Even for a profession that understands the volatile nature of its business, this past economic cycle was devastating in its proportions. Architecture firms nationally lost over $14 billion in revenue during the downturn, or 21 percent of their 2008 billings, according to the U.S. Department of Commerce. That revenue loss caused the downsizing of over 60,000 payroll positions at architecture firms; over half of these losses are estimated to have been architecture positions.
Fortunately, firms are well on their way to digging out of this steep decline. The AIA’s Architecture Billings Index (ABI) began reflecting an improvement in design activity around mid-year 2012, and monthly numbers since then–while still volatile–have been routinely positive. However, the positive scores in recent months remain well below those during the 2004–2007 design expansion, even though the 2001-2003 downturn was not nearly as severe as this past recession.
Even the modest improvement in business conditions at architecture firms has helped them recover a portion of their losses. On the revenue front, gross billings at U.S. architecture firms have increased by $8.6 billion from their 2012 low, or over half of what they lost during the downturn. And future workloads should continue to grow. Firms are reporting that backlogs—the amount of project work in house and under contract—have been steadily improving. Currently averaging about five months nationally, project backlogs have increased by about one month on average since late 2010.
The turnaround has been much less impressive on the payroll employee front. Of the over 60,000 positions lost during the recession, only about 3,000 have been recovered as of the end of 2013. Architecture firms have found ways to handle their increased project workloads other than by adding payroll staff, such as by increasing overtime for current staff, or by adding contract workers who don’t show up on payrolls.
During the downturn, architecture firms had to adapt to survive. Firms have always tended to be small, with the majority typically having fewer than 20 employees. But data from the 2012 AIA Firm Survey report shows that the share of architectural firms that are very large—those with 100 or more employees—declined by half from 2008 to 2011. Perhaps even more telling is that a larger share of firm billings shifted to the smaller firms in that same time period. Mid-size and large firms continued to generate the lion’s share of billings, but firms with fewer than 20 employees were responsible for more than one-third of total firm billings in 2011, compared to one quarter of billings three years earlier. It’s likely that a number of larger firms had to close due to the downturn, leading their architects to scatter and open their own small practices. Of the larger firms that did survive, many shrank, and are now classified in a smaller size category.
The types of projects that architecture firms worked on also changed because of the downturn. The share of firm billings from both residential and institutional projects was higher in 2011 than in 2008, when the recession was just beginning, while the share of billings from commercial or industrial projects declined during that same time period. While the housing sector was hardest hit at the beginning of the downturn, it began to show modest signs of improvement as the recovery began. Commercial and industrial projects, on the other hand, suffered as credit remained difficult to obtain and companies were hesitant to commit, fearing a double-dip recession. Data from the ABI has shown that billings at firms with a residential specialization have continued to improve since the 2012 AIA Firm Survey report was published, while firms with an institutional specialization have experienced little growth in 2013, and firms with commercial or industrial specializations have seen relatively modest increases in billings.
The economic downturn has, moreover, influenced the typical length of the project design phase at firms: Recent projects have tended to be smaller and simpler than those prior to the downturn. In a recent AIA survey, firms reported that the design phase for almost half of their projects by revenue was six months or less (design phase is defined as lasting from authorization to proceed on design activity through the construction contract award). Responding firms reported that just 21 percent of projects currently have a design phase lasting a year or longer.
Architecture firms have also seen some of their revenue sources change. In a recent AIA survey, nearly half of firms (48 percent) reported that the share of their firm billings from projects that were canceled or abandoned after design activity began, or which remain unlikely to ever be built, has increased since the recession began. On average, these stalled or canceled projects account for 11.5 percent of annual firm revenue. Some firms branched out into the international arena because domestic projects were limited. In a recent AIA survey, a sizable share of firms reported that they had billings from an international project in the last year; nevertheless, these projects account for a relatively minor portion of their billings. Firms also reported modest firm billings from nondesign revenue sources, such as construction or building operations and maintenance services. In the 2012 AIA Firm Survey, firms reported that these nondesign services accounted for an average of 10.2 percent of their firm billings.
The need for nonresidential facilities in our economy remains a moving target. Economic conditions aside, other developments influence the longer-term demand for buildings. Will e-commerce reduce the need for retail space? Will telecommuting and more flexible workspaces reduce the need for office space? How will the implementation of the Affordable Care Act change the need for healthcare facilities?
One thing is clear: We are currently well below our current construction potential. Over the past decade, we have averaged almost $400 billion in spending annually on nonresidential buildings in the U.S., ranging from about $310 billion in 2003 at that recessionary low, up to almost $500 billion in 2008 at the expansionary high. Over the past four years—even with a growing economy, a growing population, and increases in construction costs—we’ve averaged only about $350 billion in spending on these facilities, so clearly some significant catch-up is inevitable.
Apart from the ABI, two other indicators suggest that a recovery in building activity is underway. The first of these is home building activity, traditionally a leading indicator of nonresidential building activity. In 2012, housing starts nationally increased by almost 30 percent, to 780,000 homes. This past year they are estimated to have increased another 20 percent. New homes create the need for retail and other commercial facilities, and eventually lead to increased demand for schools, healthcare facilities, and other institutional structures.
And second, more design work is already in progress. The AIA is poised to launch a new indicator of future design and construction activity that looks at trends in signed design contracts at architecture firms. A signed design contract, or an authorization to proceed on the design of a project, means that design activity is slated to occur in the coming months. Since late 2010, when the AIA began collecting information on the change in design contracts, there has been considerable volatility in the direction of this indicator. Beginning in early 2013, the direction has been more consistently positive, strongly suggesting that design billings will grow in the coming months.
As the construction markets continue to expand, architecture firms will look to regain some of the losses incurred during the downturn. While some of this growth can come from increasing project workloads in a firm’s current niche, many firms will look to diversification as a rebuilding strategy.
One strategy is to increase their service area, potentially by establishing a satellite office. Another is to expand the building sectors that they serve. A third is to look offshore for work, a strategy with increasing appeal as growth in the U.S. economy is expected to remain modest compared to developing countries. A fourth is to expand firm services, such as interior design, landscape architecture, planning, engineering, or even construction.
While internal expansion may be a method to achieve firm growth, mergers and acquisitions are often seen as a quicker and safer strategy. In a December 2013 survey of architecture firms, about a quarter of respondents indicated that over the past year they had actively considered either acquiring another firm, merging with one, or being acquired by one. A majority of architecture firms think that merger and acquisition activity will increase over the coming year.
The major reason motivating the increase in merger and acquisition activity is project diversification: giving the firm the ability to add new markets, serve a broader area, or develop an international presence. The second and third most important considerations for firms are closely related to the first: allowing them to compete more effectively, and adding skills and credentials. Still, it will take several years of growth—either internal or through mergers and acquisitions—for architecture firms to fully regain losses from the recession.
For more on the future of the market, click here.