Waiting Game

Waiting Game

Commercial mortgage foreclosures and federal funding measures shape predictions for the 2010 economic construction climate

Despite recent signs of recovery for the nation's general economy, industry analysis points to trailing construction markets as a sign construction's troubles are far from over. For 2009, many construction economists are expecting steep declines in the value of new construction starts for the third year in a row, followed by only modest gains in 2010 (click here to see Table 1) “While the nation continues to suffer through a recession, the construction industry is experiencing a depression,” says Stephen Sandherr, CEO of the Associated General Contractors (AGC), Arlington, Va., who is predicting investments in construction for 2009 to fall by as much as $193 billion from last year, equaling an 18% decline.

In a dramatic reversal, non-residential construction, including institutional, commercial, and manufacturing, has weakened considerably over the last two years, replacing housing as the primary drag on the industry. This summer, the Federal Deposit Insurance Corp. (FDIC), based in Kansas City, Mo., reported one-sixth of all construction loans were in default, with a total of $291 billion in outstanding construction loans at the end of June. This has prompted many economists to warn of a potential second wave of recession.

Reversal of fortune

In its 2010 construction put-in-place forecast, FMI Corp. is forecasting the largest drops in 2010 to come from manufacturing (-35%) and lodging (-35%), followed by commercial (-29%) and office (-25%), for a total 16% decrease in total non-residential buildings when added to the other vertical markets. In comparison, the Raleigh, N.C.-based construction analysis firm is expecting a 5% increase in single-family housing and only a 1% decrease in multifamily housing (click here to see Table 2).

In its forecast for non-residential markets, Washington, D.C.-based Associated Builders and Contractors (ABC), is predicting double-digit declines in four of the seven categories it tracks, with the largest declines in manufacturing (-18.9%), commercial (-13.4%), lodging (-13%), and office construction (-11.6%) (click here to see Table 3) “While the industry battled the effects of the recession in 2009, expect 2010 to be a transitional but sluggish year on the road to recovery,” says Anirban Basu, chief economist for ABC. “Commercial, lodging, and office construction spending will be off significantly next year as office vacancy rates continue to rise and hotel occupancy rates continue to fall. Construction related to manufacturing will decelerate sharply. Previous years have represented a period of brisk retooling activity, and it is unlikely that this pace of investment can be sustained.”

McGraw-Hill Construction, New York, is expecting the value of commercial construction starts to fall 43% in 2009 (a 54% drop in square footage terms), with losses stemming largely from the third quarter (click here to see Fig. 1) “The market really got clobbered this year,” says Robert Murray, VP of economic affairs, McGraw-Hill Construction. “This is the lowest it has been in the past 50 years.”

Whereas the single-family housing sector at the beginning of its meltdown was overbuilt, the slowdown in the commercial market is related to layoffs in the financial and communications industries. The higher building vacancy rates and declining rents have rendered new office construction unnecessary and curtailed investment in additional commercial space.

Surprisingly, a bright spot for 2010 is single-family housing, which, assisted by the $8,000 tax credit for first-time homebuyers — now extended into 2010 and expanded to cover existing homeowners ($6,500 tax credit) by Congress — is expected to overcome a 36.9% decrease in 2009 and spike 24% in 2010, followed by a 27% jump in 2011, according to Reed Construction Data, Norcross, Ga. (click here to see Fig. 2). However, this is not cause for celebration just yet. “This will move it from the ‘worst you've seen’ to just ‘miserable,’” says Jim Haughey, chief economist for Reed Construction Data. “Growth is going to be predominantly in the parts of the country that did not suffer as much in the last housing recession. Still, the surplus of homes for sale and declining population indicate some markets are going to be delayed in recovery.”

Similarly, McGraw-Hill Construction is anticipating a 30% jump in single-family housing starts in 2010 (click here to see Fig. 3). “We're looking at a level of activity that brings it back to 2008 — not 2005,” Murray says. “But there is slow improvement taking place.”

However, McGraw-Hill's prediction for multifamily housing isn't as optimistic. “This is an example of a market that is still in retrenchment,” Murray continues. “It's in the midst of a correction.”

The firm is expecting the value of construction starts for the multifamily market to decrease 54% in 2009 (a total of 140,000 units), only picking up by 14% in 2010 (160,000 units).

Reed Construction Data is predicting other top areas of growth will come from markets in which projects had been planned before the recession (Table 4), such as amusement and recreation, which is dominated by stadiums, arenas, theaters, bowling alleys, and private commercial recreation areas. “These were planned during better times in the economy,” Haughey says. “Some have been put on hold, but some are coming back.”

Military base closings and rearrangements also fall into this category. “These will be done with money that was made available several years ago in better economic times,” Haughey continues.

Reed Construction Data is also predicting a strong comeback for the retail market by 2011. “Retail is overbuilt, but the first to fall is the first to recover,” says Haughey.

