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Double Takes

Double Takes

Construction industry analysts hope for a gradual recovery at best while they brace for a second recession next year

Despite a few promising signs of recovery in the previous year, the general U.S. economy experienced a backslide in 2011. The gross domestic product (GDP) fell from 3% in 2010 to less than 2% throughout this year. Additional foreclosures and falling house prices continue to loom over the U.S. economic recovery. Furthermore, disruptions in the supply chain caused by the earthquake in Japan and higher energy prices, as well as the threat of a federal government shutdown and continuing concerns about the European debt crisis, all contributed to the slowdown this year. “We’re seeing a slimdown in this recovery,” said Beth Ann Bovino, deputy chief economist, Standard & Poor’s, speaking at the McGraw-Hill Construction Outlook 2012 Executive Conference in October. “I believe it is — and will remain for some time — at half speed. We’re in very subpar growth recovery.”

As a result, economists began warning of the risk of entering a double-dip recession. Estimates that the United States would re-enter a recession grew from less than 20% at the start of 2011 to about 40% in September. “Another dip into recession is possible if the financial markets lock up again or oil prices jump farther on Middle East turmoil,” said Bovino. “We’re one shock away from another recession.”

Accordingly, construction industry analysts are hedging their predictions for the coming year. In its “2012 Dodge Construction Outlook,” McGraw-Hill Construction, New York, has built a recession scenario into its forecast. According to the report, if the recession is avoided, the value of U.S. construction starts will experience a 4% drop in 2011 followed by a 0% increase in the next year (click here to see Table 1). “We’re just scraping along the bottom,” said Robert Murray, VP, economic affairs, for McGraw-Hill Construction, also speaking at his firm’s conference. “It will take a while for nonresidential construction to make gains — possibly in 2013, but probably not until 2014.”

Under the recession scenario, the value of U.S. construction starts will experience a 5% drop in 2011 and slump further by 7% in 2012. “There is still a downside risk,” continued Murray. “We’re dealing with this extended bottom.”

Minor Adjustments

Although most construction economists are expecting the U.S. economy will avoid another recession, their forecasts for 2011 reveal an industry continuing to flatline, or worse, lapsing into deficit, with only minor improvements expected for 2012. For example, Associated Builders and Contractors, Inc. (ABC), Arlington, Va., is expecting nonresidential construction spending to decline by 2.4% this year. “For the most part, 2011 has been disappointing,” said Anirban Basu, ABC chief economist in a press release accompanying the forecast. “However, recent economic news has been more positive, including data regarding the GDP, business investment, and exports. If the U.S. economy continues to progress, eventually this will translate into more vigorous recovery in the nation’s nonresidential construction sector.”

However, ABC is forecasting a slight growth of only 2.4% for 2012 (click here to see Table 2). “The pace of recovery in the nation’s nonresidential construction industry remains soft, and 2012 is positioned to be a year of slow gain,” said Basu. “The first half of 2012 may be particularly challenging — a reflection of the soft patch in economic activity experienced during much of the first half of 2011.”

In addition, ABC’s national Construction Backlog Indicator (CBI), which stood at 8.1 months for both the second and third quarters of 2011, is not expected to advance substantially and likely will remain in the vicinity of eight months of backlog for much of 2012 (click here to see Fig. 1). “Although the backlog is one month higher from the same time last year, a backlog of less than eight months is associated with construction spending declines, while a backlog exceeding eight months is statistically associated with future construction spending increases,” according to Basu. “[The recent] level of backlog is consistent with flat construction spending.”

In its forecast, presented at the 2011 Market Insights Webcast Series in October, Reed Construction Data, Norcross, Ga., predicted a 2.2% decline in total U.S. construction spending and a 4.5% drop in nonresidential construction spending for 2011 (click here to see Table 3). “Concern over the economic outlook is acting as a drag on nonresidential construction spending,” said Bernard Markstein, the firm’s chief economist.

Nonetheless, Markstein anticipates some improvement in U.S. construction spending for 2012. Reed Construction Data’s forecast includes a 4.8% increase in total construction spending and a 5.0% jump in nonresidential construction spending next year. Furthermore, for 2013, the firm is expecting a 7.2% increase in total construction, led by an 8.5% growth in nonresidential construction spending. “With the economic outlook improving somewhat, spending totals will hold their own in the fourth quarter of this year and strengthen throughout 2012 and 2013,” Markstein continued.

According to FMI Corp., Raleigh, N.C., its construction forecast for the remainder of 2011 calls for a 2% increase in overall U.S. construction put-in-place and a 6% rise in overall U.S. construction put-in-place for 2012 (click here to see Table 4). Total nonresidential buildings will account for a 2% drop in 2011 and only a 3% increase in 2012. “Our markets and industry remain challenged at present,” writes Hank M. Harris, president and CEO of FMI Corp. in the firm’s report, “U.S. Markets Construction Overview.” “While we believe recovery will be slow, we will recover.”

