US construction forecast: short-term bad news

The origins of the downturn lay in housing. From peak activity early in 2006, real residential construction fell nearly 10% by the end of the year. It contracted another 21% in 2007 and is likely to see even worse results in 2008 with another 30% decline. We now know that the housing boom was supported by easy credit and poor lending decisions on the part of banks and mortgage companies.

Even so, the residential downturn has not had a significant impact on crane demand in the United States. Cranes are not used heavily in American home construction, and non-residential construction has been extremely strong. Indeed, the recent situation for the crane industry in the US has been stronger than it was for much of the housing boom when non-residential activity was still subdued.

However, the downturn is spreading beyond housing, as credit tightens. The Federal Reserve has intervened with rate cuts, and at least two further cuts are likely. Congress and the White House have passed measures to assist consumers in the short term while providing some investment tax incentives for business. While monetary and fiscal stimulus will help, the timing of the intervention is such that the best that can be accomplished is a rebound during the second half of the year.

With housing activity and home prices yet to hit bottom (and still falling sharply) the downturn is now spreading more broadly throughout the economy. One problem is the consumer. Their primary source of wealth, their home, is losing value, which will induce them to save more. Additionally, rising home values funded a spending boom through home equity loans and lines of credit over 2004-06.

Between tighter lending standards, declining home values and consumer unease, increased spending via home equity is no longer desirable. The best that one can hope for is that consumer spending at least stays flat in the first half of the year. Consumer sentiment has hit the lowest levels since Hurricane Katrina in 2005 and stands at levels often associated with recessions.

Retail

This matters to cranes because of its impact on retail sales and retail construction. Growth in retail construction investment continued to enjoy very strong year-on-year gains through the fourth quarter of 2007. We expect that the effects of the downturn in the residential construction market will begin to trickle down through the retail construction sector, as it tends to lag that of the residential market by roughly eighteen months.

When residential developments are no longer built, it is only a matter of time before the impact is felt in the restaurants, corner banks and drugstores and even strip malls that also no longer need to be built. We feel that a decline in retail construction growth is imminent and is likely already underway in the first quarter of this year and that the slump in this sector is very likely to worsen through 2009.

Chain store retailers' most recent sales figures are slowing sharply. The International Council of Shopping Centers report for January showed a very sharp slowing compared to 2007. Wholesale clubs' sales grew most rapidly at 6.3% over the same period while furniture retailers saw their sales decline by 8.4%, no surprise given the severe downturn in the residential housing sector.

The forthcoming decline in retail construction will likely reverberate through the warehousing sector. Warehousing construction put in place is expected to fall 5% in 2008 and a further 11.4% in 2009. Significant growth in warehouse construction will be postponed until 2011.

Consumers are retrenching because employment growth has continued to fade, and turned slightly negative in January. The latest Federal Reserve survey of bank lending practices showed credit tightening sharply and broadly. The evidence suggests that not only are mortgages being scrutinised more closely, but commercial developments are also experiencing more rigid standards.

Offices and hotels

Recent bank financial performance suggests that renewed hiring is not in the offing for this sector, a key driver of new office construction. Declining vacancy rates and rising rents will not be sufficient to support the continued expansion of office construction for much longer, as weakness in service sector employment growth will put the brakes on the current expansion in 2008.

While it is true that recent office construction development has been solid based on strong underlying fundamentals, growth in financial service sector employment is beginning to waver thanks to financial market turmoil. New deals are being delayed because of difficulties in obtaining financing, corporate profits will continue to decline, mortgage applications are decreasing due to tightening in lending standards, and many lenders of sub-prime mortgages have experienced significant layoffs due to the fallout.

Although there will likely be some job growth seen in the professional and business services sector, it is unlikely it will be enough to eclipse the weakness in the financial services sector. While 2008 service sector employment growth will remain positive, it will reflect the third consecutive annual weakening and the lowest annual gain since 2004.

Construction values in the hotel sector increased by an eye-popping 62.9% last year, and 39.6% in 2006. The industry recently experienced a period of superb growth.

In general the hotel industry's fundamentals have been very strong recently. Hotels have experienced rising occupancy rates and average room rates as well as revenue per available room. These strong fundamentals have provided a need for continued expansion in the construction industry's hotel and lodging sector.

This fast paced expansion simply cannot be maintained indefinitely, however. We expect that construction outlays will slow in 2008 and are likely to retreat sharply next year. The contraction in lodging construction investment is a result of slowing demand from both business and, to a lesser extent, leisure travel. Business travel is afflicted by many of the same factors influencing the demand for office space, but the greatest factor here remains weakening corporate profits. Leisure travel will also show some signs of a slowdown as consumers rein in their discretionary spending. We expect the downturn to be somewhat short-lived and growth in lodging construction will resume in 2010 and 2011.
Manufacturing

The housing slump is acting as a drag on manufacturing output, at least over the near term. As long as the demand for new housing is low, there will be correspondingly low supply pressures from the manufacturing sector for housing related materials. Slower consumer spending and reduced housing demand erode the business confidence needed for capital investments, especially in the manufacturing sector.

