Economic Outlook 2008

Our panel of local industry professionals share their thoughts on the year ahead

Story by Sean Fitzgerald

At the tail end of 2007, local and national economic news for the past calendar year has proven a mixed bag of gloom, prosperity and uncertainty.

A historically high rate of home foreclosures, record fuel and energy costs, the plummeting value of the U.S. dollar against foreign currencies, and volatility in domestic stock markets will do doubt create challenges in 2008. But employment and inflation rates have remained relatively steady, and new businesses have been springing up at a healthy pace.

For this last issue of B2B in 2007, we asked a panel of local professionals to discuss recent trends and key indicators within their own industry, and offer their own thoughts on local and national economic conditions in the year to come. Here’s what they had to say.

Residential real estate
On the national landscape, new home construction has decreased by double digit percentages year over year for each of the past 20 months. Coupled with a record number of home loan foreclosures and strife in the corporate mortgage industry, recent economic headlines have focuses on the residential real estate market. But the picture painted on the national canvas doesn’t necessarily mirror the local outlook.

“If you only listened to the morning news and you hear that home sales are down 50 percent and there’s twice the number of homes on the market, you’d think it’s pretty bleak out there. Not so!” said Gail Sharpe, an agent with Adashun Jones Real Estate out of its Fond du Lac office.

Nationally, those figures may very well represent the real estate market as a whole, but Sharpe emphasized it’s important to remember that global trends in other industries don’t impact markets in the same manner they do in real estate.

“Real estate is not a global market. Real estate is where you’re standing. It’s what you want to buy and sell that day,” Sharpe said. “Our numbers (in Fond du Lac County) are not that far off from 2006.”

Home sales in Fond du Lac County during the second quarter 2007 – the most recent period from which data is available – were 253, down slightly from the 272 homes sold during the second quarter 2006, according to the Wisconsin Realtors Association. The median home sale price of $125,000 was down less than 2 percent from the $127,100 median price for home sales during the second quarter 2006, which marked an all-time high for any quarter in Fond du Lac County.

In Winnebago County, the number of home sales dropped by about 7.5 percent during the second quarter, even though the median selling price for homes hit an all-time record for any quarter at $130,000. Based on the numbers, it’s hard to argue that homeowners desperate to sell are dropping their asking price below the fair value for the market.

In Outagamie County, home sales in the second quarter 2007 were higher than any previous period dating back to the third quarter 2005, when the number of home sales hit the second highest mark ever in Outagamie County.

Part of the reason the national housing market has been painted with a stroke of gloom-and-doom, Sharpe believes, is that sellers too often have only a small amount of equity in their homes after taking out second mortgages to finance other needs and wants. They take a vacation, pay for braces on the kids, or remodel the kitchen – then decide to sell their home, only to find they don’t have the equity to pay off the existing mortgage and upgrade to a new home.

Sharpe said it’s unlikely to expect a dollar-for-dollar return on improvements the homeowner makes to their home, saying “if you’re going to make improvements in your home, make them for your own enjoyment.”

Sharpe also observed the Fond du Lac area hasn’t been as active in the mid-price range as in recent years, but has continued to be active in the lower-priced range with first time home buyers. She’s also found younger and first time homebuyers have been making decisions more quickly, and too often buying more home than they were prepared to spend on mortgage payments.

Overall, residential real estate is poised to always have a relatively lucrative marketplace.

“It’s still the best long-term investment you can make.”

Manufacturing
Often during the past few years, reports on manufacturing in northeast Wisconsin have focused on loss of jobs and competition from China.

But other factors, such as fuel and commodity costs, have in some cases been just as devastating to local manufacturers.

Volatile commodity prices – particularly with certain metals and oil – have forced smaller manufactures to take lower margins just so they can maintain price stability with their own customers, indicated David Stini, CPA, a manufacturing and supply-chain specialist with Virchow, Krause & Co. in Appleton.

Stini said he works with one client who depends heavily on copper – a commodity that has run the gamut from cheap to expensive during the past three months alone.

“Some of the prices are so volatile that they have issues from week to week,” Stini said. “But you can’t send your customer new pricing schedules every month. It’s kind of a situation of asking, ‘which way is the wind blowing this week?’”

