Slow recovery awaits U.S. construction industry 

Posted December 2009

The December 2007 drop in Gross Domestic Product (GDP) was a glaring indicator that a recession in the U.S. had begun.

In the first quarter 2009, GDP fell 6.4% - the largest drop since 1982. People are anticipating a recovery, as many economists believe, but some uncertainty accompanies this optimism. With unemployment nearing 10%, job creation, which tends to lag economic growth, is slow.

Growing national debt and the falling U.S. dollar may create difficulties for the recovery.

Annual growth of GDP and private construction (current dollars) 

When will the design and construction services market improve?

How does it look right now?

• Construction put in place, as measured by the Census Bureau, fell 6.8% last year.
• Non-residential construction grew about 10%, largely from existing contracts.
• Residential construction continued in steep decline.
• The value of construction put in place will fall more than 10% this year (2009).
• The construction industry has the highest unemployment rate, about 17%.

Weak recovery for construction through 2010 with modest growth in 2011

• The second quarter 0.7% drop of GDP indicates a leveling of GDP losses.
• Third quarter GDP should show signs of growth and continuing slow increases
• Each local market will respond to its particular conditions, faring better or worse than the national average.
• Based on GDP growth, we predict weak recovery for construction through 2010 with modest growth in 2011.

Residential is first to suffer and first to recover

• Typically, residential work leads in the first year of construction expansion.
  
• At its peak, residential construction volume accounted for 55% of total construction value, but may be less than 30% this year. 
• Significant annual reductions began in 2007 with 19%, worsened in 2008 to 29% and will continue in 2009 at 25% (estimate).

Construction put in place (constant 2000 dollars) and employment growth

Business cycles - trough to trough
November 1970 - March 1975
March 1975 - July 1980
July 1980 - November 1982
November 1982 - March 1991
March 1991 - November 2001
November 2001 - 

Residential should grow in 2010 as volume is beginning to turn around this year. However, growth will likely not be strong during the first few years of the recovery. Residential growth rates are unlikely to match pre-recession rates - averaged annual growth of 15% between 2003 and 2005.

The American Institute of Architects (AIA) Architecture Billings Index continues to show a decline in billings. The index indicates continued reduction in the volume of non-residential construction. The percentage decline should be less in 2010.

Public sector continues modest growth

We are seeing the traditional recession pattern - increasing public sector spending and decreasing private sector spending.

• Typically, public sector spending is about 25 percent of total construction put in place.
• "Shovel ready" public sector spending, possible through the Federal Recovery Act, is unlikely to offset the dramatic drop in private sector spending.
• However it should help keep public sector spending growing and also offset drops in state construction, which will fall due to lower tax revenues.
• Employment must rebound rejuvenating tax revenues before state construction will rise.
• So, it may be a couple of years before state construction rebounds.

Private sector will improve slightly in 2010

• Private sector non-residential construction put in place should decline about 10% this year.
  
• We think 2010 will experience slightly improved results. 
• A modest increase in the non-residential sector put in place values should begin in 2011 as GDP growth strengthens.

Challenges for the non-residential market

Office and retail vacancies will slow the recovery. Sustained growth of business and consumer confidence is important for a return of business and consumer spending needed to help fuel construction.

However, it is unlikely consumer spending will reach pre-recession levels. The loss of wealth and expectations of reducing levels of consumer debt going forward - at least in the near-term as memories of the recession linger - will limit construction growth. While strong through most of 2008, institutional spending is falling in 2009.

Financing for commercial projects is an ongoing obstacle. The tightening of lending standards will slow the pace of construction even as the credit markets rebound. We may see higher interest rates - an additional throttle on an upturn in commercial development.

Volume will not reach pre-recession levels for several years

• Construction volumes, especially for residential, were not at sustainable levels.
• Tighter lending standards will constrain the demand for housing.
  Non-residential construction will be slow to recover to the pre-recession levels.
  
• Speed of recovery in the general economy will influence the sector.
  
• Stimulus spending will impact on inflation during the post-recovery period. 
• Higher inflation may slow recovery.

Construction cost influences

As expected, bid prices fell during the recession. Turner's Building Cost Index, which measures in place construction (output), fell more than 10% during the first 3 quarters this year. The New York City Building Congress reported costs are down 10% this year.

Building cost indexes prepared by the Bureau of Labor indicate a decline of 1 to 5 percent through August. Various input indexes indicate steady to slight declines during the first part of 2009.

Much of the decline in output type indexes is a result of competition and its effect on intangible costs (profit, overhead, opportunity, etc.), which the input cost indexes do not measure. Output (selling) indexes, eg. Turner, provide a measure of intangible costs and overall costs.

Overall costs will likely hold steady or decline, even though input costs for specific construction materials are generally rising. Generally, material prices will decline through 2009, but labor costs will rise slightly.

Looking ahead

• Worldwide, commodities volatility will continue to plague construction materials costs.
• Asia, particularly China and India, will keep pressure on prices for some key commodities.
  
• Material costs will begin increasing in 2010 as the expected residential market recovery begins.
  
• Labor costs should remain within their expected norm for annual inflation of 3 or 4%.
• High inflation could push labor costs higher.

Construction prices will rise

• Slow growth in building volume is expected, but construction prices will likely rise quickly as the building volume begins to grow.
  
• Historically, construction costs regain the intangible reductions quickly. A sluggish uptake in volume may slow this process, but prices will rebound more quickly than volume. 
• As before the recession, material prices will rise faster than overall inflation once the building recovery begins.