july 11, 2008

Nonresidential Construction Expected to Be Turning Down by Year’s End
AIA Consensus Forecast Panel sees significant easing of commercial activity, while institutional construction remains flat

by Kermit Baker, PhD, Hon. AIA
Chief Economist

Summary: The downturn in design activity that architecture firms have been reporting in recent months is projected to produce a mild decline in nonresidential construction activity this year, before turning down more significantly in 2009. Commercial facilities generally will see the steepest declines this year and next, as institutional activity is expected essentially to remain stable over this two-year period. These are some of the key results from the AIA’s midyear Consensus Nonresidential Construction Forecast Panel. Even with the downward revision of these forecasts from last winter, they remain in a range that would produce a relatively modest drop-off in nonresidential activity; significantly milder than the two most recent nonresidential recessions of the early 1990s and earlier this decade.

The prospects for the nonresidential construction industry have taken a definite turn south since the beginning of the year. In December, the AIA Consensus Construction Panel was calling for modest growth in inflation-adjusted nonresidential construction spending in 2008, balanced by a modest decline in 2009. However, now halfway through a year that has seen the broader economy weaken, their mood has grown more pessimistic. They are now calling for a modest decline in 2008 (-1.2 percent), followed by a more dramatic decline in 2009 (-6.7 percent).

Although the outlook for virtually every major nonresidential sector has deteriorated, forecasts have dropped more dramatically for commercial and industrial buildings. Hotels and manufacturing facilities are projected to show gains in 2008, but the office and retail sectors are expected to fall off considerably. For 2009, a double-digit decline in real construction levels is the consensus for the overall commercial and industrial building group, with significant declines in each of the categories in these major sectors.

Even though the overall consensus forecast for nonresidential activity has been lowered, the institutional building sector is still expected to fare considerably better than the commercial sector next year. The overall institutional outlook is now for a modest gain in construction levels this year, with almost no change for 2009. The two largest institutional categories—health and education—are both projected to see a modest increase this year. While growth should continue for health-care facilities in 2009, a small falloff in education facilities is anticipated.

Economic slowdown stalls the construction market
The main reason that forecasters are more pessimistic about the construction outlook is that the economic environment has weakened considerably in recent months. Our gross domestic product (GDP) grew by less than 1 percent during the fourth quarter of last year (when seasonally adjusted and annualized) and below 1 percent again during the first quarter of this year. Most analysts feel that we’re not going to see any improvement in our economy when the second quarter estimates are released at the end of July.

Construction Consensus Forecast—2008


Compare consensus to the forecast of various panel members above.

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• 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.


The list of economic concerns is steadily increasing. At the top of the list is the housing sector. With housing production only half of what it was in early 2006, there are many fewer opportunities in the residential design and construction industry. However, more recently, problems in the residential sector have affected our economy well beyond the housing industry.

House prices are declining in most major metropolitan areas. With falling values, owners have less equity to borrow against to supplement their spending. This has slowed consumer spending, thereby slowing economic growth. Additionally, growing home mortgage delinquencies and foreclosures have caused serious problems in credit markets and have served to restrict lending in many sectors of the economy.

In addition to problems emanating from housing, we’ve seen a downturn in payrolls at U.S. businesses. Payrolls have declined each month this year, with job losses totaling to about 325,000 through the first five months of 2008. Over this same period, the U.S. unemployment rate has climbed from 5.0 percent to 5.5 percent. With fewer jobs, there is less need for office space, while growing unemployment has made consumers nervous about their economic prospects.

In fact, consumer confidence has plummeted as a result of problems in the economy. The University of Michigan’s Consumer Sentiment Index stood at 96.9 at the beginning of 2007 (indexed at Q1-1966=100), and fell to 78.4 by the beginning of this year. As of the June reading, the index had dropped to 56.7, the lowest reading for this index since 1980.

A weak employment picture is not the only thing of concern for consumers. Despite a slowing economy, we’re beginning to see the reemergence of inflation in many consumer purchases. Gasoline prices are the most dramatic example, but overall consumer prices as measured by the consumer price index are rising at a 4 percent pace. We haven’t seen annual rates of inflation in consumer prices at 4 percent since 1991.

Increases in consumer prices pale in comparison to increases we’ve seen in key construction commodities. While consumer prices have increased 18 percent since the beginning of 2004, the prices of materials used in nonresidential construction have increased more than twice that amount—37 percent—according to data from the U.S. Department of Labor. In addition to materials that are petroleum-based, there have been sharp price increases recently in steel, many other metals, concrete, and stone.

Commercial activity to bear the brunt of a weak economy; institutional activity expected to stabilize
As the economy slows, the more cyclical commercial construction sector can be expected to see the greatest changes. With consumer sentiment scores dropping, gas prices rising, stock market averages slipping, and the unemployment rate moving up, consumer spending is likely to see a significant slowdown, putting pressure on the retail sector. In fact, growth in retail sales in our economy slowed from 5.5 percent in 2006 to 4.1 percent last year and is increasing at only about a 3.5 percent pace through the first half of this year. This slowdown in retail activity already is affecting demand for retail space. The International Council of Shopping Centers predicts more than 6,000 retail store closings this year, the most since the 2001 national economic recession. As a result, forecast panelists are expecting an 8 percent decline in retail construction activity this year, and another 10 percent drop in 2009.

Office construction activity also is expected to suffer from a weak economic environment and payroll declines. However, office construction has been very measured during this past nonresidential construction expansion, and, as a result, national office vacancy rates are at favorable levels. CB Richard Ellis reported first quarter 2008 vacancies at 13.2 percent nationally. Although up 0.4 percent from the end of 2007, they still are about four percentage points below their early 2004 peak for this cycle. Even without much in the way of excess office space in most markets, our forecast panel is projecting a 4 percent decline this year, and another 12 percent drop next year as a result of falling demand for office space in a weakening economy.

The hotel market is benefiting from a strong tailwind, having seen very strong double digit growth last year. Our forecast panel expects activity in the pipeline to produce reasonably strong results this year before dipping by almost 10 percent in 2009. Manufacturing construction is benefiting from a resurgence in U.S. export activity. A weak dollar has made U.S. goods more attractive in international markets, thereby propping up our manufacturing sector. The consensus is for almost 5 percent growth in manufacturing activity this year, matched by a slightly higher decline next year.

The volatility on the commercial side of the market is expected to be moderated by relative stability in construction levels in the institutional sector. Overall construction of these facilities is forecast to grow very modestly this year before essentially leveling off next year. The health-care sector is projected to see very stable construction levels this year and next, which belies the turbulence surrounding this sector of the economy in the national political discussion. As health-care priorities and policies continue to develop, we may see more volatility in this sector in the coming years.

The other major institutional sector, education, is also expected to see relative stability over the next 18 months. However, these sector totals gloss over differences in some of the key segments in the educational category. Education construction is largely driven by expected enrollment levels, and the U.S. Census Bureau is projecting very strong growth in college and university enrollments (up 10 percent over the next seven years), moderately strong growth in elementary and secondary enrollments (up 8 percent over this time period), while much weaker growth in high-school enrollments (up less than 4 percent overall, and below current levels for the next five years). The demographic patterns are already reflected in the construction figures. McGraw-Hill Construction reports that secondary and high-school construction activity declined at a mid-single digit pace last year, while college and university construction increased by about 10 percent.

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