Construction spending prospects are declining rapidly at the beginning of 2009 as the credit freeze recession spreads rapidly through most economies around the world. Job site activity, project starts and pre-start development planning will continue to decline well into 2009 but most markets will be improving from depressed levels by yearend. The heavy/engineering market will weather the recession best because of the source of its funding and some federally financed economic stimulus civil construction spending in the second half of the year.
The lastest (October) report on construction spending was a 1.2% month-to-month drop. The November jobs report assures another similar fall in construction spending in November. Housing construction continues to drop. Nonresidential building and heavy construction have both begun to decline in the last few months. Construction spending fell 11.6% in the last two and half years in current dollars with the inflation adjusted drop over 20%.
More significantly for the 2009 outlook, the project starts trend weakened sharply late in 2008 after trending down slowly for about a year. This was entirely due to a 30% plunge in nonresidential building starts in October from September while heavy project starts surged to a record high level. Starts fell 44% for private "for lease" projects — offices, retail, hotels and warehouse — that are the most sensitive to credit conditions and prospective spending in the economy.
The abrupt October decline in private commercial starts includes some projects put on hold until market prospects are clearer or financing arrangements can be reworked. Some of these projects will return in the coming months. However, the negative impact of the recession is delayed for project starts for public and institutional work. Starts in these sectors will gradually erode as tax collections and investment earnings continue to shrink. Already, some 2009 start projects have been delayed or cancelled.
These are the key assumptions in the Reed Construction Data outlook:
- The 2008–09 recession will be more severe than the recent mild recession in 2001 and the early 1990's but less severe than the deep recessions in the early 180-s and the mid-1970's.
- The recession will be front loaded — the panic from the surprise credit problems in September 2008 caused a larger than normal share of the inevitable spending cutback decisions to be made early. Q4 2008 GDP will drop as much as 4% with several smaller declines following.
- The 60% drop in energy prices is providing a huge boost to consumer income and the reduction of business operating costs and will prevent any further erosion in spending confidence
- Congress will enact another economic stimulus spending plan very quickly. The 2008 stimulus spending interrupted the recession in Q2 2008 with +2.8% GDP growth. The new plan will have a similar impact in mid-2009 and possibly may be enough to end the recession.
- The recovery from the recession will be unusually slow because credit costs will remain high for a recession period as lenders try to replace the capital lost to unpaid residential mortgages.
- The housing market will begin to recover before other sectors because it's recession began two years earlier than the rest of construction.
- The decline in the nonresidential building market is not due to overbuilding but to credit access and overall economic spending issues so there is some additional growth left in this building cycle beyond 2010.
The Gulf Coast was the only region whose economy was still expanding at the end of 2008, based on information through October. But falling energy prices and the resulting oil & gas field investment cuts will push Texas and Louisiana into recession early 2009.
|(Source: Federal Reserve Bank of Philadelphia)|
Each regions economic condition is set by the health of its key industries. The Great Lakes economy, dominated by motor vehicle and other manufacturing, has declined further relative to the rest of the country in the final months of 2008 and this will continue well into 2009. The expected emergency loan to the auto companies from the federal government replaces private credit no longer available but comes with spending cut mandates that will reduce industry labor costs in 2009 and further weaken the regions' economy.
Employment and income has weakened sharply in recent months in the Pacific Northwest (Idaho, Oregon and Washington) because of the heavy reliance on manufacturing, especially lumber, and electronics, two of the weakest industries in the US now. All three state governments have been forced to cut spending and increase taxes.
The New England and Mid Atlantic states had better than average economic performance through October because of their heavy reliance on financial and professional employers. This is now ending with the beginning of significant finance industry layoffs in October and business and professional services layoffs in November. These layoffs, unlike in manufacturing, are not typically recalled when business begins to improve so the Northeast economy will be a declining trend for at least three quarters. New York has the most risk because securities industries annual bonuses are the largest source of personal income in New York City.