Nevertheless, the slide in the value of the dollar relative to many of the US’s major trading partners has provided a lift to manufactured exports from the US. This is good news for the beleaguered manufacturing industry and developers. Last year's 9.2% growth in total manufacturing construction investment is expected to slow to 4% this year and just 1.5% in 2009. A return to double-digit growth is likely in the last few years of the forecast with renewed strength in all sub-sectors.

Construction of transportation manufacturing buildings will suffer, due in large part to the automotive sector, the Achilles' heel of the US manufacturing industry. The automotive industry's drag on manufacturing construction will be somewhat offset by a boost in the commercial aerospace sector as Boeing has developed a substantial order backlog. Global Insight expects a solid outlook from this sector, beyond the auto sector's near-term weakness.

Construction of chemical manufacturing facilities grew dramatically over the last three years but is slated to weaken over the forecast period. The US is a mature market for chemical sales. Sales remain highly dependent on the construction and automotive industries. As both these industries are experiencing a sharp down cycle, the outlook for chemical manufacturing plants is to flatten.

Construction of healthcare buildings will continue to grow throughout the forecast, only the medical office building segment will show deterioration through 2008, but the subsequent rebound will be robust. Total healthcare construction has posted exceptionally strong growth in the last two years. A 14.8% expansion in 2006 was followed by growth of 14.4% last year.

This growth is in large part due to the continued robust expansion in hospital construction, which comprises roughly 80% of total healthcare construction spending. Double-digit growth is expected again this year in the hospitals sector. Special care buildings, which account for the smallest share of healthcare construction spending, expanded by 7.6% last year and are likely to continue to expand rapidly. Only medical care offices will post declines this year and next.

Transport

Highway infrastructure spending will remain positive throughout the forecast period, but growth is slated to diminish as the expiration of the 2005 Highway Bill approaches. According to the American Road & Transportation Builders’ Association highway and bridge construction (which accounts for the largest share of transportation projects) rose from $57.2bn in 2003 to $77bn in 2007, a 34.6% increase. The value of highway pavements increased nearly $2bn in 2007, while that of bridge construction leaped nearly $3bn, almost a 14% increase from 2006.

Other transportation construction sectors are showing growth as well. Airport runway construction gained 6% in 2007 despite being flat the previous year, while subway and light rail construction jumped 13% in 2007 after a small drop in 2006. Global Insight expects growth of 5.6% in 2008, the value of highway and street construction will likely surpass $82bn.

The federal budget for fiscal year 2009 includes $68.2bn for federal transportation programs, a $2.13bn decline from the previous fiscal year. A budget cut in fiscal year 2009 highway investment may be coming.

The larger, more immediate threat to street and highway construction, indeed, to all public construction including schools, is the effect of the recession on state and local tax revenues. While most state and local spending for 2008 is already funded, the outlook for 2009 is likely to be more subdued.

Residential

In summary, the residential construction sector finished last year with a dismal 19.4% decline from the fourth quarter in 2006, with further declines expected through 2008. We expect that residential construction levels will reach their trough in the third quarter of 2008; however, the rebound in year-on-year growth rates will not be experienced until the second quarter of next year. From the first quarter 2006 peak to the anticipated trough in 2008 quarter three, residential construction investment will have fallen 52%, about $363bn. Investment in multifamily structures, which will reach a trough somewhat later, is likely to experience a much more subdued rebound, and will not show positive year-on-year growth until early 2010. Total residential construction will enjoy significant rebounding throughout the end of the forecast period.

Private non-residential construction continued its amazing run in the fourth quarter. On a year-on-year basis, it was up 16.5%. The growth has been remarkably consistent, increasing for 15 consecutive quarters. Areas of strength included: lodging, office, educational, amusement and recreation, transportation, communications, power, and manufacturing. These building types expanded at double-digit year-on-year rates.

Despite the apparent momentum, our outlook for this sector is dimming. Side-effects of the housing downturn, tightening credit conditions, and a slowdown in the US economy are all taking their toll. Global Insight forecasts spending on non-residential construction grows only 4.6% in 2008 and then contracts 2.5% in 2009. The downturn is broad based, but spending on commercial buildings will likely take the biggest hit.

Some sectors of the non-residential construction industry will enjoy positive annual growth this year however they are expected to begin contraction on a quarter-to-quarter basis during the second half of the year. Both the office, and lodging, sectors of the commercial construction industry will eke out low single-digit growth this year, but will likely weaken significantly next year. Construction values of retail structures are expected to begin contraction this year and continue into 2009 in the wake of the housing market bust. The manufacturing sector will also slow considerably this year. Construction values of food processing plants, plastics, non-fabricated metals and computer manufacturing facilities are expected to decline this year. Construction of healthcare buildings will continue to grow throughout the forecast, only the medical office building segment will show deterioration through 2008, but the subsequent rebound will be robust. Highway infrastructure spending will remain positive throughout the forecast period, but growth is slated to diminish as the expiration of the 2005 Highway Bill approaches.