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.
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