In 2009, the market will experience a 29% decrease, but will be followed by a modest 5% drop in 2010. In 2011, it is expected to increase by 15% (click here to see Table 5)

Finally, the climate for public works projects, with funding provided by the American Recovery and Reinvestment Act of 2009 (ARRA), looks favorable, despite severe budget shortfalls in many states and localities. “Public buildings — particularly courthouses and federal facilities in need of modernization — will receive a sizable increase next year due to stimulus funds reaching the market,” Basu says. “These segments are positioned to be among the big winners in 2010. On the other hand, segments that are less closely aligned with federal spending are generally poised for another rough year in 2010.”

McGraw-Hill Construction is predicting public works to remain steady in 2009, followed by a 14% increase in 2010. This jump is led by transportation, which the firm claims will be among the few markets that will grow in 2010. The forecast is estimating spending for transportation could reach $64.7 billion, a 13% increase from 2009. In addition, McGraw-Hill Construction is forecasting an 8% increase in highways and bridges for 2009, along with an additional 13% spike for 2010. “The expectation is that with money for highways and public transport setting the stage, this will be one of the positives in 2010,” Murray says.

Public policy

Passed in February, ARRA awarded almost $130 billion of its $787 billion budget to construction spending for 2009 to 2011. Of the money allotted to construction spending, $49.3 billion went to transportation, with around $27 billion for “shovel-ready” highway projects. In March, states were given until June 29 to obligate 50% of the funding, with the remaining money to be committed one year after receiving it. “Essentially, there was a lot of pressure to get it out fast.” Murray says. “‘Use it or lose it’ is the provision in the stimulus bill.”

To date, states have obligated $18 billion of the ARRA highway aid, according to the General Accounting Office, with every state meeting the 120-day deadline. In the absence of an official extension of highway and transportation funding through the Safe Accountable Flexible Efficient Transportation Equity Act-A Legacy for Users (SAFETEA-LU), which lapsed on September 30 and is only authorized through December 18 under a stopgap measure, states' motivation to receive federal funding is strong. Despite the federal stimulus funding, more than three-quarters of the 527 firms responding to a survey conducted by the Washington, D.C.-based Transportation Construction Coalition (TCC), anticipate either a “slight” (46%) or “severe” (32%) decline next year in the state markets in which they work.

For the current fiscal year, states filled 30% to 40% of budget gaps with federal stimulus funding. Without additional federal funding, state budget cuts will decrease the growth in U.S. domestic product by almost an entire percentage point, according to the Center on Budget and Policy Priorities, causing the loss of 900,000 jobs in fiscal 2011, which begins on July 1, 2010 for most states. Left on their own, states will be challenged with a combined deficit of $142 billion for fiscal year 2011.

A recent report from the Pew Research Center, the Washington, D.C.-based nonpartisan “fact tank,” reveals seven states — Illinois, Michigan, Wisconsin, California, Oregon, Nevada, and Arizona — are in “fiscal peril” due to widespread foreclosures, high levels of unemployment, and poor financial management. Florida, New Jersey, and Rhode Island are also in bad financial shape.

Twenty states already have cut K-12 education construction spending, and six are proposing cuts. Furthermore, 28 states have cut spending for public college and university spending, according to the Center on Budget and Policy Priorities. Fifteen states cut long-term capital plans in 2009, and another 19 are expecting cuts in 2010, according to the American Road & Transportation Builders Association (ARTBA), Washington, D.C. Only Iowa and North Dakota (both with stable housing markets) have reported emerging from recession (Smallest States Fare Best in Recession).

Other beneficiaries of ARRA funding include environment ($20.6 billion for water and wastewater and environmental cleanup), energy ($30.6 billion for smart grid and renewable energy), federal buildings ($12 billion for renovation and construction and energy-efficiency upgrades), and public housing ($7.3 billion for capital fund, redevelopment of abandoned, foreclosed properties, and community development). “Public buildings are the most direct beneficiary of the stimulus act,” Murray explains.

Under this legislation, public construction increased 5% for the first seven months of 2009, compared to the first seven months in 2008, according to the U.S. Department of Commerce construction put-in-place data. The organization's preliminary estimates for 2009 include three double-digit increases in the public sector: 20% for public safety, 19% for institutional office buildings, and 17% for health care. By August, the General Services Administration (GSA) had awarded $1.1 billion in contracts for projects in 120 buildings. An additional $1 billion is expected to be awarded by the end of the year.

However, without the same quick turnaround mandates as required for highway and transportation, these projects are not expected to hit construction start stage until next year. “These awards are really more of a 2010 event,” says Murray, offering the $1.3 billion awarded to the Veterans Administration for hospital upgrades, which will help offset what would otherwise be another decline in health care in 2010, as an example.

“There will be a decline in public buildings built by taxes,” Haughey says. “But much of the health care and higher education construction are paid for by user fees and tuitions, which is not so for fire stations, new parks, etc.”

