Construction Spending Hits Bottom; No Significant Gains Till Year-endBy Jim Haughey
Article Date: 08-01-2010
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Total construction spending fell 0.2 percent in May after the outsized 2.3 percent rise in April. Spending is now 3.2 percent above the February low point for this cycle but is down 31 percent from the peak spending level 50 months ago. May’s 35,000 construction layoffs had signaled a larger decline in construction spending. Revisions may yet validate this. Monthly construction spending totals for the rest of the year are expected to be near the May total with a small post – a tax credit dip is likely during the summer. From month to month, construction spending is as likely to rise as it is to fall.
The overall Reed Construction Data spending forecast is largely unchanged. The Reed Construction Data spending forecast projects an 8.8 percent drop in 2010 and then a 5.9 percent recovery in 2011. But it begins from a lower base due to the downward spending revisions in the annual revision of the construction spending data series. The major revision was a huge cut in the estimate for the manufacturing sector. This reverses previous major upward revisions. Manufacturing construction spending is difficult to estimate since a large share is not publicly bid and some is not bid at all but done by owners’ own employees. Generally, the downward revision in manufacturing reflects less spending for energy-related projects.
The value of construction starts in the Reed project database is still 20 percent-plus below pre-recession levels but is substantially higher than the bottom of the business cycle about a year ago. Starts have been approximately steady in recent months. Gains in housing and heavy construction have offset declines for nonresidential buildings. The decline in starts over the last several years has been almost entirely in new buildings and facilities; renovation has remained relatively strong and now comprises an unusually large share of construction activity. This type of work is heavy on labor but light on equipment and materials use.
The annual revision also reduced residential spending slightly and made a more significant cut in spending for developer-financed buildings. The stimulus plan is probably responsible for small upward revisions on the spending estimates for institutional buildings and heavy construction.
The construction forecast is based on a GDP outlook that expects near 2 percent growth in the spring and summer quarters and then near 3 percent growth over the following year. Many economic forecasts have been scaled back in May and June in response to sour economic reports both here and elsewhere in the world. The Reed economic outlook has not changed. We always expected that recovery from a credit-initiated recession would be very slow, as others have been. Recognizing loan defaults and recapitalizing is a long, slow process. Large banks did this very quickly. Other lenders have been slower but have made significant progress. Federal lending agencies still have their head in the sand and some housing finance agencies are still making bad loans and failing to write off nonperforming loans. This will be a drag on the economy, especially construction, for several more years.
Nonresidential Building Construction Still Declining
Nonresidential building construction spending declined 1.1 percent further in May. Downward revisions for this sector in recent months and in the annual comprehensive revision suggest that the Census Bureau is missing more post-start project shutdowns than it is missing project starts. Institutional construction spending fell 0.9 percent in May. In turn, this suggests that nonresidential construction is still weakening. The near-term spending trend is at best unchanged until the end of the year. With activity near the bottom for this building cycle, expect brief month-to-month expansion spurts for some types of projects through the summer but no sustained expansion until year-end.
Institutional construction is being boosted by long-delayed stimulus plan funds but at the same time being restrained by critically low state and local government budget reserves and appropriation cuts, made necessary by the high post-recession costs of medical and social programs. State tax receipts are now stabilizing, but local government tax receipts, highly dependent on property taxes, are still declining. California and several other large states have yet to make the unavoidable cuts in public construction spending that will be needed to balance their budgets. And as yet, Congress has not enacted a new round of aid to state governments. This is targeted to Medicaid and education, but most governors planned to use it for a variety of programs. The initial proposals were for several hundred billion dollars, but Congress recently failed to enact a slimmed down $24 billion version. Little if any new federal money is coming to states. California had been hoping to get $6 billion. Massachusetts included more than $600 million in its budget.
The net effect is a forecast of essentially no change in institutional construction spending until the beginning of 2011. K-12 education and public safety buildings will be the weakest sectors. Construction spending for higher education has recently begun to decline under pressure from falling state appropriations and the diversion of more funds to tuition aid.
With the recent downward revisions, developer-financed construction will see only a 1 to 2 percent further drop from May until fall. However, much larger declines will occur in the most overbuilt cities in the South and West. Real estate investors see better profit opportunities in buying existing buildings than building new buildings. Building prices are 40 percent below the recent peak level, with many properties available at even deeper discounts when the current owners lack the equity to roll over short-term mortgages. Many small developers are still failing to get financing because their usual lenders are being pressed by bank regulators to reduce investments in real estate. Occupancy and rental rates are depressed and will decline slightly more for another six months. Nevertheless, the pipeline is full with projects in planning, waiting for better profit prospects so financing can be obtained.
That said, investors who want to get in cheap on a rising market are now planning to build new space to be available for lease in 2011. The American Institute of Architects’ survey of designer activity shows that the decline in design work has ended, although no pickup has yet happened. Buildings being designed now are likely to start later this year and be ready for occupancy 10 to 18 months ahead when rental rates are higher and rising. But until late this year, most of the commercial starts will be renovation and buildings designed for special uses or to be owner occupied.
