2008 Construction Forecast

It appears that the party is over for the construction market nationally. The subprime mortgage problem, which began as a potential blip on the radar screen of the commercial market, is now a 747 in the rear view mirror.

Residential Construction

The fallout from the defaults of high-risk loans is bleeding in to the overall lending market, as it is becoming clear that almost every lender has exposure to bad loans through the buying and selling of commercialized debt obligations. And many experts are beginning to predict that another round of bad news will emerge about mortgages in 2008, as the home equity loans that were behind the high-risk mortgages begin to fail.

Again, the culprits in this scenario will be identified as the 'predatory' lenders and aggressive homebuilders who enticed buyers with teaser rates. If the forecasters are right, the defaults will also be concentrated mostly on the east and west coasts, in citites where high rates of housing growth occurred. Here again, the defaults may be limited in location, but the securitization of the debt was nationwide.

The Standard & Poors' Case Schiller Index of home prices shows just how high and how quickly home prices rose since the beginning of the decade. The good news is that for the vast majority of homeowners, their homes have appreciated significantly, even if the value will fall back over the next year or so. The bad news is that to the extent that the vertical line is overhauled, it will need to come back to more reasonable, historical appreciation rates.

At the same time, the pressure is continuing on the credit market, there is evidence that demand has begun to slip for non-residential building as well.

"The credit crunch that emerged at mid-2007 continues to be a major concern for the construction and overall economy," said McGraw-Hill's Vice President of Economic Affairs, Robert Murray, at the annual Outlook Executive Conference in October. "As a result, we're now predicting downturns in the previously resilient multi-family and commercial segments, as well as continued weakness in single family construction."

Influencing Factors

There are a variety of factors influencing a slowdown scenario, each somewhat co-dependent on the other. The exposure of the credit problems, and the related stock market pullback, have started to erode consumer confidence and spending, and Christmas spending seemed to bear that out. The Fed's easing of interest rates in response to the potential slowdown has elevated the risk of higher consumer inflation, which is already creeping above 4%.

These factors elevate the likelihood of a recession in 2008, which would act as an incentive for more Federal Reserve rate cuts, which would deepen the risk of higher inflation, which has already gone to the point of killing developer plans because costs are too high, and...well you can see where this is going.

On a national level, the housing market ended 2007 with 24% fewer starts than in 2006. While there is absolutely no good news in that figure, it's worth noting that the rate of decline did not steepen throughout the second half of the year, even though the housing news certainly got worse. This appears to be a good indication that the bottom of the decline is near. For 2008, all economists expect to see a further decline in housing starts, but the average of their forecasts is a 3% fall-off.

Non-Residential Construction

The trend in non-residential construction is changing from growth to decline. McGraw-Hill Construction tracked a year-over-year increase in contracting for 2007 of 11%, while Reed Construction Data reported a 10% increase in contracting. Unlike the housing trend, however, hte non-residential market slowed in the second half of 2007, as McGraw-Hill and Reed had non-residential contracting up 14% and 17% respectively at mid-year.

The sectors most affected by the slowdown will be retail, hotels and travel, public works and offices. One of the positive results of the weak dollar is that American-made goods are cheaper, and therefore, the demand for manufacturing space remains high, which will offset some of the decline in commercial projects. The consensus of U.S. construction market forecasters is that the non-residential contracting will be off 2-3% in 2008.

One note about that number: the forecast is for contracting dollars. With construction inflation expected to be near double-digit rates, this means that the decline in inflation-adjusted dollars could be more than 10%.

Architecture/Engineering

As a final bit of evidence on the market's direction, billings for architectural and engineering services have begun to decline year-over-year in the fourth quarter of 2007. Hiring of architects did increase by nearly 4% in 2007, though, so a few months' observation will be needed to decipher whether or not the billing level is a lull or another harbinger of doom.

-Jeff Burd, Tall Timber Marketing Group, A Construction Market Research and Tracking Firm