2010 Construction Outlook

The construction market ended 2009 in as bad a shape as it has been in for almost two decades, with non-residential construction plummeting and housing construction at record post-World War II lows. For the overall economy, however, the year ended with a host of indications that recession was morphing into recovery.

Some of the boldest pronouncements came from the National Association of Business Economists (NABE).  NABE conducted its annual meeting in October in St. Louis, and made headlines by declaring that the Great Recession was over. On the heels of their annual meeting NABE published its 2010 outlook. The forecast contained a number of major points:

• Gross domestic product will grow at a 3.2% rate for all of 2010 (this is an upward adjustment from NABE’s earlier forecast).
• The jobless recovery will turn to a recovery adding jobs in the first quarter of 2010. NABE’s economist panel predicted a decline in unemployment to 9.6% by fourth quarter 2010.
• Household spending will remain sluggish but the housing will gain momentum. Experts forecast a 38% jump in housing starts and an 8% increase in residential investment in 2010 due to low prices and low interest rates.
• Business investment will be the main engine of growth in 2010
• Corporate profits will climb 12.4% in 2010
• The dollar will remain weak. Short-term interest rates will remain below one percent and inflation will not be a problem in 2010.

NABE’s economists were divided about the need for further stimulus or Federal Reserve manipulation. The biggest source of concern expressed was for the federal deficit during the next five years.

Reinforcing NABE’s optimism about the housing market, the National Association of Realtors reported that existing-home sales increased 11.4% to a seasonally adjusted annual rate of 5.3 million units in the third quarter from 4.76 million units in the second quarter, and are now 5.9% above the 5.01 million-unit pace in the third quarter of 2008. Sales increased from the second quarter in 45 states and the District of Columbia; 28 states and D.C. saw double-digit gains. Year-over-year sales were higher in 32 states and D.C.

Lawrence Yun, NAR chief economist, said the tax credit is a significant factor. “We can’t underestimate just how powerful a catalyst the first-time home buyer tax credit has been for the housing sector,” he said. “It’s given buyers the confidence they needed to get off the fence and take advantage of extremely affordable housing conditions. The buying conditions this year are the most favorable on record dating back to 1970, but the tax credit is allowing buyers to set aside any reservations about waiting for a better deal.”

Data on home values was mixed, however. During the third quarter, 123 out of 153 metropolitan statistical areas reported lower median existing single-family home prices in comparison with the third quarter of 2008; however, the national median existing single-family price was $177,900, up for the second consecutive quarter but still 11.2% below the third quarter of 2008. Distressed sales accounted for 30% of transactions in the third quarter, which continued to weigh down median home prices.

During the second week in December, the economy received several surprising bits of data that added to the hope of a recovery underway. First came the Department of Labor report showing a decline in unemployment from 10.2% to 10%. At the end of the week came the report on consumer spending in November that showed a 1.3% increase on the heels of a 1.1% increase in October. November’s data also marked the fourth straight month of increases. And the University of Michigan’s Consumer Sentiment Index showed an increase to 73.4 in its early December survey, up from 67.4 in October and the low near 40 in January.

PNC chief economist Stuart Hoffman assessed the November jobs report with relief rather than celebration but did find cause for optimism.

“We’re still losing jobs – that’s not good – but the rate of job losses has really tapered off,” Hoffman remarked in a podcast for Marketwatch on December 4. “Our forecast all along has been that the economy will be creating private sector jobs in the first quarter of 2010, and we came pretty close to it in November. With revisions we may still find that we did.”

Hoffman noted that while it looked like the jobs recovery may have finally begun, it was important over the next year for the job creation move from government to private business.

Assuming that the reversal in these indicators is part of a trend the national economy is setting up the conditions for a recovery in the amount of non-residential construction, although it is virtually inconceivable that such a recovery will occur before 2011. In the meantime, the data on national construction activity is showing a slowdown in the rate of decline year-over-year.

The Bureau of Economic Analysis announced in late November that real investment in non-residential buildings fell 15% in the third quarter, following a 17% decline in the previous quarter and a 43% drop in the first quarter of 2009. Mirroring the trend in other data the real residential investment popped 19.5% in the third quarter, the first increase in residential investment in 14 quarters. BEA also tracks governmental gross investment in structures, which rose 10% in the third quarter after a 24% increase in the second quarter. The increased government investment, of course, is tied directly to the American Recovery & Reinvestment Act, which is moving through the state budgets. A Federal Highway Administration report in November found that 77% of the stimulus money earmarked for highway construction had been obligated (meaning contracted) and about 14% had been actually expended in payments to contractors.

No real report card exists as yet for the ARRA impact; however, a few trends have emerged that are important to next year’s construction economy. The most efficient conduits for the stimulus have proven to be the departments of transportation (go figure), primarily because they have a formula for assessing needs and distributing money as allocated. Much of the ARRA funding was earmarked for federal agencies, which have been less nimble, or are being distributed through multi-agency channels, like in the case of water projects, which originate locally but fund through states. The net effect seems to be that the stimulus will be distributed fairly evenly between 2009 and 2010.

If this proves to be the case, the additional funding will be some relief for state level construction in 2010. States are currently facing revenue shortfalls across all categories of taxes. The recession has suppressed consumer spending, keeping sales taxes lower, and reduced fuel consumption, which also reduced fuel tax revenues. And the precipitous decline in home values has eroded the property tax base. As of December 1, shortfalls existed in 35 states for the current fiscal year, and the likelihood is that revenues will actually be lower in most states in fiscal year 2011.

The lower revenues have already meant less public construction in many states, even with the added influx of funding from ARRA. By the start of fiscal 2011, most states will face a real gap between their available capital and their capital needs. Beyond the direct capital spending impact, the revenue shortfall is also beginning to be felt in the states’ ability to provide secondary or incentive funding to municipal government and private development. Budget showdowns, like the one in Harrisburg last summer, also have negatively impacted construction even when funding has been left intact, because the release of funds was delayed by the protracted negotiations. Showdowns have occurred in a number of states, and that number is likely to rise next year.

After eighteen months of economic turmoil the American economy appears to be moving again. On a limited basis, the drivers behind the growth in residential and retail construction are firming up. Global recovery, particularly in the emerging countries, is perking up manufacturing and the related categories of transportation and distribution. The biggest question marks for construction in 2010 remain the pace of job recovery and the healing of the credit markets.