Heavy Construction Spending Remains Steady
Heavy construction spending increased nearly 10 percent from the weather-depressed February level, including a 1.1 percent rise in May. Some of this gain is a correction for a winter seasonal adjustment error, and some is due to the 3.5 percent rise in the price index for heavy construction materials over the same period. But a portion of the improvement is real. Credit this to stimulus funds for transportation facilities plus the return of private power construction to the late 2009 level. This consists both of pipelines for new energy supplies and alternative fuel electricity-generating projects. While highway spending with stimulus funds is ebbing, there has been recent pick-up in stimulus-financed transportation facility and water/sewer work.
Heavy construction spending is forecast to dip about 3 percent over the next year from the combination of worsening state and local government budget positions and the continued ebbing of the stimulus impact. Overall, heavy construction weathered the recession much better than the building markets. That it is still slipping after recovery has begun in the building markets has no implication for the longer term trend. Heavy construction is always late in the business cycle.
Residential Construction Spending Declined 0.4 percent in May
Single-family construction spending rose 0.8 percent in May, but this was more than offset by a large fall in multifamily construction spending and a small drop in residential remodeling. Expect the trends to reverse in the next few months. The end of the homebuyer tax credit will trim single-family homebuilding for several months. Already, there have been steep May declines in permits, starts and home-purchase mortgage applications. While the multifamily construction spending trend is still down into the fall, the large May drop was random and not a sustainable trend. Remodeling spending will drop a little in the next two quarters and then resume, expanding at a 7 to 8 percent annual pace next year when consumer confidence is higher and existing home sales have been rising for a year.
New home sales, and hence starts, still face serious headwinds. The recent rise in for-sale inventory and the drop in consumer confidence erase some of the earlier optimism about the residential market, which will have a troubled summer with some pullback from the spring spurt. Nevertheless, expect resumed growth in the fall, driven by more private jobs, higher personal income and an expected recovery in confidence. The 10-point drop in June consumer confidence was likely exaggerated by a seasonal adjustment problem, which will be reversed.
The improvement will vary substantially by region. Some housing markets still have very excessive inventories of both new and existing homes and have not yet experienced job gains in local industries. Many of these weak housing markets are in the Southwest and South Florida.
Lingering credit problems for both homebuyers and homebuilders continue to restrain the new home market. Tens of millions of households are now locked out of the mortgage market by job and income losses, underwater mortgage and foreclosures. Others are reluctant to purchase for fear prices will drop further. At the same time, some homebuilders are unable to get land and development loans to build inventory for an expected sales increase. For some builders, their lenders are financially stressed and trying to reduce real estate loans. For other builders, their own credit history or reduced equity is the problem.
That said, the housing market is still below the currently reduced potential, which is far short of the approximately 1.8 million new homes per year, the demographic equilibrium without any credit or income problems. There is room for housing starts to expand rapidly, as much as 2 percent per month through 2011 without reaching the currently reduced potential limit.
Construction Equipment Sales Now Improving
Construction equipment shipments from U.S. factories have expanded 36 percent over the eight months through April. Orders have risen even more and have outpaced shipments over the last three months. The market situation is returning to equilibrium, although equipment inventories remain above average even after being cut by one-third relative to sales. The recent sales gains have largely been to rapidly expanding export markets and to fuel the beginning of a fleet upgrade and expansion by equipment rental houses after three years of letting fleets deteriorate.
Both of these market drivers will be positive at least through next year. But there has so far been little if any rise in sales to contractors and others who operate the equipment themselves. This is still ahead in 2011-’12.
After the spring surge in equipment sales, no further gain is expected in the second half of the year. The midyear softening of GDP growth, pullback in home construction, implementation of austerity programs in Europe, deliberate dampening of Chinese economic growth via higher credit cost, and a new round of public spending cuts in the new fiscal year all contribute to the pause. Resumed growth at about an 8-10 percent annual pace is expected early in 2011.
The volume of site work remains very depressed. The square footage of new buildings peaked in the summer of 2005 and then plunged 75 percent by the first half of 2009. It has since recovered 30 percent, mostly for housing, with another 30 percent improvement expected by the end of 2011. Again, this will be mostly for housing. This will still leave new building square footage at near half of the 2005 peak level.
Regional Economic Growth Trends Reverse with Recovery
The recession was deepest in the industrial Midwest and the housing boom cities in the South and West. This pattern changed early in the recovery. The Midwest manufacturing centers are recovering quickly. Factory production has recently been expanding at a double-digit pace. Indiana and Michigan, the two most manufacturing-dominated states, are now the fastest growing states in the country. A few of the housing boom-bust cities are now recovering briskly, although the Rocky Mountain and Florida cities also hit with declines in their tourist industry are lagging far behind in economic recovery. But note that people came to Las Vegas, Orlando and Miami for sun and entertainment. This spending is extremely cyclical. Ahead, it will recover very quickly in a stronger economy.
New Englandis again the fastest growing region because of its mix of intellectual capital industries serving the world market and large health and education sectors being boosted by new federal funds. Economic growth resumed in the Rocky Mountain states only a few months ago. Economic growth here will trail the rest of the country into 2011. New York City survived the financial recession surprisingly well. Expect the construction recovery to be relatively quick here. Farm regions have relatively strong economies. Although farm income dipped in 2009, 2008 was a record high year. Energy states, such as Texas, Louisiana, West Virginia and Wyoming, weathered the early recession better than the rest of the country but stagnated in recent months and will recover relatively slow in pace with energy prices and consumption volume.
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