Buying more raw material than needed to hedge against potential price increases is speculative, Stini warned, and often can force a smaller manufacturer to unnecessarily tap further into their lines of credit. And while interest rates are fairly reasonable right now, cash flow is generally tight already for smaller manufacturers, whose larger, original equipment manufacturing customers are more routinely withholding payment for 60 days or longer.

It’s not all overcast for smaller manufacturers.

The falling value of the U.S. dollar has discounted domestic goods and made them more attractive to potential customers in Europe and Canada, Stini noted. At the same time, many companies are finding that China isn’t fitting into their supply chain as effectively as originally planned.

Labor costs in China are increasing as its workforce gets a taste of Western luxury, and rising fuel costs do play a role in making it more expensive to ship across the Pacific Ocean. In addition, the prospect of moving goods from China will always be time- and space-sensitive.

“The fear of China taking away business doesn’t impact manufacturers of commodities that require a short lead time or are heavy and bulky,” Stini said.

As far as purchasing new, innovative equipment, interest rates are still relatively low. Unfortunately, Stini said, many smaller manufacturers don’t have the resources available to conduct a thorough return-on-investment analysis of capital purchases they’re considering, like new equipment with a seven-figure price tag.

“A lot of smaller manufacturers have traditionally been run by a gut-feeling from management in regard to making those decisions,” said Stini, who noted more expensive equipment and more complex processes make due diligence in these decisions more critical than ever before.

Commercial real estate
There’s been substantial new construction of Class A office space – particularly on Appleton’s northeast side – during the past two years. But that doesn’t necessarily mean first class office space is in high demand.

“There haven’t been that many new businesses coming in – there’s been a lot of moving around from one Class A office space to another,” said John Pfefferle, president of Grubb & Ellis/Pfefferle in Appleton and Green Bay, a commercial real estate brokerage and property management firm which oversees about 6 million square feet of space in the Fox Valley.

As a result, older Class A space – typically those offices with high-end finishing work, more glass, an expansive lobby and upgraded landscaping – is becoming more affordable for small businesses looking to upgrade. Pfefferle said newly constructed Class A space is going for about 30 percent more than older office space, which places it in the range of $20 to $22 per square foot.

It would appear that small businesses are moving into the older spaces being vacated by accounting, legal, investment, and other consulting firms. Grubb & Ellis/Pfefferle’s Appleton Office Market Trends report for the third quarter 2007 indicated office vacancy rates have continued to decline in the Fox Cities each quarter from a year ago, down from 16.2 percent in 2006 to the most current vacancy rate of 13.5 percent. Office vacancies were lowest in the Oshkosh market, according to the report, at just 7.4 percent.

The market for industrial real estate has continued to be stable during the past year or two, with vacancy rates hovering right around 11.5 percent, according to Grubb & Ellis/Pfefferle’s most recent Industrial Market Trends report. Pfefferle said his company is currently listing two large-end industrial facilities – the 800,000-sq. ft. Kimberly-Clark diaper plant closing this month, and the 200,000-sq. ft. former Fox River Paper Co. plant near Outagamie County Regional Airport.
Lease costs for industrial space have remained stable as well, Pfefferle said, but indicated that won’t impact too many local manufacturers.

“The Valley is somewhat unique in that there are several owner occupied industrial facilities here versus other places,” he said. “But I do see that trend changing slowly down the road.”

Leasing manufacturing space is more common in metropolitan areas, where owners can take the equity otherwise in their plant and property and reinvest it into equipment and operations, Pfefferle said.

Insurance
Business owners and corporate risk managers should know that the insurance market is about as soft as it’s been in the past three to four years, and it’s not likely to get any better than it is today. If you’re paying a favorable premium right now for your worker’s compensation insurance, it may not pay to shop around, said Brian McClone, vice president of commercial operations and finance with McClone Insurance Agency’s office in Oshkosh.

“Most employers are probably getting some of the best prices they’re going to get,” McClone said. “If you have a good relationship with your insurer and you have a good safety program, it’s not to your advantage to move on.”

Lower claims ratios paid out by insurers to their policy holders compared with the amount insurers have taken in from premiums has kept costs down and competition vibrant among insurers looking to attract new business. In some cases, insurers are paying 25 to 30 percent dividends on worker’s comp policies.

