July 10, 2009

Steep Downturns in Nonresidential Construction Projected Through 2010
Greatest downturn in commercial and industrial sector; institutional, more modest

by Kermit Baker, PhD, Hon. AIA
Chief Economist

Summary: A weak economy and continued difficulties with construction financing have slowed investment in nonresidential buildings by U.S. businesses, nonprofit institutions, and government agencies. Construction of buildings, which began to slow in the second half of last year, moved into a downward spiral toward the end of the year. This industry will see no relief this year, but the decline will moderate somewhat as we move through 2010. The AIA Consensus Construction Forecast Panel projects a 16 percent decline in nonresidential construction activity this year, and an additional drop of almost 12 percent in 2010.

Spending on previously started projects masks the underlying weakness in new project activity. The AIA Architecture Billings Index (ABI), which measures design activity at U.S. architecture firms, has been declining since early 2008, indicating that there in substantially less activity at present in the design pipeline. McGraw-Hill Construction recently reported that construction starts on nonresidential buildings was down 43 percent through the first five months of the year compared to the same period in 2008. In terms of the outlook, commercial projects—office, retail, and hotel facilities—are projected to see the steepest declines over this downturn, reaching almost 25 percent this year and another 15 percent next. Institutional activity is forecast to see more modest drops of 6 percent this year and less than 3 percent in 2010.

Even though the U.S. economic recession officially began at the beginning of 2008, most categories of nonresidential construction activity held up well into the year due to the large numbers of projects already underway in the design and construction process before problems in the financial sector took hold. However, overall building construction slowed during the latter part of the year, and has continued to slide through the first half of this year.

Particularly hard hit have been key commercial building sectors, but even some relatively stable institutional sectors—such as education and religious facilities—have seen unusually large declines this year.

Nonresidential construction activity is destined for further declines before it recovers. The AIA Architecture Billings Index (ABI), which tracks design activity and leads most types of construction activity by 9 to 12 months, has shown declining levels of design activity since early last year, and at present is still pointing to further declines. Both McGraw-Hill Construction and Reed Construction Data are reporting steep declines in nonresidential construction projects that have begun work so far this year.

Economic weakness is pulling down construction activity
The downturn in the broader economy is limiting the need for new nonresidential facilities. The U.S. gross domestic product (GDP) declined by more than 6 percent on a seasonally adjusted and annualized basis in the fourth quarter of last year, and by almost 6 percent during the first quarter of this year. When we get a reading for the performance of the economy in the second quarter—which will be released by the Commerce on the last day of July—most analysts are expecting another sizeable drop, but probably less that we saw in the prior two quarters. By the end of the year, the consensus is that the economy will have begun a recovery, likely however to be quite mild at least initially.

Construction Consensus Forecast


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.

This economic downturn has taken its toll on construction, but construction has not been the only sector to soften. Manufacturing activity also has been very weak, not only because U.S. consumers are buying fewer manufactured goods, but also because the recession has spread internationally, so U.S. manufacturers are selling fewer goods abroad. The high-profile casualties of this manufacturing downturn have been U.S. automakers: domestic auto and light-truck sales dipped from almost 16 million in 2005 to just over 13 million last year, and in all likelihood to under 10 million this year.

As the economy has declined, business payrolls have shrunk. Our economy has lost six million jobs since this recession began, and almost three million through May of this year alone. The construction industry has taken some of the steepest losses. Though the construction industry accounts for just over 5 percent of all payroll employment in our economy, it has absorbed over 20 percent of job losses since the national economic downturn began. Architecture firms have been similarly hard hit. From peak employment levels of last July through April of this year, architectural firms have lost almost 31,000 positions, or almost 14 percent of total employment at firms.

Even with the deep declines that our economy has absorbed in recent quarters, there are signs that we may be beginning to emerge from this downturn. The housing market is finally showing signs that is nearing—or may even have reached—its bottom. Falling house prices and favorable mortgage rates are luring buyers back into the market. Both new and existing home sales have seen a noticeable increase since the beginning of the year. Even homebuilding levels seem to be slowly edging back up, but given the large inventory of unsold homes in the market, coupled with still-growing foreclosures that are adding back homes to this inventory, we’re unlikely to see much of a rebound in new residential construction in the near future.

In spite of step job losses and the national unemployment rate at its highest level since the early 1980s, consumers are starting to feel better about the economic outlook. Consumer sentiment scores have risen by almost 14 points or about 25 percent from their low of last November through this June, according to the University of Michigan’s Consumer Sentiment index. Households are even beginning to save again, although probably this has been motivated by concern over the uncertainty of the future, and by the desire to rebuild losses from falling retirement accounts and home values. Still, the savings rate was just half a percent as recently as 2007, and it is likely to rise to about 5 percent this year.

With a weak economy, the cost of goods and services has been edging down. Largely due to falling energy costs as compared to year-ago levels, consumer prices are down a percent from year-ago levels, while producer (wholesale) prices are down almost 5 percent. This is proving to be a fortuitous development for prospective building owners and developers, as a market basket of materials used in nonresidential buildings is off 6 percent from year-ago levels, according to calculations from the U.S. Department of Labor. Paced by steep price declines for petroleum and petroleum products as well as metals (steel, copper, and aluminum are off 20 percent or more) and lumber and plywood (off 14 percent), it is generally thought that most building commodity prices will begin moving back up once construction activity starts to increase.

Nonresidential building activity poised for further declines
There are signs that our economy is on the mend. However, nonresidential construction activity tends to lag behind the rest of the economy, so it will be a while before this industry sees any improvement. The AIA’s Consensus Construction Forecast Panel projects that nonresidential construction activity will decline almost 16 percent this year once inflation adjustments are made, and another 12 percent next year. If these numbers materialize, this would be the most significant downturn in nonresidential construction in more than a generation.

Commercial facilities are slated to bear the brunt of the downturn. Overall commercial construction is forecast to decline 25 percent this year and another 15 percent in 2010. The hotel market, which may have been a bit overheated heading into the downturn, may take the biggest hit through 2010, but retail construction and offices won’t be far behind. Industrial construction also will see a dramatic decline through 2010, with reduced demand domestically for manufactured goods as well as fewer manufactured exports due to an international slowdown. Panel members are divergent in their projections for this year due to different methodologies in developing estimates of activity from projects carried over from prior years.

Institutional construction markets should fare a good deal better. Total institutional construction is expected to decline just 6 percent this year and another 2.5 percent next year as stimulus-funded projects for schools, health care, and government facilities begin to kick in. Health-care construction (hospitals, clinics, nursing homes, etc.) is projected to decline hardly at all this year and next, while spending on education facilities (public and private, including higher education) should fall about 8 percent this year as continued problems in lending markets limit financing options and stock market declines hurt the endowments of private educational institutions. However, education construction should hold its own by 2010. Spending on government buildings is one of the few nonresidential sectors where spending is expected to continue to grow this year.

Stimulus program spending will help to cushion the downturn in the institutional sector, but will do little to help with commercial or industrial facilities. Funding allocations to the public works construction sector for activities such as streets and highways, bridges, water and sewer, and conservation projects are significant, but they are much more modest for buildings. Residential and nonresidential building stimulus projects are estimated to total as much as $35 to $40 billion over the next two years. For a $400 billion a year sector, spending at this level will help, but unfortunately not much for the private side of the market.

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