Reed Construction Data is forecasting a 2% increase in health care for 2010 and a 1% decrease in education that same year. Health care is also under pressure to limit costs by the proposed Congressional reform. “Institutional construction, including hospital construction, will be soft due to depleted state and local budgets and significant pressure to contain health-care costs,” Basu says. “However, state governments will continue to receive substantial support from the federal government over the next year, which will help stabilize capital budgets.”

Temporary fix

Unfortunately, the effect of ARRA funding in the long-term and its ability to jumpstart economic recovery is in question. “It is impossible to overstate just how difficult current conditions are or how dire the outlook for next year is,” says Ken Simonson, chief economist for AGC. “One-time investments in transportation infrastructure like the stimulus help, but there is simply no substitute for having a long-term investment strategy in our roads, bridges, and transit systems.”

ABC agrees. “Once federal support ebbs, institutional construction may weaken further in years to come,” Basu says.

Also in question is ARRA's ability to preserve and create jobs, one of the act's primary goals. A recent report reveals ARRA has preserved or created 640,329 jobs so far, including more than 80,000 in construction, with $160 billion in funds and tax breaks made available through September 30. An additional $179 billion in ARRA funding isn't accounted for in the report, which, according to the White House, could increase the total number of jobs to more than one million, including 133,000 in construction.

Although stimulus funds will continue supporting transportation projects next year, the TCC reveals 44% of contractors expect to lay off additional permanent employees due to overall economic conditions. Furthermore, almost 70% of transportation contractors responding to its survey reported receiving stimulus-funded contracts work so far this year, but 63% also indicated they had to lay off permanent employees during 2009 due to adverse business conditions. “Contractors in many states still do not see sustainable, state-funded market growth on the horizon until the overall economy rebounds significantly,” says Alison Black, VP for policy and chief economist for ARTBA.

In fact, more than one million construction industry jobs have been lost during the past year, according to the Bureau of Labor Statistics (BLS), reaching 17.1% in September — double the national employment rate. “The industry's general downturn has been neatly reflected in employment totals,” says Basu, whose firm says that during a recent 12-month period, non-residential building construction employment was down 13.3%, and heavy and civil engineering construction was down 12.6%. In addition, ABC is predicting non-residential construction employment to be down in the mid to high single digits on a year-over-year percentage change basis for 2010 (click here to see Table 6)

Sidebar: Smallest States Fare Best in Recession

Those who bubbled highest burst loudest, according to David Wyss, chief economist for Standard & Poor's, New York. Whereas the states in the Sunbelt and the Rustbelt — California, Nevada, Arizona, Florida, and Michigan — are experiencing the highest rates of foreclosures and price corrections, smaller states, such as Wyoming and the Dakotas, have the strongest regional economies — and their construction markets have held up the best.

However, a recent report from Reed Construction Data, Norcross, Ga., reveals 20 states must lead the overall recovery for the industry. These key states account for more than 75% of the U.S. construction market and include those that have survived the recession, such as Texas, Maryland, and Virginia, as well as others that are experiencing fiscal crisis, such as Nevada, Arizona, Michigan, Florida, and California.

Of the 20 states, the ones most likely to lead the recovery are Virginia and Maryland, spurred by federal construction projects and federal government hiring, which drives private construction. California and Washington may also take charge, despite fiscal disasters that have put a halt to public spending. Their private economies are still relatively strong.

(click here to see Figure)

Sidebar: Little Green Houses

The National Association of Home Builders (NAHB), Washington, D.C., is predicting a 36% uptick in single-family housing starts in 2010, followed by a 48% increase in 2011. However, consumer preferences have changed due to the downturn. “People are making very different housing decisions,” says Kermit Baker, chief economist for The American Institute of Architects (AIA), New York. “Homes at the lower end of the market are doing better than custom and luxury homes, second homes, and condos.”

Baker reports that second and vacation home sales have decreased by 70%, whereas first-time and move-up homes have experienced slighter decreases (13% and 35%, respectively). In addition, the AIA Home Design Trends survey reveals that homes are getting smaller — and are likely to stay that way. Energy efficiency and accessibility also remain priorities in home design. In 2009, 50% of respondents to the survey indicated that homes are decreasing in size — only 4% reported homes increasing in size. “Evidence of interest in small homes has been more pronounced,” Baker says. “Building size decreases with concerns of affordability, but this shift won't change even with recovery.”

In addition, for the last two years the survey has revealed increased activity by firms for open space layout, in-home accessibility, informal space, and single-floor design. “These give more options using smaller space,” Baker explains.

Improvements requested by clients include low-maintenance landscaping, outdoor living space, and exterior security/lighting. Furthermore, alternative insulation or extra insulation and a first-floor master bedroom for accessibility are increasing in demand. “It's less focused on investment and more focused on meeting the needs of the occupants, particularly aging occupants,” Baker says.

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