Construction Recession Ends This Year

Jim Haughey | January 18, 2011

Construction spending for both heavy/engineering and residential projects dropped less than 2 percent in 2010, but spending for nonresidential building projects plunged nearly 23 percent to push total 2010 construction spending down 10 percent. The fourth consecutive annual decline brought the level of total construction spending to 30 percent below the pre-recession peak. Construction spending will turn and rise from the end of 2010 through 2011 and for several years beyond. The construction recovery comes an unusually long 18 months after recovery began in the overall economy and will be relatively slow.

Total U.S. construction spending will increase 5.1 percent in 2011. The gain from the end of 2010 to the end of 2011 will be 10 percent. The biggest annual gain in 2011 will be 10 percent for new residential construction, far above the 2- to 3-percent gains in all other construction sectors.

The delayed and slow construction recovery is due both to the subpar economic recovery as well as to unique restraints in the construction market. The key restraints are the collapse of the highway and housing finance systems with no replacement in sight for either, a large surplus of residential space, and the weakened financial condition of developers and homebuyers.

Contractors and their suppliers will begin 2011 in a recession cost environment. Labor is abundant with annual wage gains still in the range of 1.0 percent or less.

Credit rates are extremely low, but cautious loan-approval standards exclude a relatively large share of loan applicants from the capital market. Costs are steady to slightly down for construction materials priced in the U.S. market, such as lumber and concrete, but erratically rising at a 5 percent or more annual pace for materials priced in international markets, such as metals, plastics and energy. Contractor margins will still be below the bottom of the usual range in order to obtain work. New projects will still draw far more than the usual number of bids.

The economic environment for contractors will improve in 2011. But it will continue to worsen early in the year for many types of public work and in the most depressed markets along the southern border and in the Rocky Mountain States. Some improvement will be clearly noticeable by next summer with improvement accelerating late next year. Credit rates will be rising but will still be low by mid-year. The improved environment will firm materials pricing first before some contractors are able to raise bid prices. By the end of 2011, the materials price inflation trend will be back in the 5- to 6-percent annual increase range due to relatively stronger economic growth in the rest of the world as well as the 10 percent pickup in U.S. construction spending over the previous 12 months.

U.S. GDP growth will move from the 2-percent pace during most of 2010 to a 2.5- to 3-percent pace in 2011. This is unusually slow at the midpoint of an economic recovery, when 4 percent or more is typical. Subpar economic growth has a magnified impact on all capital goods industries, including construction. Economic growth will be restrained by the lingering credit problems that began late in 2008 and investor and consumer uncertainty after the massive changes in operating rules made in Washington in the past two years. Note that the details of many of the changes are not yet known. The results of the November election may revise or rescind some of the changes. Uncertainty always means caution and delayed spending. Beyond 2011, GDP growth will be again above 3.0 percent, permitting a quickening of the construction recovery.

Heavy construction spending, as usually happens, slowed but did not decline while the overall economy was in recession. Then the drop in heavy construction activity early in the recovery period was unusually slim because of the massive amount of federal pump-priming spending in the stimulus plan and a variety of smaller initiatives, such as Build America Bonds. Nominal-dollar heavy-construction spending is currently about the same as two years ago. Only a 5- to 6-percent gain in nominal dollar spending is expected in the next two years, but rising project costs will account for much of this gain. The price of stimulus funding in 2009-10 is no growth in 2011-12 when federal emergency funding ebbs.

Three heavy sectors will see modest spending gains in 2011, while the remaining three will see no change or small declines. The strongest sectors will be water and sewer (+7.8 percent), highways and bridges (+6.7 percent), and communications (+3.7 percent). The water and sewer gain is due to delayed stimulus funding and the residential market improvement. The highway gain is due to bringing private funds into the market. The weak sectors will be power (-2.8 percent), conservation (-1.9 percent) and transportation facilities (+0.2 percent). Power always declines at this stage of the business cycle.

Housing starts will rise 24 percent in 2011, but only  to about half of the underlying demographic demand trend. Nonetheless, this will generate the usual associated site and utility work as the development of new residential communities resumes, especially in the South and West. Note that new homes will be up to 10 percent smaller and on smaller lots than in pre-recession developments.

Construction spending for nonresidential buildings will increase 3 percent in 2011 and 10 percent from the end of 2010 to the end of 2011. The gain will jump to well over 10 percent in 2012. For developer-financed projects, the turnaround will be dramatic. Spending will rise 2 percent in 2011 after two years of 30-percent declines.

This market will be expanding at a 15-percent annual pace by the end of 2011. The steep decline in project starts has already ended. Architects are already reporting rising design activity. Spending for institutional buildings will rise 4.2 percent in 2011, mostly for nonprofit and private projects; spending on public buildings will not improve and may slip slightly under pressure from ebbing stimulus funds and cuts in state and local budgets after rainy day funds have been depleted. State taxes began rising in spring 2010 but remain 15 percent below the pre-recession level.

In spite of sluggish construction activity, domestic manufacturers of construction equipment have increased their sales nearly 60 percent in the past year. The added sales have been to rebuild rental fleets and supply the relatively strong manufacturing, utility, farming, mining and export markets. Production is still short of capacity, so equipment prices are up only 1.1 percent. Ahead, the added demand for equipment use on job sites will modestly boost both equipment prices and rental rates by mid-2011.

Jim Haughey, chief economist at Reed Construction Data, has been preparing construction market forecasts for more than 20 years.