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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