Closer look: Turning the corner

Experts at Outlook 2010 say economy is on the mend, but recovery will be slow, difficult

The fat lady hasn’t sung quite yet.

The recession that gripped the nation since December 2007 is beginning to end, but we are not out of the woods, said the economists at the Outlook 2010 Executive Conference, Oct. 15-16, Washington, D.C.

“There was a pervasive sense of gloom before spring,” said Robert Murray, vice president, economic affairs, McGraw Hill Construction, New York. “There’s a ray of optimism since spring. Things are beginning to change. ‘The recession has reached an end’ is the sense; it came to an end at the end of summer, in September.”

“This was the worst recession since the 1930s,” said David Wyss, chief economist, Standard & Poor's, New York. “[However,] there are clear signs that bad things have stopped happening. Housing is stabilizing. Consumers are starting to spend some money. And the rest of the world’s turning around.”

The construction industry had a particularly tough year in 2009, Murray said. The value of new construction starts is estimated at $419 billion, a 25 percent decline that follows shortfalls of 13 percent in 2008 and 7 percent in 2007. The earlier retrenchment was led by single-family housing, but in 2009, multifamily housing and commercial buildings showed substantial weakness. Even typically stronger segments, such as educational buildings and health care facilities, lost considerable momentum in 2009.

For 2010, the sum of the various sectors produces an 11 percent gain, to $466.2 billion, for the value of new construction starts, according to the Construction Outlook 2010 report from McGraw Hill Construction. This follows the 25 percent plunge in 2009, as well as the declines for total construction in 2007 and 2008 that brought the 2009 volume down 39 percent from the most recent current dollar peak at mid-decade. Like the recovery in the early 1990s, single-family housing is providing an upward push, but there’s a greater contribution from the public works sector.

Adjusting the construction start series for inflation provides a dramatic depiction of how severe the decline for total construction has been during the second half of this decade.

Housing

The housing market was at the center of the recession, Wyss said. “The housing market was grossly over-valued. We built too many houses. Housing prices were up 75 percent in the U.S. between 1997 and 2005,” he said.

Kermit Baker, chief economist, American Institute of Architects, Washington, D.C., pointed out how important housing is to the economy. “Normally, it contributes to 5 percent of economic growth. In other times, such as this, it goes up to 20 percent. Housing recovery has to be for real for the economy to recover,” he said. “We’ve seen home building decline by about 75 percent since 2006, the most serious recession since WWII. Housing prices have fallen over 30 percent since 2006. There will be further decline in some key markets in the months ahead.” Housing demand has fallen faster than housing supply, he said. Currently, 1.5 million homes are vacant or foresold. More than 20 percent of homes sold up to the second quarter of 2009 were foresold, he said, and almost 30 percent were sold at a loss to the homeowner.

All housing sectors are still weak, but homes at the lower end are doing better than second homes, condos and luxury homes, Baker said. “The custom home market continues to deteriorate this year; townhomes are still weak; the vacation home market will further decline this year.”

There will be strong household growth in the coming decade: 15 million, Baker said. “Almost three-quarters will be minority households. Household growth this decade has been dominated by baby-boomers, empty-nesters and pre-retirees. In the coming decade, two-thirds of the projected 15 million will come from the over-65 age range. In remodeling, there will be growth in retrofits to accommodate this aging generation.”

Remodeling fared better in this recession, but it started spiraling in 2008, dragged down by the weak economy and home building downturn, Baker said. At its peak in 2007, $300 billion nationally was spent on remodeling, much of it in high-end homes. With shrinking home equity and weak cost recovery for home improvement projects, owners are hesitant to undertake large-scale home improvement projects. Lenders are still reporting tight credit practices for home equity lines. “There will be several more quarters of decline before it starts going up,” he said. “Total planned spending running about 15 percent less than last year. … We’re out of the cyclical low of remodeling by the end of the year [2009]. Remodeling recovery will get underway by the first half of next year [2010].”

In all, “the housing market seems to be recovering, but excess inventory needs to be worked off and prices need to stabilize before we’ll see a full-blown home building expansion,” Baker said. “Once this is behind us, housing will be stronger than this decade.”

According to the Construction Outlook report, in 2009, housing starts were expected to reach a trough at 570,000 units, 74 percent lower than the 2005 peak. Home prices have declined and mortgage rates are historically low, making home ownership the most affordable since the National Association of Realtors, Chicago, began collecting this information in 1971. By the middle of 2009, this improved affordability, combined with the federal income tax credit for first-time home buyers, began to encourage a strengthening in new home sales and housing starts. In 2010, that growth will solidify and housing starts will expand 26 percent to 710,000 units. While the expected growth in starts will be large in percentage terms, it will still leave housing starts at the second lowest level in at least the last 50 years.

Single-family housing starts would fall 22 percent by the end of 2009 to a historic low of 430,000 units, 74 percent below the 2005 peak of 1.626 million units, according to the Construction Outlook. In 2010, the starts will rise 30 percent to 560,000 units. The average annual level of single-family housing starts over the past 15 years, 1994-2008, was nearly 1.2 million units. So, the level of starts will not feel particularly brisk or dynamic in 2010 even though the percentage gain is impressive.

