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Residential construction put the brakes on 2007, forcing a 1.8-percent drop in total construction spending that was forecast to grow 5.2 percent. The decline in housing starts was twice as large as expected before the year began, caused by underestimated fraud in the residential mortgage market and underestimated share of homes bought with little or no downpayment and initially discounted mortgage rates.
This year, the two-year housing recession will end and begin to recover. Spending for both heavy and nonresidential building projects will increase more than 10 percent for the third consecutive year in 2008. The four-year acceleration of growth in public construction will begin to ebb, but private construction spending will resume growing after a steep two-year decline. All told, total construction spending should grow 7.1 percent this year.
Contractors and their suppliers will be operating in the second year of subpar economic growth in 2008, which means better pricing and availability for nonconstruction purchases such as office supplies. But supply conditions will tighten for specialized materials, labor and construction services during the third year of strong growth in nonresidential construction. Economic growth and especially the expansion of construction spending will accelerate over the course of 2008.
The brief spike in interest rates for mortgages and other construction loans last summer is now largely reversed. Although rates will not be a major constraint on construction activity, most financially marginal jumbo home and commercial mortgage applicants will not obtain loans. Much of this would have happened anyway as lendors increase scrutiny of income statements and balance sheets late in the building cycle, but they are still concerned about the quality of real estate assets: both the asset value if a sale is necessary and the borrowers' ability to repay the loan. Several brief episodes of credit-rate spikes and shortage of lendable funds are possible next year in the residential and commercial markets.
Short-term changes in financial markets do not impact public-construction spending. Public facility managers have their funding committed well before construction begins. Financial markets would affect public activity only if the problems spread to the broader economy. The Federal Reserve Board acted quick enough to prevent that last summer.
The key funding sources for public construction are all now stronger than average, but they will slip back to average over the next two years. State budget balances, including budget stabilization funds, were an above-average 8.2 percent of annual expenditures at the end of the fiscal year ending June 20, 2007. This was down from a very high 10.9 percent a year earlier. Slower growth in tax receipts and rising spending will cut the balance to an estimated 6.0 percent next June, which is about average. This is still high enough to support an above-average growth in state construction spending through 2008.
States are again underestimating tax receipts for the fiscal year ending in June. Initial spending plans incorporated only 1 percent real growth, after a 5.3-percent gain over the prior year. More spending, some for construction, will be added next spring when the revenue underestimate become apparent.
Similarly, key funding sources for institutional buildings are currently strong. Rapidly rising equity prices have boosted investment fund returns. In mid-October, the Dow Jones Industrial Average was 17 percent higher than a year earlier. Taxpayers are passing a larger share of bond issues in an economy with jobs and income still growing.
Hotels were the fastest-growing project type in 2007 with an estimated 61.6 percent increase in construction spending. Hotels will be the hottest project type again in 2008, although spending growth will fall to 21.8 percent. The value of new hotel starts rose 41 percent in the first eight months of 2007 compared to the same period in 2006, according to Reed Construction Data. One factor is the boost from the development of resort and casino hotels that are themselves destinations.
Construction spending for nursing home/assisted living facilities jumped 21 percent year-to-date through August. Expect a larger gain this year based on the 59-percent rise in the value of construction starts over the same period. Privatization and industry consolidation have opened up access to new sources of capital and set off a building boom.
Highway-construction spending increased only 6.2 percent in 2007 — about half of the gain in 2006 — and not enough to cover project cost increases. Credit the weak spending to Highway Trust Fund problems. High prices cut the volume of fuel sales and thus cut tax receipts. The forecast for 2008 assumes that Congress and many state legislatures will add to their highway funds with higher fuel taxes or general-fund tax receipts. But they will not do this fast enough to prevent more project delays and cancellations. Expect highway spending to increase 8.3 percent with most of the gain going to cover higher costs.
Regionally, heavy construction will expand rapidly in the West and the Northeast due to additional public funding. Growth in nonresidential building work will be weak in the Northeast, where project starts have already begun to slip lower. Precarious public finances in the industrial Great Lakes may force spending cuts. Large public budget reserves in the Northeastern, Plains and Southwestern states may permit supplemental spending appropriations.