Guest Commentary:
The Year Ahead for Construction: Far from a Perfect ?EUR??,,????'?????<

By Kenneth D. Simonson, Chief Economist, The Associated General Contractors of America

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Nonresidential and multifamily contractors have had a rough year so far in 2009. Unfortunately, 2010 will provide modest relief, at best. But residential construction, which has grabbed most of the negative headlines until recently, is finally turning around and should do well in 2010.

U.S. nonresidential construction spending put in place in July was 3 percent below the July 2009 level and 1 percent lower than in June, the Census Bureau reported on September 1. Multifamily construction spending was down a dismal 37 percent, with a 3 percent drop from June to July. Single-family construction fell an even steeper 45 percent year-over-year but jumped 7 percent from June to July, on top of a 3 percent gain from May to June. (All figures are based on seasonally adjusted annual rates, which take into account normal weather and holiday variations between months.)

Until the simultaneous economic and financial-market collapse a year ago, universities and hospitals were ordering lots of construction. Thanks to recent gains in the stock market and improved tax-exempt bond markets, these institutions may be able to resume their multi-year expansion and modernization programs in 2010.

What can the industry expect going forward? Nationally, the economy is showing signs of returning slowly to health. Real (that is, net of inflation) gross domestic product (GDP)—the sum of all purchases of goods and services by households, businesses, government and net exports—appears to have grown in the July-to-September quarter and to be poised to get strengthen gradually through 2010. In particular, consumer spending and federal government purchases, fueled by the stimulus legislation, are likely to contribute to rising real GDP.

Business investment in inventories should resume once consumers begin buying again. But business investment in equipment and structures, state and local government purchases, and net exports are likely to remain weak for several more quarters.

These trends bode ill for nonresidential construction. There is now a huge surplus of unoccupied or underused office, warehouse, hotel and factory space that must be absorbed before more is built. State and local budgets have been battered and will not allow for even current levels of construction spending before 2011.

In contrast, there are several reasons to expect single-family construction to do well in the next year. The inventory of unsold new homes, 261,000 at the end of August, was at its lowest level since 1992. Meanwhile, the affordability of new homes has vastly improved as prices and mortgage rates have dropped sharply, making the monthly payment on a median-priced home far lower as a percentage of income. Thus, more buyers can afford homes, even though unemployment and delinquencies on existing mortgages continue to climb. Home buying, and hence construction, will be boosted further if Congress extends the $8000 tax credit for first-time homebuyers, a section of the stimulus legislation that is due to expire at the end of November.

However, the multifamily market is unlikely to get much lift from the same forces. Indeed, to the extent that families and individuals move from rental housing to owner-occupied, the multifamily market will suffer more. That market has already been disproportionately affected by job losses and the inability of new college grads to find jobs and move into their own rental units. Competition from unsold or foreclosed homes that are being offered for rent further depresses the purpose-built rental market. In addition, capital is very hard to come by as banks have tightened their lending standards for apartments and condos, as well as nonresidential income-producing properties: hotels, stores, warehouses and offices.

There appear to be two, and perhaps three, types of nonresidential construction that will do well in 2010: power, stimulus-funded projects and possibly private institutional work—hospitals and colleges.
Nationally, spending on power construction grew 14 percent in the first half of 2009 compared to the same months of 2008, according to Census. In some states this growth included wind farms, transmission lines and solar or other alternative power sources. Incentives and mandates to clean up emissions and generate more power from renewable sources will keep this market growing.

The American Recovery and Reinvestment Act, the “stimulus legislation” enacted last February, included the largest amount of federal funding for construction ever in a single bill—approximately $135 billion. The highway portion, $27.5 billion, was distributed to states and turned into contracts quite promptly. But most of the money has not been awarded yet. The full alphabet soup of federal agencies, ranging from the Environmental Protection Agency to the General Services Administration to the U.S. Army Corps of Engineers, will be doling out the money under a variety of programs. Much of that money will be awarded in 2010, although some projects may not be funded until 2011 or later.

Until the simultaneous economic and financial-market collapse a year ago, universities and hospitals were ordering lots of construction. Thanks to recent gains in the stock market and improved tax-exempt bond markets, these institutions may be able to resume their multi-year expansion and modernization programs in 2010.

But aside from these few potential bright spots, ’10 will be far from perfect for nonresidential and multifamily contractors.