“It’s a good time to really concentrate on safety and on your in-house quality control,” McClone advised, explaining that any current or future insurer would be pleased to see up-to-date and thorough records confirming employee safety training, random drug testing, and motor vehicle record checks, as examples. These control verifications are particularly important in an industrial setting, but apply as well to service and retail operations where employees are using heavy equipment, driving vehicles or placing themselves in potentially dangerous situations.

With a comparably calm hurricane season on the Gulf and East coasts during the past two years and few recent catastrophic natural disasters, a variety of insurers are competing on price and writing policies to organizations of which they might not otherwise do business. But the tilting point is coming, McClone said, and insurance carriers are going to begin to re-underwrite and re-evaluate their claims policies, potentially making it more difficult for a business with considerable risks to find affordable coverage.

Commercial construction
Like real estate, commercial construction has less to with national trends and is more related to present-time local and regional conditions.

Kaukauna-based design and build firm Keller Inc. is coming off a record sales year in 2007, said president Wayne Stellmacher, though he’s heard from many of the firm’s subcontractors and competitors that the past year hasn’t been quite as generous. Stellmacher said its sales growth within the state has been segmented by region, with Keller experiencing a vibrant market in the Fox Cities.

“We’re excited in that it appears some sectors of manufacturing are coming back,” said Stellmacher, who cited agri-business as also having strong opportunities for building and infrastructure growth in the year ahead. Keller is currently building two ethanol plants in Iowa.

Commodity costs always play a substantial role in the construction market, Stellmacher said, adding that both steel and concrete are expected to increase in cost in the months ahead. Since new home construction is down on the national level, lumber costs have come down, making stick building a more affordable choice when appropriate for a commercial building. Higher energy costs also take a toll on the construction industry.

But the cost of financing a multi-million dollar construction project is still at relatively moderate levels, and has even shown some signs of dropping a bit further before going up again.

“Money is still a bargain,” Stellmacher said.

Health care
Since health care spending in the U.S. amounted to nearly 15 percent of the nation’s gross domestic product in 2002, health care costs have crept steadily higher and are approaching 20 percent of the U.S. economic output.

While there’s a number of factors that impact health care pricing in any given market, often the largest contributor to cost is expensive construction and expensive new technology, particularly when each aren’t used often enough to spread the cost over thousands of patients. Each capital investment made by a health care system needs careful due diligence to ensure its use will reasonably justify its cost.

Such an evaluation is easier said than done in an environment of rapid medical advancements.

“The change and the advancements (of new medical technology) is at an incredible pace which often outstrips” the opportunity for a health system to always have the most up-to-date medical equipment, said Kathryn Correia, vice president of Appleton Medical Center and Theda Care Medical Center in Neenah, both among the inpatient hospitals within ThedaCare’s health system.

But new medical technology is allowing for less invasive procedures, which generally result in shorter lengths of stay for patients, and ultimately, lower bills, Correia explained. Less invasive procedures often mean fewer complications from surgery, leading to a higher quality of patient outcomes.

“It’s all about better quality and lower costs,” Correia said. “But technology and capital are only the support that leads to providing a quality and safe outcome.”

But patients aren’t always armed with the most thorough information to help them make choices to identify physicians and facilities that provide the best quality for the best cost. Correia said the continually evolving regulatory environment is driving more stringent requirements for reporting outcomes and making pricing structures more visible. That’s of tremendous benefit to patients, if they take advantage of such information.

“Consumers need to know what they’re purchasing,” Correia said. “Buy right, and buy with as much information as possible.”

ThedaCare has been leading the drive within state government to encourage greater reporting of medical quality. It’s also lead the way in process and procedure efficiencies within the health care industry, adapting many of the lean principles from manufacturing and applying them to patient care.

ThedaCare is in the fifth year of its lean journey, Correia said, which has helped improve both the speed and timeliness of patient delivery. Altogether, ThedaCare estimates it has created nearly $22 million in cost reductions or improved health care delivery to patients due to its lean initiatives in the past five years. It’s a cost-savings trend other health care systems are adopting as well.