Volume 45, Issue 12 - December 2010

feature

Tempered Optimism
Construction Forecasters Look for Good News in 2011
By Megan Headley, Ellen Rogers and Tara Taffera

“As we meet again next year, I hope we’ll be able say, yes, an expansion is close at hand.” So were the closing words of Robert Murray, vice president of economic affairs for McGraw Hill, during the McGraw Hill Construction Outlook Executive Conference in October.

As one might infer from these remarks, it’s become clear that, for the nonresidential construction industry, 2010 was not that year.

Forecasters are cautiously predicting that 2011 will be the year of expansion. Murray predicts single-family housing will see a 25-percent increase in new 2011 construction starts, and nonresidential will see an 8-percent increase.

Kermit Baker, chief economist for the American Institute of Architects (AIA), on the other hand, says there are a lot of reasons to be optimistic about the future for the construction market.


“The first quarter of this year the direction of the economy changed and that’s when we started hearing more about the possibility of a double dip recession,” Baker says. “But the numbers are starting to look positive and seem as though we are starting to pull out of the downturn.”

Inflation-adjusted total nonresidential construction spending numbers are projected to be down 20 percent this year and about 30 percent on the commercial side. Baker says the industry can expect recovery for 2011 as a whole, but probably a very modest one, with a weak first half and a stronger second half for construction spending. Overall growth will be about 1 percent, though a bit stronger on the commercial side.

“Finally, it looks like we’ll emerge from the construction downturn and see some growth as we move in the latter part of 2011,” Baker says.

Ken Simonson, chief economist for the Associated General Contractors of America (AGC), says 2010 will show that nonresidential spending is down 15 to 20 percent and residential will range anywhere from up 5 percent to down 5 percent. Total construction spending will be down 10 to 15 percent and material costs may be up by about 4 percent; labor costs will increase less than 2 percent.

As far as 2011, he expects nonresidential will finally hit bottom in most categories. And both single- and multi-family should be positive, bringing total construction spending up between 3 and 7 percent.

A Look Back
Rather than greeting his audience with “what a difference a year makes” Murray found himself looking at last year’s forecast (see December 2009 USGlass, page 28) and asking “what happened?”

That isn’t to say last year’s predictions weren’t correct—the predicted declines were simply much steeper than expected. Murray had projected a 4-percent decline for commercial buildings in 2010; in actuality that became a 17-percent decline. “Institutional building also has shown a greater loss of momentum than expected,” he notes. Rather than the expected marginal gains, this segment saw a 7-percent decline in starts, with a further 1-percent decline projected for 2011.

In other words, instead of moderate improvement in new construction starts for 2010, “we’re looking for, at best, stability and predicting a 2-percent decline,” Murray says.

Murray did try to offer his audience a “ray of hope.” He notes that commercial building in 2010 is estimated at down “only” 17 percent, compared to a 43-percent decrease in starts for 2009. “So the slope of descent is easing,” he says.

Looking at these past predictions, 2011 is coming in with its share of uncertainty. The economy is still facing headwinds, Murray says, adding, “There is still the risk of a double-dip recession taking place.” In addition, “If you look at spending and employment, the downturn is still underway. Looking at [construction] starts, it’s a little more indeterminate whether we’ve leveled out …”

Consumers and businesses continue to bring down debt, so little spending is occurring for construction, he elaborated. The effects of the economic stimulus are fading further impacting spending. His expectation is that it will be roughly mid-2011 before hiring begins to pick up.

Construction Spending
The forecasters continue to watch spending for signs of improvement.

Recent surveys of bank lending officers show, “Lenders are now easing lending standards and that represents a change and ultimately that should have a positive impact [on construction],” Murray says. This change should be setting the stage where lending can begin to pick up for business loans, although not necessarily real estate loans. He predicts that lending will begin to improve in the 2011, 2012 timeframe.

Jim Haughey, chief economist for Reed Construction Data, says credit continues to be a problem.

“As low as rates are, a lot of people still cannot get credit—and it doesn’t matter what the rate is if you can’t get it or your banker doesn’t have it,” he says.

Haughey explains that typically, when times are good, commercial developers put up 20 percent of the anticipated price of the development and the banker would provide the balance. Now those requests are for 40 percent.

“Most homeowners and a lot of small contractors and developers borrow from regional and local lenders and many of these have no money at all available for real estate loans,” Haughey says. “In the case of many smaller lenders, no re-capitalization is taking place and they are carrying a huge excess of bad real estate loans.”

Haughey also points out that public construction funds will be declining in 2010-11, followed by slow growth for several years. Total construction spending, he says, is near the bottom, likely by the end of 2010 or start of 2011.

“We’re anticipating this year construction spending will be down about 10 percent and up about 5 percent next year. It should be up 12 to 13 percent in 2012. This is about a year late compared to what happened in most economic recoveries,” Haughey says.

According to Simonson, the construction industry can expect to see “less-than-trend growth” in the coming months, “bad news for construction.”

Simonson says total construction spending has been tailing off since early 2006 and in last 12 months (August 2009-2010) it’s down 10 percent.

“Private nonresidential held up great until the economic and financial miseries of late 2008 and since then it has been sagging,” he says. “Private residential started falling in early 2006, tumbled all the way until the housing tax credit took effect in early 2009 and then rose until the tax credit went away and is now tailing off again. In the last 12 months it’s down 2 percent.”

As far as public construction, Simonson says it has been rising since the beginning of 2010 and in the last 12 months is down just 1 percent.

