Study: Productivity Gains in Construction Could Dramatically Increase Outcomes and Profits

It’s easy to state the importance of the construction industry, as it provides the foundation which makes most economic trade even possible. Globally, this industry behemoth of about $10 trillion accounts for 13 percent of worldwide GDP, and employs seven percent of its workforce.  As countries continue to urbanize, the further development of megacities (and maintenance of existing buildings) is expected to boost this total spending to $15 trillion annually by 2025.

Yet according to a recent study done by the McKinsey Global Institute, due to poor productivity gains relative to other industries, there is still $1.6 trillion left on the table each year, one-third of which is in the U.S.  If captured, this productivity loss is the equivalent of meeting half of the planet’s infrastructure needs, or boosting global GDP by two percent per year.

While the productivity challenge is global in nature, it’s even worse in the United States.  While most economic sectors in the country improved their productivity by 10 to 15 times since the 1950s, McKinsey’s analysis shows construction labor productivity remaining stuck of that in the 1930s, and has steadily declined since the 1960s.  Given that the construction sector’s share of U.S. GDP ranks close to both wholesale trade and information services, any productivity gains could have an outsized impact on the overall economy.

To be sure, not all construction projects are the same, and greater efficiencies are much easier for larger industrial and infrastructure projects than they are for housing developments or subcontractors.  Yet even for infill builders in which obtaining permits often requires making unique adjustments to garner community support, productivity gains are still possible.

McKinsey identifies 10 root causes of productivity misses, including external forces such as regulation and corruption, industry dynamics including high fragmentation and misaligned incentives, and operational factors including inadequate design processes, poor project management, under-skilled labor and under-investments in digitization, innovation and capital.

From the perspective of the builder or the subcontractor, it certainly makes business sense to be planning for the next downturn, and it’s much cheaper and easier to issue layoff notices than mothball capital-intensive investments in technology and machinery.  According to the NAHB’s 2016 Cost of Doing Business Survey, responding home builders reported an average of $16.2 million in revenue and net profit margins of $1.0 million (6.4 percent) in fiscal year 2014, so expensive investments are often unrealistic.  But it’s also that industry-wide protective mindset which has contributed to annual productivity gains of just 1.0 percent over the past 20 years, versus 2.8 percent for the global economy and 3.6 percent in manufacturing.

So what are the solutions?  McKinsey has identified seven distinct areas which could benefit from embracing various best practices, which combined could increase productivity by 48 to 60 percent while also saving costs of 27 to 38 percent.  These include (1) Reshaping regulations (something now being attempted in California to boost more housing production) and increasing transparency; (2) Awarding contracts more collaboratively; (3) Rethinking design and engineering processes while encouraging more off-site manufacturing; (4) Centralizing and digitizing supply chains and purchasing departments; (5) Improving on-site construction by moving from process-based to more holistic operating systems; (6) Infusing digital technology, new materials and appropriate automation into the process; and (7) Retraining a workforce that is aging, depends largely on immigrant labor and suffers from both seasonality and cyclicality.

Here in the U.S., larger players – especially those in the public sector -- will generally be the first to strategically decide what’s best for them, but everyone should be ready for four types of disruption:  (1) Rising requirements from clients in terms of volume, time, cost, quality and sustainability; (2) More industry consolidation, greater transparency and disruptive new competitors; (3) More new technologies, materials and processes; and (4) Rising wages and potential limits on immigrant labor. 

As these trends roll out and eventually put pressure on the building industry, there are some reasonable steps suggested to make it easier.  These include a greater use of digital Building Information Modeling (BIM) to enhance transparency and collaboration; reshaping regulations in support of higher productivity; more transparency on costs across the industry; publishing performance metrics on contractors; and considering regular skills development of the existing labor force versus the reliance on low-cost, transient immigrants.

The Harvard Center for Joint Housing Studies currently projects 1.36 million new U.S. households per year between 2015 and 2025.  While the industry is projected to approach that level of starts by 2018, in August of 2017 the annualized starts rate was 1.18 million, leaving a theoretical shortfall of 180,000.  

The American Household, circa 2007

The U.S. Census Bureau has released their findings from a 2007 survey of American households, with various stories across the media landscape posted today.

First, from BuilderOnline.com:

For homeowners with a mortgage, house prices were still on the upswing, with a median value of $216,400, up a respectable four percent from 2006 for owner-occupied housing units with a mortgage.

There were 51.6 million of such owner-occupied homes with a mortgage in 2007, according to the Census bureau, accounting for 46 percent of the country’s 112 million occupied homes. Each month, these households spent a median of $1,464 to live in those homes, a 4.4 percent uptick in housing costs from 2006. But the real jump came in real estate taxes, which jumped more than 6 percent to $2,099 for owner-occupied homes with a mortgage.

The good news is that at least in 2007, these homeowners could afford such increases … sort of. With a median household income of $73,408 last year, this group only spent 23.9 percent of its income on housing costs, a surprisingly affordable percentage given the soaring home prices of the now-past housing boom. In contrast, the median household income for all Americans last year was $50,740.

