The Fight of the Century? Stimulus Dollars VS. Stagnant CreditBy Robert A. Murray
Article Date: 08-01-2009
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Signs of a bottom are evident, and while improvement is not yet within reach, losses would be far worse had stimulus not been applied.
The downturn for construction has turned out to be especially severe during 2009. Tight lending standards and the weak economy are taking their toll on commercial building and multifamily housing, and the previously resilient institutional building sector is losing momentum.
It’s true that the federal stimulus act should soon be a plus for construction, but the first half of 2009 witnessed just the early signs of a lift for transportation public works, and not much else. Lists of projects and guidelines for using stimulus funds have been provided for such programs as energy-efficiency upgrades to federal buildings, but the impact has yet to show up at the construction site.
As a result, the volume of construction starts in 2009 is now estimated at $437 billion, down 21 percent. This will be the third year of retreat, following declines of 13 percent in 2008 and 7 percent in 2007. The 21 percent slide includes the support that the stimulus act is expected to provide to public works during the second half of 2009, contributing to a 9 percent full-year gain for that sector. Without the funding provided by the stimulus act and its lift to public works, total construction in 2009 would see a decline closer to 25 percent.
After the unrelenting gloom at the start of 2009, the news about the U.S. economy began to shift in the second quarter 2009, moving toward the belief that the worst of the recession has passed. The payroll employment statistics had registered especially steep declines from November through early 2009, with January showing a job loss of 741,000. The rate of descent then eased over the next four months, with May showing a more “moderate” job loss of 322,000. The corner has yet to be turned – the June employment report revealed job losses increasing once again to 467,000. At mid-2009, the unemployment rate stands at 9.5 percent, and since the start of recession in December 2007 through June 2009 a total of 6.5 million jobs have been lost.
A similar picture is present in the GDP statistics. At the end of 2008, the economy contracted 6.3 percent, to be followed by another 5.5 percent decline in first quarter 2009. In general, the economy continues to be depressed, certainly by the standards of mid-decade, but the pattern has moved from steady deterioration to what is looking more like uneven stabilization at a low level. For the second quarter, real GDP is still expected to be down about 3 percent, to be followed by a flat pattern in the third quarter and slight 1 percent expansion in the fourth quarter. Given the very weak start to 2009, real GDP for the full year will be down 3 percent.
In testimony before Congress in May, Federal Reserve Chairman Ben Bernanke stated that the “pace of contraction may be slowing,” and noted that consumer spending showed some improvement in the first quarter, with an additional boost likely to come from the stimulus program. On a cautionary note, Bernanke pointed out that the gains in consumer spending would be limited for the near term, due to the weak labor market, tight credit conditions, and the declines in household wealth. Going forward, Bernanke indicated that the economy is “likely to remain below its longer-run potential for a while,” as firms stay cautious about hiring, which will keep the unemployment rate elevated well into 2010. The plus of this sluggish recovery is that slack capacity will work to restrain inflation, keeping this spring’s run-up in energy prices from having a more broad-based impact on price levels.
Federal Stimulus to Provide Lift
The federal stimulus act will provide some help to the economy in 2009, with more support to come in 2010 and 2011. The American Recovery and Reinvestment Act of 2009 carried a price tag of $787 billion, with the stated goal of creating or saving at least 3.5 million jobs by the end of 2010. In June, the Obama Administration estimated that 150,000 jobs had already been created or saved, and called for accelerating the pace so that 600,000 jobs are created or saved over the summer. Funding going to the construction industry will play a part in the job creation process – it’s estimated that the stimulus bill includes about $130 billion for construction.
The transportation sector was clearly the big winner in the stimulus act, as funding for transportation infrastructure came to $49.3 billion. Highways are allocated $27.5 billion, the largest share of the transportation total. Mass transit is provided $8.4 billion, and airport improvement grants get $1.1 billion. For highways in particular, the boost to construction should come quickly. The Federal Highway Administration apportioned funds to the states on March 2, releasing $26.7 billion for projects. States were given 120 days from the date of apportionment to obligate 50 percent of this funding (June 29), with the remaining 50 percent of the funding to be obligated one year after apportionment. The highway funds carry a “use it or lose it” provision – unobligated money will be redistributed by the U.S. Department of Transportation. In addition, the funds don’t require the usual state matching share, which for highways is 20 percent of the project’s total cost.
The early indications are that this funding is beginning to get to the construction site, as many states had a backlog of projects ready to go. On June 25 the U.S. Department of Transportation reported that $19 billion has been obligated for more than 5,300 highway and other transportation projects, as every state met the 120-day obligation deadline. The House Transportation Committee said that based on reports through the end of May, stimulus-funded highway and transit projects going out to bid totaled 4,098, with work started on 1,243 projects at a combined value of $4.4 billion.
