percent gain in 2007.”

Office building construction has been strong so far in 2007 with a 26-percent increase and massive projects in New York, Chicago and other cities. Shelbourne Development is breaking ground on a $1 billion-plus Chicago high-rise that would be the tallest in North America and several large skyscraper projects are getting started in New York.

Stadium construction continues to look promising with major projects such as new stadiums for the Dallas Cowboys, New York Giants and Jets, and baseball stadiums for the New York Mets and Yankees, and Washington Nationals in various stages of construction.

New York state of mind

New York is a booming construction market right now with stadium and skyscraper projects and more, with work trickling down to smaller contractors and rental centers. “From where we are, we see business continuing to go up,” says Tony Perrota of TP Rental Services, Brooklyn, N.Y. “There is a lot of demolition now, so a lot of plumbing, electric work and carpentry will follow. We indirectly get work on the big stadium projects from some of the subcontractors we do business with. There are five Empire State Building-size jobs going on right now, including Freedom Tower and Trump Plaza.”

Other rental companies in the New York area report strong non-residential business, from small and large contractors, for small and large equipment. Site work, roadwork and underground transportation projects are creating significant demand, rental owners say. Independent rental companies play a strong role in The Big Apple, and United Rentals, headquartered not far away in Greenwich, Conn., has three branches in Manhattan.

Texas is bigger than it used to be

Mark Chestnutt wasn't thinking about 2007's rental market when he wrote that song, but it's an apt description nonetheless. Although earlier this year some Texas rental customers were probably thinking of building an arc — it rained 44 consecutive days at one point over a 50,000-square-mile area — construction has been strong in the Lone Star state and rental companies doing business in the state have been enjoying solid demand, especially in Houston and San Antonio.

School construction has been vibrant with Texas outpacing the rest of the country in that area. Overall commercial construction is strong and to this point the drop-off in residential hasn't affected the state as badly as most of the rest of the country, according to rental people in the area, with house inventories not as high or moving as slowly as in most areas.

“It's amazing how many strip centers we can build here,” says Steve Watley of Champion Rentals in Houston. “There's a lot of work here in remodeling, and a lot of new construction in strip centers, shopping malls and parking facilities.”

“Work is very strong, whether it's commercial site work or residential,” said Howard Hicks of San Antonio-based Holt Cat Rentals. “Retail and industrial is very strong, as is oilfield business exploration and oil site projects.”

“Any economies based on oil have been strong,” adds Jim McCullough, president of Case Construction Equipment (see accompanying story on page 32).

Cover the bases

The military plays a major role in the U.S. economy, but the arms industry is not necessarily the primary customer segment for rental companies. The opening and closing of military bases, however, can create major projects for the rental business. Often more important is the changing in activities at a particular base that can lead to significant refurbishment and redesigns and the dismantling and construction of buildings on the base.

“Some of those projects will run into billions of dollars,” says Simonson. “And more important to the global economy will be the relocation of tens of thousands of military and civilians and their families. For instance, they expect 22,000 people to be added to Fort Meade, between Washington and Baltimore, in the next four years. That puts tremendous pressure on state and local government to come up with enough highway capacity, schools and other infrastructure. It also gives local developers huge incentive to put in more housing and retail.” Fort Bliss, near El Paso, Texas; and Fort Bening in Georgia are among others that have seen a lot of military-related construction activity.

Simonson adds that strong stock market results this year will mean that universities conducting capital campaigns will have more success getting donations from wealthy alums and other donors, leading to a strong period in university-level construction.

Don't bet the house

It's no secret that the housing market has softened. The ongoing headlines about the collapse of the subprime lender market, coupled with an oversupply of housing overbuilt in recent years, are evidence enough, and conversations with rental people around the country indicate that the housing slowdown is having an impact. How much and how long are still up in the air. Companies specializing in rental of heavy earthmoving equipment for housing contractors are obviously feeling the pinch more strongly than those companies primarily oriented towards the non-residential market.

“I don't see residential recovering before 2009,” says PCA's Sullivan. “It all revolves around inventory. There are increased foreclosures, and many will be concentrated on the back half of this year because many of the re-sets will go in Sept. 1. The problem is compounded by tightening of the lending standards. It's much more difficult to qualify for loans than it was a couple of years ago, even though mortgage rates are relatively low. It's going to take a while to burn off these inventories.”

