January 11, 2008

After Strong Growth in 2007, Nonresidential Construction Activity Is Projected to Flatten Out
A weakening economy in 2008 is expected to stall the current nonresidential construction expansion

by Kermit Baker, PhD, Hon. AIA
Chief Economist

Summary: Emerging weakness in the broader national economy has dampened the mood of the leading nonresidential construction forecasters. The AIA Consensus Construction Forecast Panel is now projecting a modest 0.7 percent inflation-adjusted increase in nonresidential construction activity this coming year, with a modest 1.3 percent decline in the commercial categories, but a reasonably healthy 4.2 percent gain in institutional facilities. Our forecast panel does not expect improvement as we move into 2009; the consensus is for a small decline of 0.9 percent in nonresidential activity for next year. Again, the commercial sectors are expected to fare worse than the institutional categories.

National economic slowdown underway
This past year turned out very positive for the nonresidential construction sector. Spending on the construction of nonresidential buildings increased by an estimated 18 percent (before inflation adjustments), according to U.S. Commerce data covering activity through November 2007. This growth almost offset a comparable percentage decline in residential activity. Nonresidential spending was particularly strong for lodging facilities (up more than 60 percent), public safety and transportation (each up more than 20 percent), and offices, communication facilities, and amusement and recreation facilities (each up close to 20 percent).

Construction Consensus Forecast—2008


Compare consensus to the forecast of various panel members above.

No need to click, just hold your mouse over the panel member.

• Portland Cement Association figures represent billions of 1996$, all other sources show billions of 2000$.
• Moody's Economy.com figures for Healthcare represent Public Healthcare only.


Unfortunately, the strength in the nonresidential construction sectors has not been able to offset other weaknesses in our economy. Since the problems in credit markets emerged earlier this summer, there has been much more talk of an increased probability of an impending recession in our economy. The Federal Reserve Board has begun responding to this emerging weakness by instituting multiple cuts in interest rates over the past several months in an effort to stimulate the economy.

There are several problems with our economy at present. At the top of the list is the ongoing deterioration of the housing market. What started out two years ago as a problem of excess inventory of unsold new homes has expanded into a broader problem affecting the overall economy. With an excess supply of homes on the market, house prices began to slip, declining about 5 percent last year. With falling house prices, many homeowners have become concerned about their financial situation and are cutting back their spending in response.

Additionally, though, problems in the residential subprime lending market have caused further problems. During the years that house prices were rapidly appreciating, lenders were often less diligent in their underwriting standards, and investors were often less concerned about the underlying risk of loans they were purchasing. As house price increases have begun to slow in most markets and actually decline in many, mortgage defaults have mushroomed. This has made lenders hesitant to lend even for purposes that would seem to carry little risk, provoking a credit crunch in many sectors of our economy.

Inflation has become more of a threat as oil prices approach $100 a barrel

The residential sector is not the only problem in our economy. Inflation has become more of a threat as oil prices approach $100 a barrel. Consumer price increases are currently running over 4 percent annually, producing consumer inflation rates that we haven’t seen over an entire year since the economic recession in 1991. Producer prices, which are more oil dependent, are rising even faster. Inflation for these products is increasing at more than 7.5 percent from a year ago, and we haven’t seen that pace of gains any year since 1981, another recession year in our economy. While oil prices are expected to ease back and take pressure off of inflation, in the meantime they are creating serious problems for the Federal Reserve Board, which is simultaneously dealing with a weak economy and high inflation.

In response to these conditions, consumers are getting nervous about the economic outlook. The University of Michigan’s Consumer Sentiment index was estimated at 75.5 in December, having begun 2007 with a reading of 96.9. The average score for 2007 of 85.6 for this index is the lowest annual score since 1993 as our economy was beginning to recover from the deep early-1990s recession.

Employment growth has been viewed as one of the few favorable signs in our economy. However, even this indicator is showing signs of weakness

Employment growth has been viewed as one of the few favorable signs in our economy. However, even this indicator is showing signs of weakness. A mere 18,000 payroll positions on net were added nationally in December, bringing the annual total to just over 1.3 million. Less than 40 percent of the payrolls added in 2007 were during the second half of the year, so job growth is clearly slowing.

Construction material costs continue to be volatile
Unfortunately, oil prices are not the only construction material input that continues to experience unusual price fluctuations. Overall, materials used in the construction of nonresidential buildings increased 5.5 percent between November 2006 and November 2007, somewhat below overall inflation in producer prices. In addition to petroleum products, construction inputs that have seen unusually high increases over this period include iron and steel scrap (+28.5 percent), construction sand/gravel/crushed stone (+8.1 percent), selected steel products (+5.8 percent), and fabricated structural metal (+5.4 percent).

However, we have also seen the commodity price cycle begin to adjust for other products that had seen dramatic increases in recent years. Prices of gypsum products are down more than 23 percent over the past year, while prices for insulation, lumber and plywood, aluminum, and natural gas are all easing a bit. The weakness in the residential sector has resulted in lower rates of increases for products used in multi-unit residential projects (up 4.1 percent over the past year), and single-unit residential projects (up 2.6 percent).

Commercial/industrial markets feel the weakness
While commercial construction ended 2007 on a high note, the AIA Consensus Forecast Panel expects a significant slowing of this growth in 2008. Overall, the consensus is for a modest decline in commercial activity (-1.3 percent in inflation adjusted dollars), mostly the result of a projected 5.7 percent decline in retail and other commercial activity. Office construction activity is expected to eke out a small gain—1.7 percent— while the strong growth in hotel construction is expected to slow, but still see a 5 percent increase for the year.

A slowdown in manufacturing activity will take its toll on industrial construction. After reasonably healthy gains this year, the AIA Panel is projecting a 3.8 percent decline in manufacturing construction in 2008.

While commercial construction ended 2007 on a high note, the AIA Consensus Forecast Panel expects a significant slowing of this growth in 2008

As is often the case at this stage in the construction cycle, our forecast panel is expecting more stability in the institutional building categories. Overall, these forecasters expect 4.2 percent growth in institutional construction, paced by a 5.6 percent gain in health-care construction and a comparable 5.5 percent increase in educational facilities.

An early look at 2009: no recovery projected
Our forecast panel also provided their current view of how 2009 is likely to shape up for nonresidential activity. In general, the panel does not expect that the slowdown for this year will result in a recovery next year. Overall, our panel is expecting nonresidential activity to decrease almost 1 percent in 2009, with a more significant decrease in the commercial sector (down 3.6 percent), with only modest growth in the industrial (0.4 percent) and institutional categories (1.9 percent).

On the commercial side, all the major sectors are projected to see declines in 2009, with offices down 3.7 percent, retail down 3.6 percent, and the hotel category down 3.1 percent. On the institutional side, religious facilities (up 4.0 percent) and health-care (up 3.6 percent) are expected to be the strongest performers, with education and public safety about flat, and the amusement and recreation category down 2.6 percent.

In summary, 2008 and 2009 are projected to be the trough of this current construction cycle

In summary, 2008 and 2009 are projected to be the trough of this current construction cycle. Inflation-adjusted construction activity is projected to see essentially no gain over this two-year period. In contrast to previous cycles, this downturn is expected to be unusually mild; the result of a fairly short nonresidential expansion that began only in 2005 and produced very little overbuilding in any of the major nonresidential construction categories.

news headlines

recent related
› After a Strong 2007, Nonresidential Construction Growth Projected to Moderate in 2008
2007 Projected as Another Strong Year for Nonresidential Projects
An Upturn in Nonresidential Construction in 2006 Is the Consensus