In its “Fall Forecast: 2011” report, Portland Cement Association (PCA), Skokie, Ill., is forecasting a 3.7% decline in the value of total construction put-in-place for 2011 and a mere 0.9% increase in the value of total construction put-in-place for 2012 (click here to see Table 5). The value of nonresidential buildings construction is expected to dive 9.4% in 2011 and come up a mere 3.2% in 2012. “While the consensus of economists believe that a double-dip recession is not likely, the risks remain high,” writes Ed Sullivan, chief economist for PCA, in the report. “It is important to recognize that even the meager growth that is being generated is partially supported by fiscal policy actions in the form of a payroll tax holiday and extended unemployment benefits. Both programs are set to expire at the end of the year. Lacking an extension of these programs suggests the potential of a growth slowdown from even today’s meager levels early next year.”

The PCA forecast is predicting the value of residential buildings construction to decline by only 0.1% in 2011 and to rise by 1.8% for 2012. However, by 2013, PCA is anticipating a jump of 17.3% and for 2014 an additional 33.4% rise. “The Great Recession was construction focused,” continues Sullivan. “Residential, nonresidential, and state discretionary construction levels collapsed. Despite economic growth, the residential sector, for example, will continue to be plagued by a large volume of foreclosures, tight lending standards, and weak new home prices. I don’t see a rebound in most of that market until 2014.”

All in the Multifamily

Construction activity is related to general economic growth and employment. According to Sullivan, construction’s recovery depends on job creation to reduce, and eventually eliminate, the adverse impacts of foreclosures, tight lending standards, and commercial occupancy and leasing rates as well as the severity of state fiscal conditions. “Job creation is key to generating household formation and favorable homebuyer affordability, lowering nonresidential vacancy rates, raising ROIs, and reducing state deficits,” he explains in his forecast report.

However, because the impediments to a construction recovery are so large, according to Sullivan, even if economic growth and job creation accelerate at a sustained rate, the benefits will not materialize quickly. “The reduction in our job creation outlook translates into a longer wait for a construction … recovery.”

In 2011, the nation’s unemployment rate hovered around 9.1% — with higher employment rates in areas most affected by the burst of the housing bubble (click here to see Map). Only 72,000 jobs were created on a monthly basis in the previous six months, compared to more than 200,000 jobs per month in the period from February to April. “We lost nine million jobs and only gained about two million,” said Bovino. “In a weak job market, there’s no need for offices, and if people aren’t spending, no malls or retail.”

Ironically, there still exists the hope that housing, which triggered the recession with its boom/bust cycles, will lead the charge to recovery, according to the FMI Corp. report. “Everyone is waiting on housing to lead the way out of the recession,” writes Phil Warner, research consultant. “After all, building new housing usually requires new streets, schools, shopping centers, and the entire supporting infrastructure.”

However, with the expiration of the homebuyer tax credits in 2010, tighter credit for housing developers, weak home prices, and an expected resurgence of foreclosures on the horizon for 2012, demand for single-family housing has remained weak. “Housing is at its most affordable levels right now, but potential buyers and banks are wary of foreclosures, and, like banks and business, they are trying to rebuild their savings wiped away in the markets,” writes Warner.

By some estimates, the number of homes vacant year-round has risen to 14.3 million, which is 11% of the total inventory of 131 million. The percentage of homes vacant year-round has averaged around 8% over the last three decades. Therefore, the current level of excess inventory stands at approximately four million homes. However, the “shadow inventory” — homes that are either currently in foreclosure, have mortgages in default but have not yet been foreclosed upon, or have been foreclosed by banks but not yet put on the market — puts a damper on new home construction. Estimates put the true level of excess inventory in the residential market at around 10 million homes.

New household formation due to population growth is traditionally a driver of demand for residential
construction. However, at just 11.8 million to 13.8 million new households to form between now and the end of the decade, household formation is not keeping pace. In fact, FMI Corp. reports 200 million fewer households than one would expect, given current population growth.

According to McGraw-Hill Construction, the value of single-family housing starts will decline by 5% in 2011 (click here to see Fig. 2). In addition, the number of single-family dwelling units under construction will have experienced a decline of 9% by the end of this year (click here to see Fig. 3).

Yet, a separate niche market will benefit from these conditions. “The move to rent when people aren’t able to or can’t afford to buy shows up in multifamily housing,” said Bovino.

