by Kermit Baker, PhD, Hon. AIA
Chief Economist

Summary: Growth in billings at architecture firms dipped in August, but remained at healthy levels despite growing concerns over credit tightening throughout the economy. Given the broader slowdown in the economy, this credit tightening could signal a longer trend of slower billings growth at architecture firms over the next several quarters. However, barring a more serious collapse of credit markets or a recession in the broader economy, design and construction activity in the pipeline should keep nonresidential construction strong at least through the first half of 2008.

National credit markets grew very volatile in early August as investors became concerned about growing default rates among borrowers in the subprime residential market. Although this problem was concentrated among subprime borrowers (borrowers considered to be higher credit risks), there have been reports of credit becoming more restricted for a much broader range of construction projects. This is occurring while commercial mortgage delinquency rates remain near historic lows, according to commercial broker Marcus and Millichap. Although tightening in lending did slow work on some projects at architecture firms, conditions remained relatively healthy overall, with the AIA Architecture Billings Index recording a 53.9 score in August, down from 60.0 in July. Inquiries for new projects also showed slower growth in August, with the inquiries slowing to 60.5 in August, down from 66.2 in July, and at its lowest level of the year.

Billings at firms in the Northeast remained very strong, but dipped a bit from July levels. Firms in the West reported some acceleration of business activity during the month. Firms in the Midwest and South reported healthy but easing levels of activity. Commercial/industrial firms reported very strong levels of billings growth, while institutional firms reported easing growth levels. Residential firms noted their first decline in billings since late 2006, no doubt in large part due to the credit restrictions in that sector.

Broader economy stumbles
The broader economy appears to have stumbled from the concerns over credit market trends. While the estimate of GDP growth for the second quarter was revised up to 4.0 percent (adjusted for inflation, and seasonally adjusted and annualized), economic indicators since June have been significantly weaker. Payrolls grew modestly in July, and declined in August for the first time in several years. Construction payrolls declined in both July and August and have dropped 55,000 since the beginning of the year.

Consumers seem spooked by recent events, as the University of Michigan’s consumer sentiment reading dropped in August, and the preliminary September reading shows no meaningful improvement. Many economic forecasters feel that the possibility of a national economic recession has increased recently.

Modest effect on most architecture firms
In response to reports of financing problems spreading to the nonresidential construction sector, we asked our work-on-the-boards panel for their opinion on the effect that this situation will have on business at their firm over the next few months. On a five-point scale, with 1 indicating no impact and 5 indicating a great impact, the average score was 2.7, or somewhat moderate. Just under half of respondents (46 percent) rated the situation as a “1” or “2” (no impact or very modest), while just under a quarter (22 percent) rated it as a “4” or “5” (reasonably significant or great concern). Not surprisingly, residential firms were the most concerned about the situation.

Respondents were also asked whether any projects at their firm had been directly affected by the credit market problems. Between a fifth and a quarter of firms reported that it had affected projects already. Again, residential firms reported the highest share that had faced problems (37 percent), while just one-fifth of commercial/industrial firms and 17 percent of institutional firms had been directly affected. Smaller firms were more likely to report projects being directly affected (31 percent of firms with annual billings under $1 million) than larger firms (17 percent of firms with annual billings over $1 million).