Economic Cycles and Construction for Architects

• Navigating economic cycles and adjusting to construction industry fluctuations are essential for architects to succeed
• Architects need to understand economic cycles because most revenue comes from construction-related services

National Economic Expansion (2001-2007)

• The national economic expansion peaked at the end of 2007
• The nonresidential construction sectors experienced strong growth, while the overall construction sector saw more modest growth
• The housing market peaked in early 2006 and then declined, offsetting gains in nonresidential construction

Economic Downturn (2008)

• In early 2008, the construction sector experienced steep declines
• Construction activity spiraled downward, with total spending falling from over $1 trillion in 2008 to under $800 billion by 2011

Impact on Architecture Firms

• There was less building design and pressure on design fees and construction bids
• Gross revenue at architecture firms dropped from over $44 billion in 2008 to $26 billion in 2011, a 40% decline
• Over 8.8 million payroll positions disappeared nationally from early 2008 to early 2010
• Construction payrolls declined by over 2.1 million between 2007 and 2011
• Over 28% of architecture firm positions disappeared between 2007 and 2011

Project Mix Changes

• Residential projects tend to increase early in a cycle, commercial/industrial projects mid-cycle, and institutional projects later
• Residential billing averaged 14% of total firm billing between 2001-2011
• Commercial/industrial projects averaged 27%
• Institutional projects averaged 53%
• Residential billings grew to 18% in 2005, and fell to 11% in 2008

Multifamily Housing

• Multifamily activity was a growing share of design activity for residential projects in 2011
• Commercial/industrial design activity decreased sharply during the downturn
• Commercial/industrial design activity was near its bottom in 2011 with shares below its decade average
• The institutional share was near its decade high by 2011 while the other sectors fell

Services Expansion

• Firms expanded the services offered to clients
• Firms investigated new work areas during downturns

Share of Payroll Positions

• The share of payroll positions lost during the downturn was greater than the share of architecture firms closed
• The average number of payroll employees at a typical firm declined from 10.3 in 2008 to 8.8 in 2011
• Nearly a quarter of architecture firms nationally are sole practitioners
• Over 60% of architectural firms had fewer than 5 employees on their payrolls

Firm Size

• Firm locations with 100+ employees account for over 20% of architecture staff
• 50+ person firms account for over a third of all employment
• Net revenue per employee is almost twice as much at larger firms than smaller firms

Firm Fragmentation

• Firm layoffs pushed down average firm sizes, and unemployed architects start new firms.

Age of Firms

• Over a third of firms nationally were founded since 2000
• 60% were founded since 1990
• Only 10% of firms existed prior to 1970

Staff Changes

• The largest share of job losses was among technical and nontechnical staff
• Architecture staff positions increased their share somewhat while the share of design professionals remained unchanged

Economic Cycle Phases:

• Early expansion: Acceleration period after a downturn for new growth
• Peak growth: Growth rate reaches its high point
• Late expansion: Growth begins to slow
• Market peak: Actual economic output is at its peak
• Early contraction: Slow growth transitions to accelerating decline immediately after the market peak
• Peak decline: The rate of decline is at its steepest
• Late contraction: Decline pace slows
• Market trough: Economic output is at its lowest point

Construction Industry Cyclicality

• Conditions favorable lead to many projects being undertaken
• Unfavorable conditions lead to few construction projects

Historical Construction Activity

• There was a strong upturn in the construction industry in the early to mid-1980s, generated by tax code changes
• There was a fairly significant downturn in the early 1990s because of the collapse of the savings and loan system
• The 1990s saw strong construction activity due to the technology boom
• There was a mild construction downturn between 2001-2003
• The 2004-2007 construction industry upturn was fairly modest
• The rapid decline in house prices led to a financial system meltdown in the Great Recession

Architecture Firms' Challenges

• Chronic volatility in project activity leads to uneven revenue streams
• Declines in activity create significant staffing, overhead, marketing, and credit challenges
• Rapid growth presents challenges in hiring, training, and meeting deadlines

ABI (Architecture Billings Index)

• The American Institute of Architects launched a monthly survey of design activity at architecture firms in 1995
• Principal purpose is to develop a database of national and regional business trends at architecture firms for comparison purposes.

Using the ABI

• AIA assembles a national panel of architecture firms to participate in an ongoing survey to measure business conditions
• About 75% of nonresidential buildings are designed by architects
• Firms report billings for the just-completed month compared to the previous month
• The ABI is computed as a diffusion index
• Scores above 50 indicate an aggregate increase in activity

Economic Indicators

• Monitor conditions relevant to the firm's served market area
• Changes in employment: Look for job growth
• Consumer Confidence: Gauges spending willingness
• Financial indicators: Look at interest rates, lending standards, and loan volume
• Housing indicators: Key leading indicator for the broader economy and nonresidential construction sectors

Firm Diversification for Stability:

• Geographic: Serve larger areas to broaden the economic base
• Building Type: Focus on different sectors with varying cycles
• Services: Offer related or expanded design services