Environmental public works programs are allocated $20.6 billion in the stimulus act. The EPA clean water state revolving fund is provided $4 billion, while the drinking water state revolving fund gets $2 billion, which will support more sewer and water supply construction. To expedite the use of this financing, the stimulus act also drops the 20 percent matching requirement for states drawing on the revolving funds. The act requires that at least 20 percent of each state revolving fund be devoted to green-water or energy-efficiency projects. In addition, the U.S. Army Corps of Engineers gets $4.6 billion under the stimulus act.
Energy-related projects are supported by the stimulus act’s $30.6 billion in spending and tax incentives. To modernize the nation’s electricity grid, $11 billion is allocated, including $4.5 billion for the “smart grid” investment program. Just what constitutes “smart grid” construction is still emerging, so it’s likely that initial disbursements will be directed more at research grants. Production tax credits for renewable energy were extended for wind energy through 2012, and for biomass, geothermal, and some others through 2013. The stimulus act also granted more borrowing authority to public utilities, such as the Oregon-based Bonneville Power Administration, in order to go ahead with major transmission line projects.
As shown by the Federal Reserve’s quarterly survey of bank loan officers, lending standards continue to be very tight. In the October 2008 survey, 87 percent of the respondents said that they had tightened standards, the highest reading ever. The January 2009 survey showed some easing in the degree of tightening, when 79 percent of the respondents reported tighter standards. This continued with the April 2009 survey, when 66 percent of the respondents reported tighter standards, although this remains very high by historical standards. A full 66 percent of the respondents reported diminished demand for commercial real estate loans in the April survey, making it 11 straight quarters in which at least 25 percent of the respondents cited diminished loan demand.
The more restrictive climate has meant that owners and developers have found it extremely difficult to refinance short-term loans obtained just a few years ago – however, there have been a few instances where construction loans are getting issued this year. In short, there has been some improvement in the lending environment compared to last fall, but only to a small degree that would affect developers willing to look to other loan sources or take on more difficult loan terms. A significant easing of lending standards that would benefit a broader range of commercial projects is still at least a year away.
For state finances, the latest Fiscal Survey of the States (June 2009) indicates that the fiscal position has grown more dire – “the 50 states are facing one of the worst fiscal periods in decades.” For fiscal 2009, general fund expenditures are estimated to decline 2.2 percent, and the recommended budgets for fiscal 2010 point toward another 2.5 percent decline. This would be the first time in the history of the survey (going back three decades) that state general fund expenditures had declined in consecutive years. The report notes, “While the American Recovery and Reinvestment Act of 2009 has helped states avoid draconian levels of cuts, it will not end the need for states to cut spending, as exhibited by the 2.5 percent decline in governors’ recommended budgets for fiscal 2010.”
With credit markets essentially shut down at the end of September 2008, state governments were put in a financial squeeze as they tried to raise cash for operating expenses. The financial rescue package last October and subsequent actions to help the bond market provided some relief to the tight lending environment. This “improvement” is relative to the lending shutdown last October; the financing environment for the states continues to be more difficult than two to three years ago. The Center on Budget and Policy Priorities reports that at least 47 states are facing shortfalls in their budgets for this year and next. The situation is most glaring in California, which continues to go through contentious debate over its budget in an effort to reduce a $26 billion deficit.
The following updates the 2009 projections for construction starts of major sectors.
Public Works and Electric Utilities
Public works construction in 2008 retreated 2 percent to $119.6 billion, after five years of growth. In 2009, the public works sector is forecast to climb 9 percent to $130.6 billion, lifted by the stimulus funding. Excluding the stimulus support, the erosion in state finances would have caused public works construction to slide further in 2009, with activity falling by as much as 10 percent.
Highway and bridge construction in 2008 retreated 1 percent to $52.9 billion, due to several factors. The federal transportation bill (SAFETEA-LU) began to wind down as it moved towards its final year in 2009. The funding guidelines are typically front-loaded in these multiyear bills with flatter spending towards the final year. The shortfall in the Highway Trust Fund was another factor – higher gas prices in the first half of 2008 led to a reduction in car travel, causing gasoline tax receipts to decline. Last September, Congress was forced to transfer $8 billion from the general fund to the Highway Trust Fund, as a necessary step to maintain continued financing for highway projects.
While the fiscal stress remains high for the states, the Federal Highway Administration released $26.7 billion to the states in March. The stimulus money for highways and bridges is making its way to the construction site, notwithstanding criticisms in late spring that it was taking too long for the stimulus funding to have an impact. Just after the stimulus bill was signed, the Missouri DOT voted to award an $8.5 million contract to replace a 1,000-foot long bridge over the Osage River. Not far behind was Maryland, approving $365 million in transportation projects the day after the bill was signed. California, which received $2.6 billion for highway and bridge projects under the stimulus act, approved a list of 57 projects totaling $625 million in early March. With such actions taking place by the states during the first half of 2009, highway and bridge construction picked up the pace in late spring, with further strengthening to come during the second half of this year. For 2009 as a whole, highway and bridge construction is forecast to rise 15 percent to $60.8 billion.
