By Kermit Baker, Hon. AIA, AIA Chief Economist
An uneven economic recovery, hesitancy on the part of lenders to finance construction projects, the weak financial position of governments at all levels, and rising costs of key building material commodities are all conspiring to restrain a recovery in the nonresidential construction sector. The AIA Consensus Construction Forecast panel is projecting a decline of 5.6 percent this year in nonresidential spending for buildings, followed by a modest recovery of 6.4 percent in 2012. Because these predictions come on the heels of a more than 20 percent downturn in the overall nonresidential building sector last year, and a more than 30 percent drop in spending on commercial buildings, this year’s and next year’s expected declines are quite modest in comparison.
Commercial facilities—office, retail, and hotel—are expected to see a more significant decline ( 6.5 percent) this year, but also a stronger recovery (almost 12 percent) next year. Spending on the construction of manufacturing facilities is expected to see a steep decline this year of almost 16 percent, followed by a relatively modest rebound of 8 percent. The traditionally more stable institutional sector is expected to fall just over 3 percent this year, and then offset this decline with a 4 percent increase in 2012.
The economic recovery continues to disappoint
While the 2008–2009 economic downturn was certainly severe, this recovery has still been unusually weak. In prior post-WWII recoveries, the U.S. economy averaged more than 6 percent growth (inflation adjusted) in the first year of a recovery, and more than 4 percent in the second. In the first year of this recovery, growth was only 3 percent, and when figures for the second quarter of this year are released, it’s likely that the second year gains will be below the first year. This modest level of growth is not too surprising given that the economy lost an additional half million jobs during the first year of the recovery, and gained just over one million during year two. At present, there are almost seven million fewer payroll positions in our economy than when the recession began in early 2008.
With such slow growth, most businesses and institutions do not feel the need to expand their facilities, although spending on renovations to existing facilities has remained quite strong. For example, McGraw-Hill Construction reports that nonresidential construction awards for new buildings and additions declined 43 percent between 2008 and 2010, while awards for building alterations declined less than 2 percent over this period.
Unstable home prices, unusually severe weather conditions, rising energy costs, concern over growing debt, and the rising national unemployment rate (up from 8.8 percent in March to 9.2 percent in June) have made consumers extremely nervous. Both the University of Michigan Consumer Sentiment Index and Conference Board Consumer Confidence Index have fallen since the beginning of the year. Business confidence has not fared much better. Moody’s Economy.com reports that business confidence has fallen significantly from March, as the recent slowdown in the economy has many businesses worried that 2011 will generate significantly slower growth than anticipated.
Falling business confidence is becoming more of an issue internationally, which could impact construction levels and demand for design services in regions that have seen rapid growth in recent years. Moody’s Economy.com survey of global business confidence shows a dramatic decline since the beginning of the year in the Asia/Pacific index, largely due to the continuing problems from the Japanese earthquakes. But even the fast-growing Chinese economy seems to have stalled a bit recently. In contrast, the business confidence index for South America has been trending up this year, and the European index is holding its own, in spite ongoing government debt issues in Greece, Ireland, Spain, and Portugal. Solid business confidence in Germany, the largest European economy, has largely offset concerns in other areas.
Regional patterns emerging
As the construction markets begin to recover, some areas of the country are performing better than others. Though national construction employment is at almost exactly the same level as a year ago, 23 states have reported increases in construction payrolls over this period. Somewhat surprisingly, Michigan leads the pack with a 5.2 percent increase in construction payrolls over the past 12 months. Seven other states–Hawaii, Texas, Tennessee, Oklahoma, Kansas, North Dakota, and Illinois—and the District of Columbia have seen gains of 3 percent or more. At the other end of the spectrum, Nevada and Rhode Island have each lost 10 percent or more of their construction payrolls over the past year, with Georgia not far behind.
The Federal Reserve Board monitors economic conditions for each of its 12 districts, and its report from early June was that nonresidential markets were beginning to show some improvement, in contrast to the still-stalled residential sector. From the report: “Nonresidential real estate leasing markets have been generally stable, while construction activity has remained very subdued. Loan demand was steady to stronger in most districts, especially in the commercial and industrial sector, and widespread improvement was reported in credit quality.”
In terms of conditions in specific districts: “Commercial leasing markets showed modest signs of improvement in the Richmond and San Francisco districts. Boston and Dallas noted some firming in property sales markets, but Kansas City reported declines in prices for office buildings. Nonresidential construction, though widely reported to be at very low levels, rose modestly in the Boston, Chicago, Minneapolis, and Dallas districts, though Chicago noted that public sector projects are becoming smaller. Cleveland observed a pickup in industrial and high-end commercial development, but [also saw] a pullback in healthcare-related projects. Richmond reported some pockets of strength in the retail market. More broadly, contacts in a number of districts expressed a general sense of optimism about the outlook for the second half of 2011.”
Construction commodity prices remain volatile
In spite of a still-depressed construction sector, material prices remain unusually volatile, with some recent increases. Overall, prices for construction commodities have increased 7.5 percent over the past year, just slightly higher than the 7.3 percent overall increase in wholesale prices. In the overall wholesale price index, energy costs have been the main culprit. Without food and energy prices factored in, the overall index rose by just over 2 percent. However, price volatility in the construction sector certainly extends beyond energy costs. Steel, copper, and aluminum prices have all increased 10 percent or more over the past year, offsetting price declines for lumber and many concrete products. Some analysts feel that price pressures for construction commodities are shifting. According to Ken Simonson, chief economist of the Associated General Contractors of America, “The noise has died down over diesel, steel, and copper prices. Now the attention has shifted to asphalt, plastic, roofing, and insulation.”
Momentum is beginning to shift in the nonresidential construction sector, but even after the markets begin to recover, there is a long climb to get back to the levels enjoyed before the recession. Home building generally creates demand for nonresidential facilities, so the extremely weak housing recovery is not generating much demand for new projects. Job growth also is a key factor in creating need for new buildings, and, like home building, an employment recovery has not gotten underway to any significant degree. All of this points to a fairly modest expansion in the nonresidential building sector once growth resumes in late 2011 or early 2012.
*With the release of this update of the AIA Consensus Construction Forecast, all construction spending figures are presented in current (non-inflation adjusted dollars). Prior reports were presented in real (inflation-adjusted) terms.