Even though both multifamily and single-family housing peaked in 2005, the downturn came much slower to multifamily, according to the Construction Outlook. Multifamily starts edged down just 2 percent in 2006 and 13 percent in 2007, while single-family starts dropped 18 percent and 30 percent in those years. The continued start of large, multimillion dollar projects, that spend years moving through the planning pipelines, shielded the multifamily market from more pronounced losses during those years. In 2008, however, starts tumbled 31 percent to 310,000 units. At that time, large multifamily projects, such as the Chicago Spire, suddenly found it more difficult to secure debt or equity financing. In 2009, the deepening economic downturn and continued scarcity in financing were expected to create another 55 percent plunge in multifamily housing, bringing starts down to 140,000 units. With this decline, multifamily housing starts would be down 73 percent from the 2005 peak of 530,000 units. As the economy begins to stabilize in 2010, multifamily starts will advance 14 percent to 160,000 units, but the level of construction will still be the second-lowest in at least the past 50 years.

In addition to large project starts, the rental market also helped temper the blow to multifamily housing starts in 2007-08, according to the Construction Outlook. As prospective homeowners waited out the downturn in housing prices, the demand for rental units increased. Many developers, therefore, began to convert condo projects into apartments as they went to start or even after breaking ground. In 2008, the McGraw Hill Construction Pipeline database showed that multifamily condo starts plunged 31 percent over the year, but rental starts rose by 37 percent. With the dramatic increase in unemployment, however, multifamily rental starts weakened substantially toward the end of 2008 and sank 38 percent in the first half of 2009 compared to a year earlier.

At the same time the condo market remained particularly vulnerable in 2009. Condo starts dropped 62 percent in the first half of 2009 compared to a year earlier.

Commercial buildings

“The construction industry had a particularly tough year,” said Murray. “2009 saw the sharp drop in commercial buildings, and institutional buildings also has taken a downturn this year. The stimulus bill was passed in February, and our data shows it’s beginning to come out. The financial market is stabilizing, but watch out for a second unrest in commercial mortgage in 2010.”

Construction market indicators show steep declines, Murray said. “McGraw Hill's indicator shows a 25 percent drop in constructions starts [in 2009],” he said. “That being said, there was a slight uptick at the end of 2009. Single-family housing bottomed out in the second quarter of [2009]. It will be creeping up from now on. Commercial building also got clobbered [in 2009], 55 percent down in square footage. Institutional buildings was down 15 percent in dollar trends and 23 percent in square footage. Public works also was down.”

In 2008, construction starts dropped 26 percent to 779 million square feet, down from the most recent peak of 1,056 million square feet in 2007, according to the Construction Outlook. The decline in dollar terms was 16 percent to $84.5 billion. The moderate dollar downturn reflects the start of several massive office and hotel projects in 2008, and the fact that the relatively less expensive project types, such as stores and warehouses, were the hardest hit in 2008. Another factor contributing to the 2008 slide for commercial building was the sharp drop-off in the availability of commercial mortgage-backed securities, which reduced the funds that banks had available for commercial real estate loans. In 2009, the decline for commercial buildings in square footage was 54 percent to 358 million square feet, and in dollars down 43 percent to $48.2 billion.

The stimulus act does not offer direct help to commercial buildings; its indirect benefit will be moderating the decline in employment and setting the stage for a faster economic recovery, according to the Construction Outlook.

The $787 billion stimulus bill allotted about $130 billion in construction-related spending for 2010-11, Murray said. “The big winner was transportation [that got about $45.2 billion.] There were a lot of deadlines in highways, and the money had to go out fast. Environment and energy got money too."

The Build America Bond Program will be issued in 2009 and 2010 by state/localities for capital expenditures, Murray said. “States/localities can receive 35 percent reimbursement by the federal government for their interest costs; or bond receivers can receive 35 percent tax credit.”

In the near term, commercial building is facing a particularly tough financial climate. Bankers are still tightening lending standards and affecting projects such as the Echelon Resort in Vegas, or the Chicago Spire and the World Trade Center towers, Murray said. “Commercial real estate loans are seeing rising delinquencies,” he said. “If this gets out of hand, it could be another crisis situation going into 2010.” In the second quarter of 2009, delinquencies climbed 7.9 percent, the highest reading since 1993. In addition, a large volume of commercial mortgages that were issued at mid-decade are coming due between 2009 and 2012. With property values flattening out or declining in numerous markets, as the result of the recession, it will be difficult for many of these mortgages to qualify for re-financing.

The recovery in commercial construction has been pushed back to 2011 at the earliest, assuming that credit markets continue to improve and lending conditions become more accommodative, according to the Construction Outlook. Government intervention in the commercial mortgage-backed securities market may help to alleviate stringent lending conditions, but credit availability will nevertheless remain considerably tighter than at mid-decade.

For 2010, the loss of momentum will continue, though the declines will ease as contracting retreats another 7 percent to 333 million square feet. 
 

E-mail Sahely Mukerji, senior editor, at smukerji@glass.org.