PCA is forecasting a 44.7% hike in the value of multifamily construction put-in-place in 2011. This is especially striking in comparison with the 49.5% decrease the market experienced in 2010. The National Association of Home Builders (NAHB), Washington, D.C., is forecasting a 44% hike in multifamily housing starts in 2011 (click here to see Table 6).

“The bright spot this year and next is multifamily housing,” said Murray, whose firm is anticipating a 15% increase in dwelling units this year, followed by a 17% increase in dwelling units (click here to see Fig. 4). Comprised by both apartments and condominiums, multifamily housing has been advanced by a push for downtown redevelopment and by support from both empty-nest Baby Boomers and young adults. In addition, the market benefited from the American Recovery and Reinvestment Act of 2009, which allotted funds for housing projects.

Public and Private

In its 2012 economic forecast for the U.S. commercial and industrial construction industry, ABC is predicting gradual progress, driven by private construction, which will offset the ongoing declines in publicly financed construction (click here to see Table 7). “ABC anticipates ongoing improvement in the volume of privately financed construction as economic conditions gradually improve and lending institutions become more comfortable lending to deep-pocketed investors operating in stable contexts,” said Basu. “Much of the growth in recent years has emerged from publicly financed projects, including projects related to the U.S. stimulus package passed in February 2009. With the impact of stimulus-funded projects steadily declining, the U.S. nonresidential construction sector will become increasingly dependent on privately financed projects for growth.”

However, according to Basu, certain market segments are better poised for growth than others. Leading the way in recent months has been construction related to the nation’s power industry, which ABC projects to expand 11.4% during the course of 2011. “The driving force for the United States appears to be in energy, and the growth of this economic segment has been evident in a number of states, including Texas, Oklahoma, North Dakota, and Pennsylvania,” said Basu.

ABC is expecting power construction to continue to lead the way with a projected 9% increase in spending in 2012.In addition, health care may be another likely candidate for economic expansion. This is true for a number of reasons, including thawing credit markets, the nation’s demographics, and health care reform, which will continue to increase the number of Americans with insurance and therefore enhance utilization, according to Basu. Because of this, ABC projects health care construction spending to increase by 8% in 2012.

“In many communities across the nation, industrial contractors can be characterized as busy, or at least increasingly occupied, while commercial contractors generally have struggled with overcapacity in 2011,” said Basu. “However, following several years of decreased spending, ABC expects lodging and office construction to progress in 2012.

Unfortunately, the impact of tight state and local government budgets will continue in 2012, according to Basu. “A number of key categories closely linked to state and local government spending are expected to decrease in 2012, including educational spending, edging down 4%.” Overall, ABC is predicting public nonresidential construction spending will slip 2% in 2012.

For the most part, the stretch of ARRA stimulus funds reached only as far as 2010. As of now, 83% of the dollars have been spent, and 71% of the projects have been completed. Twenty-five states have spent 90% of their funds, 15 of which have spent more than 95% of their funds. Still, an estimated $5.8 billion will be spent in 2011, although that number is down 49% from the $11.4 billion spent in 2010. The remaining balance of ARRA funds — approximately $3.8 billion — will be released in 2012.

Yet, federal spending for government construction, especially infrastructure construction, is expected to decline. According to Sullivan, lack of assured federal funding will drag down the public sector until 2014.

The McGraw-Hill forecast concurs. “Public projects really got clobbered by waning of public stimulus funds,” said Murray. “Hard to see anything in the way of growth for 2012.”

According to FMI Corp., there is a sense that the United States is facing a long-term slowdown in public financing, whereas at the same time needs for public construction are on the rise. “The budget gap between available or planned funding for public construction projects is large and growing; however, the national political gap is even larger. That is the basis for ongoing unease and sets an unharmonious tone for business everywhere,” reads the “2012 U.S. Markets Overview.”

In addition, state and local construction spending has declined more than $25 billion in 2011. While some of this decline is due to decreased federal distributions to state programs, according to FMI Corp., reduced spending also ties to the way state budgets operate, how state and local construction is funded, and why a stable economy is needed to maintain a working balance between the public and private markets. “From where we stand now, with all ARRA funds expired and little to no discussion of short-term future federal support, state revenues and the public service programs are in considerable distress,” reads the report, which cites that in 2012, 42 states will be working to close $103 billion in budget gaps on top of those shortfalls experienced between 2009 through 2011. States are working on closing the gap using typical service cuts, new taxes, and reserve funds, all while trying to cause the least amount of damage to the economy as possible.

“The sharp falloff in state and local government spending leaves contractors scratching their heads and asking themselves where the public projects that have kept them afloat for the past three years have gone,” continues the report. “State and local owners are ultimately in a place where private investment must return in order for their situations to improve. Private-sector growth is the only sustainable way to increase revenues from tax collections and regrow programs to the levels maintained in 2007.”

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