Markets that participated the most in the housing boom of recent years, that tended to attract speculators, are generally the ones with excessive inventories, so markets such as Florida, Arizona, Nevada and California are looking at longer housing slumps, economists say.

While nonresidential construction continues strong and economic activity remains vibrant in many areas, the consensus among rental people is that demand has definitely softened in 2007.

“Everything is much less vibrant than in 2006,” says Jamie Cowin of Birmingham, Ala.-based Cowin Equipment. “This is especially true of coastal areas like Florida, where housing was and is a bigger driver than non-residential.”

For the most part, rental companies and manufacturers report that their customers still are busy, but less so than the past few years.

“Highways, roads and bridges, and long-term projects are still going pretty strong but the portfolio of work for contractors is not typically nine months like it has been the past few years, but many have four- to six-month portfolios,” says Case's McCullough.

“It's been a hell of a ride and I think it's going to go on a bit longer, but it's starting to flatten a little bit,” says Bob Kendall of Seattle-based Star Rentals. “I [recently] met with several of our big customers and they said, ‘We're as busy as we've ever been, but we can see it peaking.’”

While a softening in demand seems widespread, reaction is far more measured than the slowdown that occurred earlier this decade. “If you go back to 2000, there was a lot of liquidation of rental fleets and oversupply of the used equipment market, that created the recession in our business,” says McCullough. “There was a lot of dumping equipment into auctions, but we haven't seen anything like that. I haven't seen liquidation of fleets by big rental companies, nor have I seen trade packages coming from national rental companies beyond the norm.”

Reaction from rental companies has been far more measured as well, in part because demand is still good, but also because of improved systems and software that enable rental companies to manage far more effectively.

“It's, all things considered, still an outstanding year,” says Beno Jurgemeyer, CEO of Sunstate Equipment Rentals. As Jurgemeyer points out, when rental companies are professionally managed, their ongoing analysis of utilization rates leads to continual adjustment of fleet size, enabling companies to avoid massive fleet dumping when conditions slow down, because they see the signs much quicker.

For many rental companies, the natural strategic response has been to place less emphasis on residential and increase diversification to other markets. “The residential slowdown has affected some of our customers, but it hasn't affected us too much because we have a very diverse customer base,” says Jim Maetzold of Aurora, Colo.-based Worldwide Rental Services. “Weak state highway programs for earthmoving projects affect us, and the private sector including commercial grading and housing is very fragile. We have moved units into the booming pipeline market and the strong environmental market.” And Maetzold sees growing rate pressure on a number of fronts, an observation shared by many around the country.

With residential not likely to return strong before 2009 — although not all economists agree with Sullivan's timetable — many rental companies express concern about the delayed effect of the housing slowdown. When new housing isn't built, ultimately neither are new roads, schools and retail facilities and all the other infrastructure required to support residential. “What replaces the existing projects when they complete these malls and strip centers?” says consultant Dan Kaplan. “On the other hand, you have positives. You've got professional management, you've got the software, and the movement from ownership to rental. But for things to turn around, more projects need to come out of the ground and capex spending needs to increase. At this point, I don't see it.”

Still, Sullivan contends, the market fundamentals are still strong. “What you've got is sustained growth,” he says. “When you have sustained growth, you add jobs and you improve the underlying fundamentals of nonresidential construction. Nonresidential construction is an investment, and an investment is dictated by two things: What is your expected return on investment and do you have the money to plow at that investment? Right now corporate profits are doing very well, and at the same time the interest rate environ-ment is still favorable for borrowers. So you have access to funds. Vacancy rates and utilization rates are still improving. So if you argue that the economy is not going to go into recession and that we're still going to have relatively good economic growth, I am suggesting that the economy's growth rate will slow significantly the second half of this year. Nonresidential is growing at double-digit rates and those growth rates are still going to be good, but they are not going to be double digit any more.”

Still Sullivan admits that ultimately the question of the subprime lending market's ultimate impact is yet to be seen. “We really don't know what that's going to mean in terms of defaults and foreclosures,” he says. “We don't know how it's going to play out because we have no precedent for it.”

That uncertainty seems to be the dominant mood going into the second half of 2007.

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