The most surprising findings came from data detailing the financial characteristics of American households. Despite the extensive coverage on the indebtedness of American homeowners, the American Community Survey showed that only 1.1 percent of those with mortgages had both a second mortgage (the now-uncommon “piggyback” loan) and a home equity line of credit.

Nearly three-quarters (73.3 percent) neither carried a second mortgage nor maintained a home equity line of credit.

Next, from BuilderOnline.com, the rise of the non-traditional household:

Known as the American Community Survey (ACS), this set of Census data covers the social, economic and housing characteristics of the nation’s population. The 2007 information shows that the number of married-couple family households rose 345,223 to 55.9 million, but the average household size remained largely unchanged at 3.25 family members for this often-pursued group of home buyers.

At the same time, the data showed that the total number of households edged up to 112,377,977 in 2007 with an average household size of 2.61 people.

It also illustrated the rise of non-traditional households. The number of female-headed households with no husband present rose slightly to 14 million. So did the number of male householders with no wife present, although this represents a smaller group at just 5.2 million. Finally, non-family households totaled 37 million...

The Joint Center for Housing Studies at Harvard University agrees, says Rachel Drew, a research analyst at the center. Though Drew had not seen the Census data at press time and could not comment on the specifics of today’s release, she co-authored the Joint Center’s "State of the Nation’s Housing" report and says many of its findings are similar to today’s information from the Census.

“Married couples are a shrinking share of American households,” the center concluded in its report. “Several trends have contributed to this shift, including higher labor force participation rates for women, delayed marriage, high divorce rates, low remarriage rates, and greater acceptance of unmarried partners living together. The resulting growth in unmarried-partner, single-parent, and single-person households has increased the share of adults in all age groups heading independent households.”

Researchers at the Joint Center believe that many of these household trends will continue. It expects that unmarried partners will head 5.6 million households in 2020, up from 5.2 million in 2005. It also projects that between 2010 and 2020, the number of unmarried householders with children is projected to increase from 11.0 million to 11.8 million.

What does this all mean for home building? Myers says the market for families with kids appears to be stagnant, but there are other target markets to pursue, as builders have done for years. “First they were building for young families, and then they were building for move-ups buyer,” he says. “I think they will now build for the empty-nesters with no kids and couples with no kids.”...

According to a story in USAToday, however, housing costs are eating up a significant share of incomes in many areas:

Last year, 38% of homeowners with mortgages spent 30% or more of their before-tax income on housing — the threshold the government defines as unaffordable, according to an analysis of Census data done for USA TODAY by the Joint Center for Housing Studies at Harvard University.

And 15% of homeowners without mortgages and half of all renters had trouble meeting housing costs, the analysis found...

The median home price slumped 7.1% to $212,400 from July 2007 to July 2008, according to the National Association of Realtors.

Among the largest 100 metro areas, Miami- Fort Lauderdale had the highest percentage of cash-strapped homeowners with mortgages. Nearly six out of 10 homeowners with mortgages there are spending 30% or more of their income on housing. Stockton, Calif.; Riverside-San Bernardino, Calif.; Cape Coral-Fort Myers, Fla.; and Los Angeles-Long Beach round out the top five.

In 13 of the largest metro areas, at least half of homeowners with mortgages spent 30% or more of their income on housing.

Most of those markets are also in areas of the country hardest hit by the recent wave of home foreclosures as the value of real estate — which soared during the housing bubble — collapsed in the past year.

McCue says the growth of homeownership was halved from 2006 to 2007, while renting reversed itself and gained in popularity. "From 2005 to 2006, renting went down by almost a quarter of a million households. It went up by almost as many from 2006 to 2007."

Nearly 75% of homeowners with household incomes under $50,000 struggled to pay their mortgages, versus 23% of those who made more than $50,000.

Homeowners with mortgages and whose incomes were lower than $20,000 continued to struggle most. Nearly all spent at least 30% of their income on housing.

Among the largest 100 metropolitan areas, half or more of homeowners with mortgages in these metros were in the "cost burdened" category of spending at least 30% of their gross income on housing in 2007.

Metro area	Share of mortgaged owners "cost burdened"
Miami-Fort Lauderdale-Miami Beach	58%
Stockton, Calif.	57%
Riverside-San Bernardino-Ontario, Calif.	55%
Cape Coral-Fort Myers, Fla.	55%
Los Angeles-Long Beach-Santa Ana, Calif.	54%
Modesto, Calif.	54%
San Diego-Carlsbad-San Marcos, Calif.	53%
San Francisco-Oakland-Fremont, Calif.	53%
Sarasota-Bradenton-Venice, Fla.	52%
Oxnard-Thousand Oaks-Ventura, Calif.	52%
San Jose-Sunnyvale-Santa Clara, Calif.	51%
Las Vegas-Paradise, Nev.	51%
Sacramento-Arden-Arcade-Roseville, Calif.	50%

Note: Because the percentages are estimates, precise ranking is not possible.

Source: Analysis of Census data by Harvard's Joint Center for Housing Studies