The Sun Is Still Shining

Sept. 28, 2010

In the coming year, contractors can expect the overall construction volume in Iowa, Kansas, Western Missouri, and Nebraska to increase about 7 percent over 2007 levels.

While commercial building is expected to suffer a 14-percent loss in volume and sewer/water anticipates a 5-percent downturn, there are minor as well as significant gains in other sectors.

In the coming year, contractors can expect the overall construction volume in Iowa, Kansas, Western Missouri, and Nebraska to increase about 7 percent over 2007 levels.

While commercial building is expected to suffer a 14-percent loss in volume and sewer/water anticipates a 5-percent downturn, there are minor as well as significant gains in other sectors.

Transportation (other than highway) construction will probably remain at 2007 levels, miscellaneous civil work will see up to 17-percent gains. Total highway and heavy building will enjoy modest 3.4-percent growth.

There are several reasons why the forecast is not sunnier but most of them have to do with the economy.

The Economy Hits A Snag

The growth of U.S. economic output was surprisingly strong in the second and third quarters of 2007. This strong performance was registered in the face of a heavy drag from the downswing in housing production as well as substantial turbulence in credit markets associated with deepening problems in the subprime mortgage market. This comes from Kermit Baker, Ph.D., Hon., chief economist of the American Institute of Architects (AIA).

Then the economy slowed in the final quarter of 2007, and the chance of a recession moved up. The late-2007 downshift in economic growth reflects, to some degree, inevitable weakening of exports, business inventory investment and other components The housing downswing also continued to deepen in the fourth quarter of 2007 and we're now looking at a substantial slowdown in growth of consumer spending.

Despite the continued weakness in the Midwest residential sector, the numbers show there were solid gains in most nonresidential construction sectors in 2007 and 2008 is projected to see much slower gains, but gains nonetheless. Commercial construction is expected to improve, with institutional activity adding substantially to the growth in 2008.

Concerns For 2008

As noted above, the housing market continues to deteriorate and is not only slowing the economy directly but causing ripple effects. The National Association of Home Builders' (NAHB) survey of builders continue to document serious adverse impacts of tightening mortgage lending conditions on home sales and sales cancellations. These impacts definitely are showing up in the standard measures of new and existing homes sales.

This is not only slowing the economy directly, but rising concerns over falling home prices are already encouraging consumers to cut back on their spending in the future.

Also, there is growing concern that inflation may begin to accelerate in our economy. High oil prices continue to add pressure to inflation, and long-term interest rates have begun to trend up recently. Inflation in building commodity prices has been a major source of disruption to the construction industry in recent years, but fortunately fluctuations in commodity prices have begun to moderate recently.

Slower Commercial Growth In 2008

On the commercial side, most major sectors are projected to see losses or slower growth in 2008, while the institutional sectors will continue to experience moderate growth levels. Spending on the construction of office buildings climbed over 11 percent last year before inflation adjustments,sliding into the downward trend expected for 2008.

Retail construction activity has seen more modest gains recently. Spending may experience a small decline this year according to some forecast panelists. Retail construction is the sector most closely connected to residential activity, since stores generally are added shortly after housing subdivisions are completed. With housing expected to see another year of weak activity in 2008, retail construction activity is expected to moderate also. Some of the Midwest's major retailing chains, such as Wal-Mart, Home Depot and Kohl's, have recently scaled back on their expansion plans.

Hotel construction has been the strongest nonresidential construction sector recently, with spending activity projected to climb. However, once this current spate of projects is completed, activity is projected to level off, with little or no gains forecasted for 2008. Much of last year's surge was fueled by a round of casino construction, which is expected to slow in the near future. McGraw-Hill Construction reports data indicated that the national hotel occupancy rate climbed in 2007 and may have surpassed 60 percent. Unfortunately, occupancy rates are expected to ease off somewhat in 2008.

Stabilizing Institutional Miscellaneous civil (or institutional) construction sectors are projected to show less volatility in 2008 than commercial facilities. As reported above our four-state regional institutional construction spending is expected to increase significantly in 2008.

Even with rising long-term interest rates, the financial position of state and local governments is strong enough to support continued growth in educational construction. Also, according to McGraw-Hill Construction, the education market has benefited more than any other sector from the recent interest in sustainable "green" design. As a result, experts expect an increase in education construction in 2008.

Iowa, Nebraska and Kansas all have been chosen for energy production facilities. Biofuels plants and wind turbine manufacturers are moving into the Midwest and adding to the construction volume increase.

Health care is expected to see even stronger growth. With recent emphasis on increasing health care coverage, including several state mandates for universal or near-universal coverage, health care construction has become one of the fastest-growing institutional construction categories. Iowa is certainly reflecting this trend, with health systems announcing new facilities at a growing rate. Projections are for a strong increase in 2008 spending.

Fed Relief In 2008?

The Fed enacted quarter-point cuts in both the federal funds rate target and the discount rate at the conclusion of the Oct. 31 Federal Open Market Committee (FOMC) meeting. In late November, both Fed Chairman Ben Bernanke and Vice Chairman Donald Kohn delivered addresses that revealed increasing concern about downward pressures on economic growth, coming largely from the housing sector, as well as renewed turbulence in financial markets, coming largely from the subprime mortgage market.

Both Bernanke and Kohn referred to spillover effects from housing and mortgage markets to the broader economy.

It's now highly likely that the Fed will enact additional cuts in the federal funds and discount rates this year. NAHB's current forecast assumes quarter-point rate cuts at the Jan. 31 FOMC meeting. Deeper rate cuts after that are also possible if evidence shows the economy slipping toward recession.

Housing Recovery Will Begin In 2008

Home sales and production for 2008 as a whole most likely will turn out to be below the 2007 totals, but crucial turning points are likely to be registered during the year — assuming the Fed keeps us out of recession and mortgage markets function more normally.

NAHB's current forecast shows troughs for sales of both new and existing homes in the first quarter of 2008. In view of the inventory overhang, they don't expect housing starts to start upward until the third quarter of the year. Given normal lags, the housing production should begin to register positive growth by the first quarter of 2009.

That should send a strong signal to other sectors that might increase the modest 7-percent overall four-state regional growth.

Contractors in Iowa, Kansas, Western Missouri, and Nebraska will still have to deal with increased costs of construction materials and fuel this year. Labor costs and shortages will also complicate job bids. Equipment purchase prices will continue to rise in 2008 but increasing pressure from rental operations should bring some relief.

All in all, the sun is shining on most job sites, and if the pundits and experts are right, by year's end, the Midwest shouldn't need to fear the bite of winter.