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HVAC Market Heats Up

HVAC demand grows thanks to increased consumer, construction spending

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A number of factors are coalescing to turn 2018 into a profitable year for distributors of heating, ventilation and air conditioning equipment, which is welcome news for service centers selling into this market. The economy is growing, construction is building, consumers are spending and recent changes in the tax code are creating incentives to replace aging commercial HVAC systems. 

And while steel tariffs have raised prices across the board for sheet metal and HVAC equipment, the market is experiencing its second-consecutive year of solid growth.

“In my opinion, last year was really the first real recovery year,” says Talbot Gee, president of Heating, Air-conditioning and Refrigeration Distributors International. His organization represents HVAC parts and equipment distributors, who have seen business increase, primarily on the back of the economy. “Last year, we were able to sustain greater than 6 percent annual growth throughout the year, and then we saw it accelerate at the end of last year and the beginning of this year.”

In addition to selling directly to manufacturers of HVAC equipment, service centers also provide contractors with the sheet metal, primarily galvanized steel, for ductwork in HVAC systems. Some metal distributors, such as Beaver Steel Services, specialize in this market, supplying both the steel and other products used by HVAC contractors in Pennsylvania, Maryland, West Virginia and Ohio.

The rising market has translated into higher demand for Beaver Steel’s products, according to Kurt Treser, regional account manager at the Carnegie, Pa.-based company. He says business is up about 15 percent compared with last year, and expects that momentum to continue beyond the typical installation season, which usually runs from April to October. 

“Demand’s been steady,” Treser said. “A lot of customers have backlogs going into the fall, which is unusual but a welcome thing to see.”

Craig Mathiason, president and chief operating officer for Jemison Metals, Birmingham, Ala., says his company’s HVAC business is up in the high single-digit range to start the year. “Demand’s been very robust,” he says. “Of the guys that we do business with that are in this market sector, business is up.”

Shipments of heating and cooling equipment in the U.S. have increased in every major category, according to the Air Conditioning, Heating and Refrigeration Institute. Year-to-date shipments of residential gas storage water heaters are up 8.1 percent through June, residential electric storage water heater shipments grew 6.3 percent in that time, commercial gas storage water heaters increased 5.2 percent, commercial electric storage water heater shipments increased 0.8 percent, shipments of gas warm air furnaces increased 11.7 percent, shipments of oil warm air furnaces increased 9.1 percent, and combined shipments of central air conditioners and air-source heat pumps increased 6.1 percent

Similarly, average sales for HARDI distributor members are up in 2018. Sales increased 4.5 percent among HARDI distributors in June and 6.4 percent year to date through June.

Houston, Texas-based equipment manufacturer Goodman Manufacturing Co. also reports a pickup in business. Nathan Walker, senior vice president of corporate marketing, says fiscal 2017 finished with strong growth that has continued into 2018. “Currently, demand for commercial and consumer HVAC products is strong,” he says. “The strength of the economy in the United States is allowing homeowners to replace, rather than repair, existing, old, energy-inefficient systems and business owners are upgrading similar older installations of HVAC systems.”

Indeed, the overall economy is something that many in the HVAC marketplace are watching closely. That’s because economic growth influences things like consumer spending and building construction, two major indicators of future HVAC demand.

Treser says forecasting the HVAC market is tied directly to what’s going on in the economy. “The years tend to trend similarly,” he says, noting that anomalies such as large downturns or upturns in the economy can significantly influence demand. “We’re seeing a big upturn in the economy right now, which is nice to see.”

Vince Sandusky, CEO of the Sheet Metal and Air Conditioning Contractors’ National Association, says that the economy, particularly its effects on the construction industry, are fueling HVAC growth in 2018. “There’s this pent-up demand from the recession and certainly now that we’re going through an even more increased economic growth pace everywhere, there’s just a lot of construction-related work out there right now, and it’s not slowing up,” he says.

SMACNA, whose 1,834 member firms perform work in industrial, commercial, institutional and residential markets, reports that total engineering and construction spending increased 4 percent in 2017, and Sandusky anticipates at least 6 percent growth in 2018.

“There’s just a lot of work out there,” he says. “Construction has to be a good proxy for us. You can’t build a building without sheet metal work in it, so our growth numbers and our industry growth numbers would mirror construction.”

That being said, both residential and nonresidential construction spending are up through June, according to the U.S. Census Bureau. Total year-to-date construction spending increased 5.1 percent compared with the first six months of 2017. By sector, residential construction spending increased 8.1 percent through June, nonresidential construction spending was up 2.9 percent and public construction spending jumped 4.7 percent.