Effects of Economic Downturns on Architecture Firms

• Net loss of about 6% of all AIA member-owned firms between 2009 and 2012
• The number of firms with 100+ employees declined by over 20%, while sole practitioners increased
• Many firms replaced payroll positions with contract positions

Long Term Downturn Effects

• AIA asked architects about what happened to downsized full-time architectural staff during the recession, and speculate future
• About 30% were still working on a P/T or contract basis, 30 working outside the profession, and 40 were not employed in 2011
• About 40% of these downsized workers were estimated to never return to architecture practice

The ABI (Architecture Billings Index)

• The ABI is designed to mimic the business cycle for design activity
• Scores above 50 indicate an increase in design activity
• Scores ranges mimic the stages of the expansion and contraction economic cycles

Minimizing Long Term Negative Impact

• Diversification has been a strategy to allow firms to achieve more stable revenue across cycles in the practices
• Geographic , Building type, or expanded Services

Financial Management Overview notes

• It involves the ongoing monitoring of a firm's financial resources
• To allow firm principal(s) to exercise sound business judgment in response to developing trends
• Basic knowledge needed is understanding the component parts of the Profit-Loss Statement and Balance Sheet
• 7 key financial performance indicators of Profit and loss and the 4 financial performance indicators of the balance sheet can assist leaders
• Two essential components of a financial management system are the Annual Budget and the Profit Plan

Acrual vs Cash Based Reporting

• Developed for each new coming year it be advantageous for their development to begin before the coming year
• Getting an early start will enable firm leaders to respond more effectively to new opportunities using the most current data.
• Comprehensive financial management system is based on a firm's accounting system.
• Accounting reports data are the realm of accounting personnel and its outside tax consultant. -Financial management reports are the responsibility firm management even with others might develop/compile.
• Accounting reports focus is primarily on cash-flow, accounts payable, and tax liability, which are identified in the cash-basis reports.
• Management focus on the key indicators from the data provided in the accrual-basis report.

Additional definitions

• Understanding the following accounting terms is necessary
• Accrual-basis accounting: revenue earned less expenses incurred
• Cash-basis accounting : income received minus expenses paid
• Net operating revenue: net dollars remaining after deducting consultants' fees and expenses, plus project-related exps
• Utilization rate: direct labor as a percentage of total labor
• Hourly billing rate: dollar amount charged per hour of direct labor Net multiplier: net operating revenue divided by total direct labor,
• Net profit: dollars remaining after deducting all direct and indirect labor and indirect expenses,
• Current earnings: net dollar amount after distributions are made + taxes deducted

Financial planning tools

• Cash-basis report indicates dollars received and payments made: determines quarterly and annual tax liability.
• Accrual-basis report provides a snapshot of a given accounting period: records only invoiced amounts
• Every design firm can establish goals for goals financial performance

Key points

• The essential distinction between accounting reports and financial management reports relates to to whom they are made
• Accounting reports serve external needs related to tax liabilities and Financial management focuses on business decision
• Cash basis serves need the firm's accounting while the accrual's for management
• The Maddox Format (Robert F. Mattox) has 30year-old
• It highlights how it differs by using easy to read and understand performance metrics
• Net profit is the major measurement to strive to increase
• Establish and reevaluate on an annual basis allows trends changes to evolve and goals are met

Chart Of accounts

• The development of chart of accounts is used organize data
• hierarchy that starts and works to create multi numbered results so dollars spent all can be tracked
• Table 7.1 helps explain chart for accounts
• Master chart supports both cash or accrual, and will be needed for monthly data and decisions

Annual budget

• It and chart interact as a tool
• Specific categories tracked to look at how close you are tracking to goals

Profit plan

• Bottom line tracked and data points reviewed
• Direct and indirect time
• Time sheets are used as the one item firm sells, so they are very important.

Financial reports

• Financial reports have 4 areas and tell you if doing well
• Net perating revnue +labor % total + expenses and net profit

Annual Budgets and Profit Planning

• Annual review vital to monitor progress
• Four primary areas to consider
• revenue
• Expense and its control
• Each aspect should be planned as to help make profit at the firm

Financial report topics

• Chart of accounts
• Annual budget
• Profit plan
• Time sheets
• Finances
• Management skills

HRM Overview

• Understand the function of Human Resources
• Align culture to retain and to hire
• Align goals
• Recruit
• Develop performance indicators that are clear
• A HR structure is needed whether there are very few individuals or even many

Values and benefits of HRM structure

• All of US economy is in transition so HR tools will help navigate the times
• Legal compliance can be a goal to have correct policies and procedures
• Those charged with HR must bring a viewpoint HRM can act to create growth

Actions and planning

• Strategy to meet requirements
• A plan and how it is implemented
• Components needed
• Performance
• Legal
• Employee relations
• Rewards and recognition -training and development
• Leadership
• Retention

Cycles of an economy

When booming there are large requirements, but downturns are good to recruit smart people. Week 5 - 6 have many more specifics to remember. It is detailed data.

Understanding economic cycles and construction industry fluctuations is crucial for architects. The national economic expansion peaked in 2007, followed by a downturn in 2008. These cycles impact building design, design fees and construction.