On the other hand, Baker points to trending in commercial property values as a reason for some optimism about the construction outlook. “We did see a very steep decline in commercial property values during this cycle. It peaked after the housing prices peaked in mid-2007, but fell harder than the housing prices decline; commercial property values fell about 40 percent, peak to trough, and housing prices nationally fell about 30 percent,” he says.

As far as commercial property values now, Baker says the second-quarter numbers released by the MIT Center for Real Estate are very positive.

“We think there is some hope that the significant decline we saw in commercial property values may turn around faster than the decline in housing prices,” he says.

Multi-Family Housing
Multi-family housing was one of the pleasant surprises of 2010, forecasters say. “Multi-family has made a surprisingly decent rebound mid-year, compensating for the single family lull,” says David Crowe, chief economist for the National Association of Home Builders (NAHB). He acknowledges that the rebound had come as a surprise, as earlier this year he’d predicted that multi-family construction starts in 2010 wouldn’t surpass those seen in 2009.

Last year Murray had predicted a slight increase in construction starts of 5 percent, which became a 9-percent increase in actuality. He expects that segment to see further growth in the area of 24 percent in 2011.

“Multi-family has picked up in part because of the tax credits for condos,” Haughey says.

Crowe notes that another contributing factor is, not surprisingly, increasing number of renters who have had their credit destroyed as homeowners.

According to Crowe, this area is among those leading in recovery. “It’s only retardant is the same as in single-family [construction], and that’s that builders are having trouble getting credit.”

Among the hot spots Murray sees for this segment, based on construction starts in 2010, are New York, followed by Washington, D.C., Boston, Houston and Chicago.

Looking back, however, Simonson says that multi-family spending was down 52 percent from August 2009-2010, while improvements, additions and renovations to existing single- and multi-family are up 4 percent.

As far as permits, Simonson says multi-family appears to be bobbing up and down and is now up over the past 12 months. It, however, took another dive in September. Simonson says we’re starting to see markets where affected rents are rising and vacancies are dropping … “eventually we’ll see developers of apartments back on the market; the condo market will remain depressed until 2011, and maybe beyond.”

Nonresidential Starts
In focusing on specific nonresidential segments, Murray notes, “Because activity is so low right now it is very easy to get double-digit [percentage] gains—but you also have to look at the absolute increases in terms of square footage.”

For stores, Murray expects a nearly 18-percent decrease in 2010, followed by a 19-percent increase in square feet started in 2011.

“There’s no question we’re looking at an over-stored nation,” he says, adding, “still … we are seeing some activity take place.”

Rather than starting construction on new stores, Murray says, “Some of the more financially viable retail chains are engaged in some renewal of formats in order to be competitive.” For example, Walmart is considering constructing smaller stores in urban areas in order to continue its expansion.

Hotel construction is facing difficulties as well. While Murray forecasts an 11-percent increase to 20 million square feet in 2011, “20 million square feet for this category is still pretty paltry,” he says.

Following a 28-percent decline in office building construction in 2010, Murray predicts a 13-percent increase in 2011 to 59 million square feet.

“The stage is being set for some resumption of the office building market,” Murray says, pointing to a few early signs.

According to Murray, a number of large corporations are beginning to post gains in their earnings, and if those companies want to continue growing some investments in buildings, and people, will be necessary. He points to facility expansions begun for Cox Enterprises in Atlanta and the Canon headquarters in Melville, N.Y. Data centers in particular, Murray says, are breaking ground on new buildings. By region, Murray notes, D.C. continues to be the most active in terms of the square footage.

“In thinking about the office market you have to step back and look at the fundamentals,” he says. He points to expectations that office employment will start to pick up in 2011 or 2012. “The market is still in bad shape but we are seeing signs [it] is leveling off,” he adds.

Overall, Murray says he expects “stronger gains taking place in the 2012, 2013 timeframe.”

If multi-family construction was a pleasant surprise in 2010, institutional starts were a glaring disappointment. Overall that category saw a 17-percent decrease in construction starts in 2010, with a predicted 2-percent decline in 2011.

“Schools essentially have lost momentum,” Murray says. “This year we’re looking at an 18-percent decline and it’s going to continue in our estimate in 2011.” He points to the dampening of state and local budgets as a contributor. School districts facing decisions to lay off more teachers are clearly holding off on more construction. Fortunately, he adds, “The college and university segment has not seen as steep a drop as has K through 12.”

Health care was flat last year at 68 million square feet in starts, and Murray predicts a modest pickup in 2011 of 6 percent.

Murray admitts the forecasted 1-percent drop in institutional buildings overall is a best case scenario, with the potential for a 5- to 10-percent decrease as a worst case possibility. The saving grace for this market segment, he comments, is that it is not as volatile as single-family or nonresidential construction.

Next Year
Overall, nonresidential construction is predicted to have an 18-percent decrease in construction starts in 2010, followed by an 8-percent increase in 2011. Compared to the peak in 2007, “you’re still talking about pretty low levels,” Murray says.

In looking back at previous downturns, Murray says, “I guess what’s different is the size of the downturn in terms of the most recent construction cycle.” He adds, “There’s no question this has been a real landmark downturn …”

The good news is that increases in commercial construction are in sight. “Personally, I think commercial building could pop in a positive way in 2012, 2013,” Murray says. To get to that point, he added employment growth must strengthen and banks must start lending.

The bad news? There’s a lot of uncertainty regarding the long year ahead.

Megan Headley is the editor and Ellen Rogers and Tara Taffera are contributing editors for USGlass.

 


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