The Garrison Report #2007-12

The Year 2007 in Review

Listen to the audio version of this report here

In 2007 there were many notable events within the construction industry, but two events impacted not only the U.S. construction industry, but the entire nation. The first was the figurative collapse of the housing market, and the second was the literal collapse of the I 35W bridge in Minneapolis. These two events might appear to be unrelated, but they are both symptomatic of what's ailing the construction industry;namely, the lack of the collaboration and communication necessary to create a clear vision.

In an interview with Congressman John Mica, the Republican chairman of the Transportation and Infrastructure Committee, he said what's missing is a clear vision of where the nation's infrastructure is headed. Not since the Federal Aid Highway Act of 1956 that created the interstate system has the nation had such a clear vision regarding its infrastructure.

Despite the fact the American Society of Civil Engineers (ASCE) has been reporting for decades that our nation's infrastructure has been decaying, the politicians and the public were shocked by the tragic event in Minneapolis. ASCE's overall D grade is really a failing grade because colleges do not graduate students with an overall D grade. Unfortunately, in our society a bigger problem occurs after a disaster: we search for someone to blame instead of collaborating to find a solution to the problem.

In the infrastructure case, everyone shares some responsibility. The public resists taxes or user fees to fund the infrastructure costs; the politicians and government agencies fail to provide the necessary leadership to do what needs to be done because it isn't popular in the short term; and the construction industry hasn't done its share of exposing the problems and using its knowledge and expertise to help find solutions to this complex issue.

The sheer magnitude of the problem indicates the need for a more collaborative approach. ASCE estimates the infrastructure needs an investment of $1.6 trillion over the next five years, and this doesn't include security needs because ASCE has been denied access to this area. As bad as the cost figures are, the bigger problem may be the critical labor shortage within the construction industry. Without sufficient labor, critical projects will be delayed, placing the public at risk and increasing the costs. It's critical that all stakeholders come together to find ways to raise the necessary funds and obtain sufficient qualified labor to perform the work.

The housing industry is even more complex because it's even more fragmented than the construction industry overall. The situation is further complicated because the new construction market must compete with the existing housing market. However, if people are honest with themselves, the evidence was there to predict the current housing collapse. The symptoms included rapidly rising prices; shortage of labor driving up labor costs and increasing construction time, which further increased costs; increased code provisions due to natural disasters; easy money and the government trying to get its share by increasing impact fees on new construction. None of these are intentionally evil or even bad, but in an environment where each entity considers only its own perspective while ignoring the impact of its actions on other industry segments, one finds the perfect formula for disaster.

Of course, consumer groups argue that competition for financing is a good thing because it lowers financing costs. The problem is if it pushes up construction costs because of high demand, does anyone really gain? In other words, if the lower interest is offset by the higher construction costs, there is no added value. Worse, when the subprime market allowed people who potentially weren't qualified to purchase a house they couldn't afford, did the system do them a favor before foreclosing on them a couple of years later? Excessive demand leads to labor and materials shortages, which drives up house prices, which in turn leads to a drop in value for buyers. When sales prices correct, homeowners are suddenly trapped because they can't refinance and they can't sell their houses without writing a check.

I'm certainly not in favor of direct government control or intervention. However, that doesn't prevent collaboration between the various elements within the homebuilding industry to find solutions that work for all stakeholders. For example, if lenders actually understood the impact of their actions and how those actions increased the risks to themselves and other stakeholders, they could modify their lending practices. In essence, when low-cost financing increases demand for new housing above the industry capacity to provide it, the industry starts to spin out of control until it eventually collapses. Unfortunately, this lesson has been learned the hard way this past year.

If the housing industry segments collaborated, they might be able to create a vision for the housing industry and a volume that would be more sustainable, therefore moderating both the up and down spikes that take a severe toll on the industry, its customers and many individuals impacted by the housing market.

If affordable housing is the desired outcome, which is supposedly the argument for the low interest rates, then maybe the industry should find a better way by working together. For example, impact fees could be levied on a price basis, instead of a unit basis, in order to place a smaller burden on lower-priced housing. If the industry segments worked together, they could develop more efficient house plans rather than constantly increasing houses sizes. This is critical if the industry is truly concerned about rising construction costs. In 1970 the median house size was 1,385 square feet, but by 2005 the median house size had risen to 2,227 square feet. That's a 61 percent increase over 35 years, but worse, just before the collapse, the average house increased by almost 4 percent between the years 2004 and 2005.

There is obviously a big difference between production builders and custom builders. Production builders are closer to manufacturers since they design and build the product before they sell it. They often allow some minor customizing. This is no different from many manufactured products such as computers or autos, but by necessity they set limits on what the customer can change. This provides an opportunity to collaborate with customers to increase value instead of moving toward costly sexy trends. In the long run, this would create a more stable market. On the other hand, custom builders could certainly use their knowledge and expertise to guide their customers toward better value. For example, they might steer homebuyers toward greener homes by explaining the value of investing in long-term savings while at the same time being more environmentally friendly.

The scope of this report isn't sufficient to explore all the ways the housing industry segments could collaborate to improve the industry for all stakeholders. We must settle for merely raising the consciousness of the need for collaboration. During boom times, it's difficult to get people to listen, but the events of 2007 have created sufficient pain throughout the industry that enough people might start working together.

There are no easy or simple solutions to the housing problems or the infrastructure challenges, but that's the point. Complex problems require collaboration to find sustainable and meaningful solutions. Both segments are in crisis; therefore, the time has come for change.

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