Ailing residential market impacts overall construction outlook
Jan 1, 2008 12:00 PM
As the construction outlook continues to slide due to an ailing residential market, economists fear a broader turnaround may be delayed until 2009.
After a year in which total housing starts are expected to drop to 1.363 million, things don't look much better in this market for 2008, where the numbers are forecast to plummet 11.9% to 1.2 million, according to National Association of Home Builders (NAHB) projections.
NAHB Chief Economist David Seiders anticipates single-family unit starts to show a 50% decline from their peak in the first quarter of 2006 to a trough in next year's second quarter.
Though the outlook for the current housing downswing is bleak — with starts, sales, prices and permits off — some economists are saying they expect the industry to bottom out and start turning around in 2008. Seiders' short-term forecast is based on several assumptions: skillful management of monetary policy by the Federal Reserve, maintenance of solid growth in personal income and employment, a manageable wave of home mortgage foreclosures, and better performance of mortgage markets going forward.
However, he observed that the long-term potential for housing activity is good. “By the end of 2009, we may be at a pace of 1.5 million units of new housing production (including manufactured homes),” he explained. “Once we are out of the woods, we should see good growth in front of us — maybe 2 million [units] per year.”
McGraw-Hill Construction's annual Construction Outlook report sees more positives in the 2008 market than some, forecasting an overall drop in US construction spending for next year, fueled by tighter lending conditions and weaker job growth. Against this backdrop, the level of new construction is expected to decline 2%, to $614 billion, following an 8% fall in 2007.
Mirroring the NAHB forecast, Portland Cement Association (PCA) Chief Economist Ed Sullivan sees real construction spending contracting in 2007 and 2008. He does not anticipate a recovery in housing starts until mid-2009, with regions experiencing boom/bust conditions to endure a longer recovery. In addition, the prospects of slower economic growth combined with tighter credit conditions are likely to result in a contraction of nonresidential construction activity during 2008. Sullivan expects a more subdued pace of job creation to moderate growth in state revenues and materialize in more subdued growth in public construction activity in 2009 and 2010.
PCA believes the possibility of a recession materializing in the next six months is 40%. It expects the Federal Reserve to reduce the interest rate 75 basis points during the next three quarters. However, if the impact of the sub-prime mortgage crisis is worse than expected and energy costs hit consumers harder, a recession is possible.
“If a recession occurs, construction spending will decline nearly 13%, causing a 10% decline in 2008 cement consumption and decreasing kiln utilization rates to 85%,” said Sullivan. “An additional 3.8% consumption decline would occur in 2009, followed by growth in 2010.”
PCA expects 2007 cement consumption to decline 6.9%, followed by a 2.5% fall for 2008. Gradually, powder usage is expected to recover in 2009, but volumes are expected to remain below the record levels (set in 2005 and 2006) until 2011. According to PCA's baseline cement consumption scenario, the current peak to trough reflects nearly a 12-million-metric-ton reduction, or a 9.1% decline (2005-2008). It is likely that domestic capacity increases will outstrip growth in consumption during 2007-2009. Reduction in imports, lower capacity utilization rates and potentially higher-than-desired inventory levels may characterize this period.
Significant increases in clinker capacity are expected to materialize during 2008-2012. The US cement industry has announced plans to increase clinker capacity by nearly 25 million metric tons between 2007 and 2012. The aggressive capacity expansion reflects a $5.9 billion investment, which will increase capacity 27% compared to 2006 US clinker capacity. The expansion spans seven greenfield sites and expansion of 18 existing facilities.
The likelihood of weaker near-term cement consumption, coupled with the aggressive expansion in capacity, may result in lower kiln utilization rates. During the height of the past cyclical peak (2005), PCA calculated kiln utilization rates at 95%. These rates could slip to a range of 85% to 87% during 2008-2009. A one percent reduction in utilization rates translates into a 1-million-metric-ton reduction in domestic supply.
Powder import volumes are expected to show a sustained decline throughout most of the forecast — remaining at or below 20 million metric tons. Imports are expected to decline 33% during 2007, followed by an additional 17% reduction in 2008, an 11% drop in 2009, and a 5% fall in 2010. The expectation of stronger consumption leads to a small increase in imports by 2011, according to PCA's forecast; however, the likelihood of sustained high freight rates adds downside risk to these import projections.
Increases in demand for seaborne trade have pushed freight rates to record levels. Through September, rates from Asia to the United States have increased $17 per ton, or 31%, since a year ago. Transatlantic freight rates have reached nearly $16 per ton, or 52%, since 2006. While dry-bulk freight rates are highly volatile, PCA believes that further tightening may materialize during the next two years or longer.
According to PCA, real construction spending is expected to decline 3.9% in 2007 and 3.7% during 2008, leading Ed Sullivan to expect the residential building recession to continue into 2009. Given the number of expected housing starts through 2008, plus the unsold home inventory, likely foreclosure rates and new structural lending restraints on home purchases, PCA does not believe a recovery in starts activity will materialize for at least another six quarters.
Critical cement-consuming states that fully participated in the housing boom, such as Florida and California, may not see a housing recovery until 2010.
In past forecasts, strong sustained growth in nonresidential construction was expected to cushion the adverse impact on cement consumption arising from housing sector weakness. While the potential still exists for this scenario, PCA now expects a modest decline in nonresidential construction to materialize in 2008, compared to strong 2007 levels.
Year-to-date, real nonresidential put-in-place construction spending is 17% above 2006 levels. In contrast, McGraw-Hill Construction Dodge contract awards data have shown declines in nonresidential construction activity for 10 consecutive months. Nonresidential construction activity is highly sensitive to changes in broader economic conditions and can result in rather sudden and dramatic changes in volume.
McGraw-Hill's Construction Outlook finds some positives in 2008. Transportation projects should continue to see moderate growth amid a renewed emphasis on infrastructure maintenance and upgrades, particularly in the aftermath of the I-35W bridge collapse in Minneapolis. Financing from public sources will stay generally supportive, and the growth of public-private partnerships also offers the potential for greater funding. Finally, growth in “green” construction practices means that the demand for sustainable building design and materials will continue to rise.
The report also highlights institutional building, which it says will rise 4% in dollar volume, while square footage edges up 1%. School construction is poised to strengthen again after its 2007 pause, and transportation terminals also are expected to grow. The other institutional structure types, including healthcare facilities, will see a modest loss in momentum. In addition, manufacturing buildings will retreat 11% in dollar volume, after a 40% surge in 2007 that featured the start of several unusually costly projects plus a large number of ethanol plants. Square footage for manufacturing buildings in 2008 is expected to advance 5%.
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