When developing a business plan for 2008, consider hedging your bets.
Economists at the Reed 2008 Construction Forecast Conference gave the U.S. economy and the outlook for the construction industry mixed reviews. The conference took place Oct. 3-4 in Washington, D.C.
The cautionary note “was sobering, but it adds balance” to the forecast, says Michael F. Maher, member of the audience and commercial unit manager at Rehau Inc., a Leesburg, Va., supplier of polymer-based solutions for construction, automotive and industrial applications.
The sub-prime mortgage crisis, the decline in residential housing starts due to excess capacity and the fall in home prices slowed the economy in 2007. However, Mark Vitner, director and senior economist at the Charlotte, N.C.-based Wachovia Corp., sees indicators for slow, modest growth in the United States during the next two years.
“The economy is headed for a long period of growth well below the non-inflationary sustainable rate near 3 percent,” said Jim Haughey, chief economist at Reed Construction Data, Norcross, Ga.
Vitner expects real gross domestic product to grow at a rate of 2.5 percent in 2008 and 2.9 percent in 2009, up from 2 percent this year. Business fixed investment in equipment and software is increasing at a rate of 3.8 percent this year; a pace he and Haughey expect to be sustained and possibly exceeded in 2008, perhaps rising to a 4 percent rate of growth.
New jobs continue to grow. According to the Bureau of Labor Statistics, non-farm payroll rose by 110,000 in September, following revised increases of 93,000 and 89,000 in July and August, respectively. Unemployment has stayed at 4.7 percent; a level that “remains below what is normally referred to as full employment,” Vitner said. Disposable personal income increased 4.4 percent year over year as of August 2007, sufficient momentum to support consumer spending, he said.
“Core inflation remains relatively low,” Vitner said. It's moderate enough for the Federal Reserve Board to cut half a percentage point from the interest rate in September and another quarter point—to 4.5 percent—on Oct. 31. After the September cut, Bernard M. Markstein, director of forecasting and senior economist at the National Association of Home Builders, Washington, D.C., had predicted the fed would reduce interest rates twice more this year, by a quarter point each time.
In most of the country, where 80 percent of Americans live, housing prices continue to rise, Vitner said. The sharp decline in resale prices for existing median single-family homes is limited primarily to high-value markets.
Exports of manufactured goods advanced by a $109 billion in 2007, offsetting the decline in residential housing starts, Vitner said. Excess inventory in single-family residential housing continues to impact new housing starts, slowing the rate of new construction from a high of 2.07 million units in 2005 to 1.375 million units in 2007, 1.25 million next year and 1.4 million units in 2009.
Bloomberg, New York, and the Los Angeles Times released a poll earlier this year that found a majority of Americans expect the country to go into a recession. Vitner, however, does not foresee a recession. When Wachovia’s economists went through the GDP “piece by piece, making conservative, but realistic assumptions, things didn’t look that bad,” he said. The odds of a recession occurring next year “are no worse than 30 percent,” he estimated. To put that estimate in perspective, Wachovia’s economists always assume at least a 15 percent probability of a recession, even in the face of robust economic growth.
Still, the outlook for the construction industry is uneven. Construction spending declined by 4.5 percent in 17 months from $1,192.2 billion in 2006 to a low of negative 1.2 percent growth, or $1,177.4 billion in 2007, Haughey said. He expects total construction spending to make a comeback, increasing by 7.3 percent to $1,263.9 billion in 2008 and 10.3 percent to $1,394.5 billion in 2009.
Spending on new residential construction declined 20.4 percent to $376.4 billion this year as the housing industry struggled to move excess inventory. “Mortgage rates are not the problem,” Markstein said, rather it is the “tightening of lending standards [that] are a drag on the housing market.” While he supports lenders as they raise standards in the sub-prime market, Markstein is concerned “that their skittishness is imposing requirements that are too tough in the prime markets, putting further downward pressure on housing demand.”
New residential construction dollars will show no gains in 2008, Haughey said. The beginning of its recovery will come in 2009 with an estimated gain of 13.6 percent for an invested total of $427.6 billion in 2009, he said.
The NAHB forecasts the real, inflation-adjusted single and multifamily fixed investment components of the gross domestic product to fall 22.6 percent in 2008 and then rebound 7.5 percent in 2009, Markstein said.
Multifamily construction “faces a further slowdown” from 2007, Markstein said. Starts will drop to about 270,000 units in 2008 from a projected 290,000 this year, before demand recovers to 295,000 in 2009. The condominium market also will see tough times. “Quite simply, too many condo units were built,” he said. Suzanne Mulvee, senior real estate economist for Property and Portfolio Research, Boston, expects some of these to be converted into apartments.