“When I listen to what my members tell me and then I compare that with what I’m seeing in some of the specialized market reports, I would tell you that office, commercial and healthcare construction seem to be consistent in terms of being strong markets with a lot left to run in them,” Sandusky says. “The construction reports tell me that communications construction is running strong and public safety is doing pretty well right now too. And for the past couple years, the healthcare and office construction markets have been pretty strong and are remaining so.”

Residential construction is another important indicator for the HVAC market, as a new home typically means installation of a new furnace, air conditioning unit and some ductwork. According to Evan Barrington, vice president of economic analysis and forecasting at The Stephenson Company, there’s been a lot of activity in both single family and multifamily construction to start the year. 

“Residential construction has picked up, with both single family and multifamily improving,” he says. “I think it was a surprise to a lot of people that the multifamily numbers have been as strong as they have so far this year. Single family just continues to gradually improve. Whether you look at the permits or the starts, we’re kind of at a relatively steady upward pattern.”

Additionally, consumer confidence is rising, meaning that homeowners are more willing to invest in new heating or cooling equipment. “On the residential side, no one plans for their air conditioner or their furnace to go out,” Gee explains. “If they’re not in a good place or they’re not feeling good about where things are financially, their willingness to accept a four- to five-digit replacement cost is not there. But in times like this, they’re more willing to do so.”

The HVAC market may also be getting a boost from the Tax Cuts and Jobs Act, which was signed into law in December. The new tax law made significant changes to the expensing tax provision, making the costs of certain energy-efficiency improvements to HVAC and related systems immediately deductible as business expenses. Previously, the cost of these upgrades could be recovered only gradually through depreciation schedules that extended several decades. 

According to SMACNA, the new tax law now allows HVAC system investments made on or after Jan. 1, 2018 to be fully expensed up to $1 million per building. “We campaigned for a lot of elements of the new tax law,” Sandusky says. “We think anything that provides an incentive, whether it be through taxation or expensing, for building owners to build more buildings or to replace HVAC equipment that’s nearing the end of its useful life is helpful for us. We applaud it.”

Gee agrees. “Finally, HVAC equipment and systems are eligible for expensing, whereas before they’d been subject to a 35-year depreciation schedule,” he explains. “That has always been a huge drag on the retirement and replacement of commercial HVAC systems, and now that that’s gone it does seem to have provided some tailwinds to that market.”

One potential headwind for the HVAC market is the impact of the Section 232 tariffs on prices. According to Gee, all of the major HVAC equipment manufacturers announced price increases within weeks of the tariff determination. “Every manufacturer, every supplier, whether they’re based in the U.S., Mexico, Shanghai, wherever, used this as an opportunity to raise prices,” he says, noting that cost of equipment is up about 6 percent on average.

In March, AHRI, which represents manufacturers of heating, air conditioning, commercial refrigeration, and water heating products and equipment, announced its opposition to the tariffs on steel and aluminum. “As major users of steel and aluminum, we have been proactive in explaining to the administration that the HVACR and water heating industry would be negatively impacted by an increase in tariffs, as would the consumers that rely on the products we manufacture,” said Stephen Yurek, AHRI president and CEO. 

Despite these price increases, both Gee and Sandusky note that the tariffs have not yet had a negative impact on demand. “We haven’t seen an impact on demand as a result of the tariffs,” Sandusky says. “We’ve seen some pretty ugly pricing schemes going on out there and higher costs, but that has not yet reached the level where the facility owners are saying ‘I don’t think we’re going to build this year’ or ‘we’re going to wait until steel prices come down.’ We just haven’t seen that.”

Still, he notes that contractors are struggling to recoup the cost of price increases that went into effect in the gap between when they actually bid a job and when they purchased the material to start building. Additionally, he says SMACNA members are frustrated by price increases that exceed the 25 percent tariff on steel and 10 percent tariff on aluminum.

“Metals manufacturers and distributors have to do a better job of explaining to their customers why their pricing has well exceeded the levels of the tariffs,” Sandusky says. “This lack of transparency from them, with regard to pricing and the factors that are influencing that, it’s causing confusion, concern and some level of irritation among their customers.”

Tariffs aside, the HVAC market is strong, and metal distributors, equipment makers and analysts all expect it to remain so at least into 2019. “Our current view of the near future looks exciting,” Walker of Goodman Manufacturing says. “Continued consumer confidence, coupled with a strong economy, should help continue the strength of the residential HVAC market. On the commercial side of the business, we anticipate continued growth, as owners embrace the need to retrofit inefficient HVAC systems.”

Sandusky agrees. “Right now, things are moving along fairly well, he says. “My members are reporting that they have great backlogs, meaning that they’ve contracted for work through this year and into the next with strong backlogs. I’m not expecting a 
downturn in 2019.”