The Pacific, Rocky Mountain and South Atlantic regions are all faring worse than the rest of the country at the beginning of 2009. Each region is suffering from manufacturing layoffs, declining tourism and leisure industry revenues, very depressed housing markets which is limiting spending in other construction sectors and probably a net outflow of illegal immigrants which reduces the need for additional building space and facility capacity.
|Energy & Metal||Price change % Oct '07 to Oct '08|
|Asphalt (at refinery)||89%|
|Const. Machinery Rental||-1%|
|Materials Indexes Total|
Extremely volatile materials prices were a nightmare for cost estimators in 2008 but appear certain to be less volatile in 2009. Cost trends began the year on track with the 4.5% annual cost increases in the previous two years then jumped at a 20% annual pace from February to July before declining sharply at the end of the year. The latest data (October) show construction materials cost 10% above a year ago. Materials inflation is expected to decline to about 4% in 2009.
These exaggerated price changes followed changes in the world demand for energy, metals and other commodities. Record high world economic growth ended abruptly late in the summer when the depreciation and/or freezing of lenders' capital forced then to trim loans, ending a four year boom in investment.
With world economic growth slowing from 5% early in 2008 to 2–3% in 2009, the prices of US construction materials based on commodities prices in world markets will decline into the first quarter of 2009. Spring 2009 prices are expected to be similar to spring 2008 prices.
The serious domestic recession in the US will trim inflation for construction materials prices in US domestic markets. This means slim or no price increases through the spring while construction activity continues of decline. Moderately rising prices will return by the end of 2009 when construction activity, while still depressed, is again rising. There will be a risk of spot shortages and price spikes late in 2009 and early in 2010 until suppliers adjust to newly expanding demand. Brief shortages and price spikes at his stage of the building cycle have occurred before for lumber, plywood, OSB, gypsum products and structural steel.
Asphalt pricing is a unique situation. Refineries have been converted to produce more gasoline and other light products and less asphalt from each barrel of oil. Asphalt supplies will remain constrained and prices elevated.
|Spending in Oct 2008 sea. adj. ann. rate||Percent Change From Oct 2007||2007 Total Spending||2007||2008||2009|
|Water & Sewer||44,053||10.6||38,743||1.6||8.9||3.2|
|Conservation & Development||5,180||-9.7||5,219||2.3||-0.2||3.7|
Civil construction is less of a boom/bust market than other construction sectors and will weather this recession better as it has previous recessions. Job site activity is not as scalable as it is for building contractors, especially residential contractors, because of the tediously long approval and financing process for civil projects and the supply constraints on the specialized labor, design, equipment and materials resources need for civil work.
Residential construction expanded more than 50% in 2003–05 early in the building cycle. Nonresidential building construction expanded nearly 50% in 2006–08 late in the building cycle. But civil construction expanded about 50% over the last six years, including substantially higher project cost inflation. Unlike building contractors, civil contractors are not competing with a surplus of unused facility capacity.
The credit freeze is not as immediate constraint for civil contractors because their projects rely much less than building contractors on rolling over short term financing from the credit market. Typically, long term funding is in place before the project begins. Nonetheless the credit freeze is already causing the delay and postponement of projects scheduled for a 2009 start. Highway Trust Fund balances are falling with reduced fuel purchases and funding from general fund appropriations and bond issues will be reduced in many states. Some state DOT's no longer have their share of matching funds.
As a result, new project starts in 2009 will drop substantially, especially early in the year, but job site construction spending will be much less impacted because of the long duration of projects already underway.
Surging growth in power construction is projected to end in 2009 but the 75% rise in power construction in the last three years will be largely maintained. The recession is sharply reducing the strain on both electricity generating and natural gas production capacity. Population growth has slowed abruptly in the southwest which accounted for a substantial share of the planned new generating capacity. Also reduced access to credit and elevated credit costs contribute to ending the construction boom. Improving the electricity distribution grid remains a major market driver although the prospect of public funding for this is now dimmer. Alternative fuel for electricity generation remains a long term market driver but will contribute very little to power construction contracts in 2009 unless Congress provides the funding.
The nominal value of highway construction will continue to expand but the inflation adjusted activity will continue to shrink modestly. The forecast assumes that economic stimulus funds that Congress is now considering will be modest, late in 2009 and largely offset by the usual funding delays that accompany the renewal of the six-year federal highway funding program. Congress could be more generous. The huge costs of the financial crisis and the last election have gone a long way to remove fiscal constraints on federal spending. It may no longer be necessary to identify where the funding is coming from to obtain an appropriation. Note that the monthly federal deficit approached $200 billion in November with little public outrage. In this situation Congress may find a few tens of billions more for highway work.
