Expert Forecasts What to Expect from the Construction Market in Coming Months
May 5, 2010

As Kermit Baker, chief economist for the American Institute of Architects (AIA), stated during a recent construction forecast, "It's been a tough construction cycle. Even though most of the rest of the economy has been performing reasonably well, the construction sector has not caught up with it yet." Baker was one of the economists who spoke yesterday during a construction market webinar organized by Reed Construction Data, the Associated General Contractors of America and the AIA (CLICK HERE for related article). Baker provided perspective on trends in the housing market and also some of what architects are saying about conditions in the non-residential market.

"Housing is one sector that has posted disappointing results so far in its recovery. It hit bottom over a year ago, but the key housing indicators (housing starts, new and existing home sales, etc.) have seen only modest gains to date and even though house prices are stable, or even slightly increasing, they have fallen more than we've seen in any recession over the past 75 years," said Baker, who explained that prior to this down turn housing prices had never fallen during an entire calendar year on a national basis.

"Housing prices fell almost 30 percent, but all major indices of housing prices show them stabilizing if not recovering," he said. "On the other hand, there are still some markets that could see further declines, but that's a lower and lower number."

Looking at the country, Baker said there are two main categories that saw the least in terms of price declines. These are old-line manufacturing cities where prices really never boomed and benefited from the recent uptick in manufacturing activity and the other group is the energy-based economies.

"So the corridor from Austin to Boston has been the best in terms of holding its prices," said Baker, adding that areas that had been extremely over-built, such as Las Vegas, Phoenix and parts of Florida, have seen very steep pricing declines.

"Falling house prices have put many homeowners in a precarious situation where the outstanding mortgage balance is greater than the value of their home and unfortunately this is an increasingly common situation," said Baker. "Almost a quarter of the homeowners with mortgages are under water as of the end of last year; an additional 5 percent have less than 5 percent equity in their home so they are vulnerable of going under water if the prices were to drop any more in their area."

As he previously stated, Baker said housing market improvements since the beginning of last year have been disappointing.

"Typically we see housing activity improve 20-30 percent in the first year of a recovery; this time new and existing home sales are up less than 10 percent and housing starts are up less than 20 percent," he said. "To get those numbers we needed a strong performance in March; prior to March they were running below that."

In terms of architectural trends, Baker referred to the AIA's Architectural Billings Index (ABI), which he says is trending up, but very slowly. In terms of its different sectors, single family residential has been the strongest of late and, according to Baker, there have been some signs that once we work off excess multi-family inventory there might just be some improvement on the rental side as well.

Both the commercial and industrial sectors, as well as institutional, have leveled off and "we have not seen much in terms of promising signs in recent months and they don't seem like they are ready to turn around," says Baker.

Looking at the ABI on a regional basis, architectural firms in all regions are still reporting modest declines in activity. Firms in the Midwest, though, seem to be the closest in terms of recovery and the index also shows that firms in the Northeast have also done a little better than average in recent months.

Baker says commercial property values are affecting the non-residential construction outlook to a significant degree.

"The over-supply of buildings and the resulting drop in rents has pushed down property values. Commercial property values have dropped about 40 percent since their high in early 2007," said Baker, who added that there are a couple of important implications of this decline.

"One is it's very difficult to justify the cost of a new facility when existing facilities have declined so much in value," Baker explained. "Second is that as existing facilities come up for refinancing lenders will no doubt re-appraise their value and cut back on credit, which could lead to a serious default situation in the commercial sector, akin to what we saw in the residential sector: if values don't come back before refinancing need to occur they may not cover the value of the outstanding mortgage."

So, where things are heading and when we might see the beginnings of a turn-around? Baker says we can look at the last three recessions, see how they unfolded, and find four major benchmarks to go by: the stock market, gross domestic product (GDP), payroll employment and non-residential construction starts.

Typically, according to Baker, we begin by seeing improvements in the stock market, followed by some improvement in the broader economy (GDP). If that is sustained, then businesses will bring back payroll employment and if that continues to grow and businesses start to think about adding new facilities, that's when non-residential construction starts are likely to pick up.

In this recession, the stock market hit its low in March 2009 and the general economy picked up around June or July 2009. In terms of payroll employment, Baker expects that to pick up probably by the second quarter and toward the end of the year we could possibly see an increase in non-residential starts.

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