Additional stimulus funding was provided to other transportation accounts, including $8.4 for mass transit, $8 billion for high speed rail, $1.3 billion for Amtrak, and $1.1 billion for the Airport Improvement Program construction grants. In particular, the amount allocated for high-speed rail was a surprise, and could end up helping to fund such proposed projects as a high-speed rail line from northern California to the southern part of the state. The application procedures for the high-speed rail projects needs are being established, and funding carries a “use it or lose it” deadline of 2012, longer than that for highways. As a result, high-speed rail is not expected to lift construction activity much in 2009, but it may very well provide a large boost in 2010 and 2011.
The environmental public works group (sewers, water supply systems, and river/harbor development) edged up 2 percent in 2008 to $38.1 billion, after 12 percent expansion in 2007. Sewers and water supply systems each retreated 1 percent, while river/harbor development advanced 14 percent as the result of continued efforts to improve flood protection in and around New Orleans. In 2009, environmental public works will begin to derive some benefit from the stimulus bill, including the cash infusion to the state revolving funds, which will enable the environmental public works group to strengthen 5 percent. In particular, river/harbor development for 2009 is estimated to climb 19 percent, helped by the stimulus bill’s $4.6 billion to the Corps of Engineers.
The electric utility category in 2008 soared 67 percent to $29.7 billion, the highest amount ever reported for this category. The elevated volume reflected the start of several very large power plants, including a $2.9 billion coal-fired plant in Lively Grove, Ill. A substantial number of gas-fired power plants were also reported as construction starts in 2008, and the amount of wind farm construction increased. Based on recent experience, last year’s heightened volume of power plant construction is likely to be followed by retrenchment, which is made even more likely by the current weakness of the U.S. economy. For 2009, electric utilities are forecast to see a 35 percent decline in construction starts to $19.2 billion. Running counter to this trend will be continued strength for transmission line projects, as part of the $11 billion directed at electricity grid work, which includes $4.5 billion for the “smart grid” investment program.
Single-family housing is currently very weak, but the worst of the correction appears to have already taken place. The single-family downturn accelerated in 2008, as construction fell 41 percent to 549,000 units (McGraw-Hill Construction basis), steeper than the declines in 2006 (down 18 percent) and 2007 (down 30 percent). Activity fell further in first quarter 2009, before stabilizing in the second quarter. Given the very weak start to this year, single-family housing for all of 2009 is estimated at 400,000 units, another 27 percent annual decline. Compared to the peak year 2005, single-family housing starts in 2009 will be down 75 percent.
Multifamily housing in 2008 dropped 31 percent to 310,000 units, much steeper than what occurred in 2006 (down 3 percent) and 2007 (down 12 percent). The overbuilt condominium segment of multifamily housing has been in the midst of a correction for some time now, and 2008 showed large declines in such condo-dominated markets as Miami (down 58 percent) and Las Vegas (down 61 percent). New York is the largest market for multifamily construction in the nation, and it retreated a slight 1 percent in 2008, as its level of apartment construction stayed strong. However, given last fall’s upheaval in the financial sector, multifamily housing in New York is experiencing a sharp decline in 2009.
Large high-rise projects have been especially hard-hit by tight lending standards, as the number of multifamily projects valued at $100 million or greater fell from 44 in 2007 to 26 in 2008, and in the first half of this year only two such projects reached groundbreaking. For 2009, multifamily housing is forecast to fall an additional 47 percent to 165,000 units, which would be the lowest volume for multifamily housing since 1992 (161,000 units). Some help for multifamily housing may come from the $4 billion allocated to Housing and Urban Development’s public housing capital fund, as well as the $1 billion for community development block grants. The stimulus benefits will be focused on renovating and upgrading existing buildings, and may not be reflected at the construction site until 2010 and beyond.
In 2008 commercial building showed the impact of the sagging economy and tighter lending standards. New construction starts dropped 26 percent to 778 million square feet, down from the most recent peak of 1,056 million square feet in 2007. The decline in dollar terms was not as severe, as contracting retreated 16 percent to $84.4 billion. The more moderate downturn in dollars reflected the start of several massive office and hotel projects in 2008, and the fact that the relatively less expensive project types, stores and warehouses, were the hardest hit in 2008. Another factor contributing to the 2008 slide for commercial building was the sharp drop-off in the issuance of commercial mortgage-backed securities, which reduced the funds that banks had available for commercial real estate loans. In 2009, the decline for commercial building will be steeper – in square footage terms down 47 percent to 410 million square feet and in dollars down 39 percent to $51.3 billion.
The stimulus act does not offer direct help to commercial building – its indirect benefit will be moderating the decline in employment and setting the stage for a faster economic recovery. In the near term, commercial building is facing a particularly tough financial climate. Lending standards on commercial real estate loans are very tight, and there’s mounting concern over rising delinquencies of commercial mortgage-backed securities. In addition, a large volume of commercial mortgages that were issued at mid-decade are coming due between this year and 2012. With property values flattening out or declining in numerous markets, as the result of the recession, it will be difficult for many of these mortgages to qualify for refinancing.
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