Water and sewer spending tracks site development which will be at the bottom for this building cycle in 2009. Communications construction spending is now dominated by cell phone and interne networks. These markets are maturing and now growing less rapidly. Financing constraints will slow the deployment of new features that require new and reworked towers. The lingering impact of high fuel costs and now sharply reduced travel and freight in the recession has cut both the need for new transportation terminals and the ability to fund them.
The nonresidential building boom is over. It began in spring 2004 and lasted through spring 2008, measured by job site construction spending. The 2004–08 boom was short compared to the six and half year building boom in 1994–00. The latest boom was not ended by overbuilding but by economy wide credit problems and the resulting recession. Hence the downside of the building cycle is likely to be relatively short compared to the three and half year real estate bust period earlier in this decade.
Private commercial construction got the quickest and hardest hit from the credit freeze. The value of starts in October 2008 plunged 44% from September 2008 for the sum of hotel, office, retail and warehouse. Projects ready to start were held up to redo financing and/or wait for a clearer view of the scale of the recession. A large share of the October drop was recovered in November. This suggests that the abruptness of lost financing arrangements — rather than lower space demand — was very significant in October. These projects, unlike public and institutional projects, depend considerably on rolling over short term loans in the credit market for financing.
Access to credit has improved by the beginning of 2009 so the projected further decline in nonresidential construction is primarily due to weaker space demand. Public and institutional construction did not entirely escape a direct hit from the credit freeze. But instead of stopping project about to start or already underway, the impact was the postponement and cancellation of scheduled 2009 starts. There was no downturn in starts at the end of 2008.
|Spending in Oct 2008 sea. adj. ann. rate||Percent Change From Oct 2007||Tota 2007 Spending||2007||2008||2009|
|Amusement & Recreation||23,819||6.1||21,610||13.8||7.4||-4.5|
Commercial (retail) construction spending dropped 11% in the twelve months ending in October 2008. The decline began when consumer spending slowed sharply early in 2008 under pressure from soaring energy prices. Inflation adjusted consumer spending recorded an unusual decline in the final quarter of 2008 which will keep construction activity shrinking well into 2009. Note that most of the reported fall in consumer spending is due to falling prices for energy and other goods and still weakening auto sales. The volume decline at other retailers was minimal.
Real estate investors now see retail as the least attractive commercial market. In the past year the retail vacancy rate has risen from 10% to 15% and rental rates have dropped about 4%. The vacancy rate will rise several more percentage points by the end of summer and rental raters will keep slipping at the same pace into 2010.
Office construction spending was 10% higher at the end of 2008 than at the end of 2007 but will slip slightly through early 2010. The small decline in nominal job site construction spending includes a 10% plus fall in the square footage of office project starts by the middle of 2009. Substantial layoffs are underway in office based industries. The finance and professional and business services industries cut 410,000 jobs from July to November with larger cuts expected early in 2009.
In the past year the office vacancy rate rose from 15% to 17% and office rental rates fell marginally after a five year rise.
Education construction spending, adjusted for rising project costs, stopped growing in the middle of 2008 and will slip marginally for two years. Expansion will resume in spring 2010. Education escaped a direct hit from the credit freeze because rolling over short term loans is not a significant part of education project funding. The recession has a delayed impact on education construction because project managers don not have to consider the availability of paying tenants in their build/no build decisions.
Spending on private school projects will slow and recover first because investment earnings and tuition income react more quickly to changing economic conditions than do property tax receipts.
Healthcare construction spending has been steady in nominal dollars but declining in inflation adjusted dollars for more a year although the nursing home sector has been expanding. This weakness was partly due to shortages of skilled tradesmen, specialized designers and contractors comfortable with these complex projects. The worldwide cutback in facility construction has lifted this constraint. Nonetheless, credit access delays and higher borrowing cost are expected to cause a brief drop in healthcare construction activity early in 2009. Overall, healthcare construction will fare relatively well during the recession because its largest source of income, patient charges, will continue to expand.
Manufacturing construction spending tripled in the last four years but will decline for at least two years at a double-digit pace, measured after adjusting for changing project costs. The recent boom was largely for process improvements in the metalworking, oil and petrochemicals industries and for commodity processing. The recession ends the need for these investments for several years.