Nonresidential construction spending increased 16.3 percent, year over year, accounting for $397.6 billion this year, Haughey said. He does not anticipate a decline as the rate of growth slows, “but more of a pause or plateau,” with an increase of 10.4 percent in 2008 and 7.9 percent to $473.7 billion in 2009.
Investments in lodging, office space and health care facilities will help drive the growth in nonresidential construction, and analysts expect the sectors to continue to be strong through 2009. “Construction spending will expand fastest in 2008 for hotels and healthcare and slowest for retail and education,” Haughey explains in a written analysis, “U.S. Construction Outlook 2008-2009,” published by Reed.
Spending in the health care sector rose 11 percent, year over year, during August. Year-to-date starts for hospitals are up 14 percent and 49 percent for nursing homes and assisted living facilities, Haughey said.
Increases in hospital receipts—fees and admissions—and supplemental state appropriations underwrote much of the growth in hospital construction, Haughey said. He attributes the surge in nursing home construction to “privatization and consolidation, which provides access to new sources of capital.”
“Retail is expected to be the weakest commercial market ahead,” Haughey said. The rate of spending for public safety as well as amusement and recreational facilities also is slowing.
Heavy engineering is experiencing double-digit growth that began in 2006 with an 11.5 percent increase and will continue through 2009. The projected 12 percent increase in 2009 will represent an investment of $282.9 billion, Haughey said. The power, communications and transportation industries have significantly upped their investment in infrastructure.
Contractors will experience a faster rate of inflation than the rest of the economy because of pressure on construction cost, Haughey said. “Higher oil prices and booming Chinese growth” helped fuel a materials price increase of 9 percent in 2007, he says. Rising materials prices will fall off the 2007 pace because of sub-par growth in GDP both in the U.S. and abroad, but still increase by about 5 percent in 2008.
Skilled labor shortages in nonresidential construction will worsen, Haughey said, with shortages translating into higher wages. Wages increased at a rate of 3.6 percent during the past three years and then had a 5 percent rate of growth during the third quarter this year. In 2008 and 2009, the pace will abate, because the unemployment rate is expected to rise from 4.7 percent to 5 percent, but still outpace economic growth, he said.
“Companies are stealing talent from other companies, paying workers more,” Mulvee said. “Workers today move to where they want to live” and companies tend to follow them.
Their destinations of choice are the South and West, except, for the most part, California, Mulvee said. As a result, amongst large metro markets, Phoenix and Miami boast the highest levels of office construction underway as a percentage of inventory—close to 4.8 percent for both—during the second quarter this year. In smaller markets, the California counties of Riverside and San Bernardino lead with office construction underway accounting for 9.2 percent of inventory. Las Vegas and Austin, Texas, follow with about 8.2 percent and 7.5 percent.
Ed Sullivan, chief economist, with Portland Cement Association in Skokie, Ill., acknowledges the positive elements in the economic picture, but sees a weakened economy with an elevated risk—40 percent—of a recession. “It’s a toss up, the economy could go either way,” he said.
The sub-prime crisis concerns Sullivan and he wonders how hard it will hit the general economy. In 2006, the mortgage crisis caused 400,000 homeowners to lose their homes. Banks will foreclose on another 1.2 million homes this year, and the crisis will deepen in 2008, before improving in 2009, Sullivan says.
However, the issue is no longer just about housing, “it’s about credit,” Sullivan said. He expects the sub-prime crisis “to bleed through to every sector of the economy.” In his presentation to the PCA Board in September, Sullivan said, “we believe that it will spill over into commercial lending hindering nonresidential construction activity. Additionally, high inventory conditions in the residential market will suppress that sector and slow down recovery efforts.”
Sullivan expects consumer spending will be affected as well. “When the growth rate of consumer spending is impaired, it adversely impacts job growth and overall economic performance” because consumers generate more than two out of every three dollars of the U.S. economy, he said.
To know which way the economy is veering, watch trends in job creation—it’s cause for concern if it drops below 100,000 a month—actions by the fed, fuel prices, fuel availability, and consumer and business confidence, Sullivan says. “The psychology of investors and consumers can quickly take a turn for the worst,” Haughey said.
Investors got a jolt when the labor department announced that jobless claims filings unexpectedly jumped by 28,000 during the week ending Oct. 13. “This is certainly not good news, but we still need to see a definitive trend weakening,” Sullivan said. “We will have a better picture and be able to better assess recession risks with another two months of job data.”
Prudent strategic planners should “add an extra dose of conservatism” to their business plans because of these uncertainties, Sullivan said.
The author is a freelance writer from Annapolis, Md., email@example.com.