Keeping house: nonresidential construction flourishes, but slow housing starts and credit woes put downward pressure on the construction market.
The construction industry of 2007 has been something of a see-saw, with total spending numbers depending largely on the margins between the high-rising nonresidential sector and sluggish residential construction.
Month after month, the pattern has repeated residential housing starts continue to falter, and some months, the surge in nonresidential building is enough to make up for the housing slump--in other months, it isn't.
As of press time, the latest construction industry numbers released by the U.S. Census Bureau reported an increase of 0.2 percent in total construction spending in August. The seasonally adjusted annual rate of $1.167 trillion saw an increase over the revised total from the previous month, but the figure was still down 1.7 percent from the same time period last year.
According to Ken Simonson, chief economist for the Associated General Contractors of America (AGC), private residential construction spending fell 1.5 percent--the 18th consecutive monthly decrease--while private nonresidential construction increased 2.3 percent. This gain was accompanied by a 0.7 percent increase in public construction.
According to Simonson, the nonresidential sector has played a large part in bolstering the entire industry. Referring to the October employment report issued by the Bureau of Labor Statistics, Simonson says, "Today's employment report shows nonresidential construction is still boosting the economy, despite the homebuilding meltdown.
"Seasonally adjusted total construction employment fell 14,000 in September, and that was down 112,000 or 1.5 percent compared to September 2006," he continues. "But that masks divergent trends in nonresidential and residential construction."
Simonson says the employment pattern of the two sectors mirrors the balancing act spending patterns on the surface. "The BLS numbers show that over the past 12 months, employment in the three nonresidential categories--nonresidential building, specialty trades, plus heavy and civil engineering--climbed 42,000 or 1 percent," he says. "Meanwhile, residential building and specialty trades employment supposedly shed 154,000 jobs or 4.5 percent. That gap, while large, vastly understates the actual difference," he says. "Census Bureau figures for August show residential construction spending was down 16 percent from a year before, and nonresidential was up almost 15 percent. With all signs pointing to still less homebuilding ahead, it's likely that residential employment is also down roughly 16 percent. That means about 400,000 'residential' specialty trade contractors are now doing nonresidential electrical, plumbing and other work."
Simonson says that reclassifying these workers would show nonresidential construction has actually added more than 10 percent to its payrolls. "Moreover, the BLS report shows there is more growth ahead. Architectural and engineering employment rose 3 percent in the past 12 months. Their output will turn into construction jobs in the next several months."
Construction employment isn't the only aspect of the market suffering from levels of uncertainty and bleak outlooks. Simonson says market watchers can expect the cost of that labor as well as the cost of construction materials, to increase as well in the coming year.
The AGC released its fifth Construction Inflation Alert in early October, warning owners, budget setters and contractors to expect larger materials and labor cost increases in 2008 than they have experienced in the past 12 months.
"Nonresidential construction has had a banner year so far in 2007, and we've seen spending on nearly every segment increase compared to 2006, despite the plunge in homebuilding," says Simonson. "The materials cost surges that plagued the industry in 2004-2006 have slowed dramatically, and labor remains available in most markets."
Simonson warned that many observers expect that the end of the calm is coming soon. "The worsening slide in homebuilding and turmoil in the credit markets threaten some types of nonresidential construction. At the same time, some materials costs are beginning to turn up again, and labor costs have started to accelerate," he says.
The cumulative increase in producer price index (PPI) for construction input since December 2003 (28 percent through August 2007) remains more than double the 13 percent increase in the most common measure of overall inflation, the consumer price index (CPI) for all urban consumers. Labor costs, in contrast, have risen at a similar rate for construction and for the private sector as a whole.
The cumulative difference matters because the estimates for many projects now being bid, especially in public facilities, were prepared in 2003-2005 under the assumption that construction costs would escalate at the same rate as the CPI. That divergence explains why some projects are being canceled, delayed or entirely redesigned.
"The housing meltdown and the more recent credit market turmoil do have some spillover effects on nonresidential construction," notes Simonson. "Retail, suburban office and local government construction are especially affected by the drop in homebuilding, home sales and property values, respectively. Tighter lending standards and financial-firm layoffs will trim construction of offices and other income-producing properties, such as hotels and warehouses."
Meanwhile, the nonresidential industry has benefited from greater availability of specialty trade workers who have lately shifted from residential work. Simonson adds, "But wages have begun rising more steeply for specialty trade contractors, suggesting that the number of workers suitable to switch is close to exhaustion. In the next several months, the rate of wage increases is likely to reach 5 to 5.5 percent, up from a recent 4.5-percent gain."
Labor costs are likely to accelerate further as well if residential building begins to draw back specialty trade contractors to late 2008. "Construction wages could go up 5 percent to 6 percent annually for several years beginning in 2008," Simonson says.
Simonson addressed additional concerns over the rising costs of doing business in the construction industry with other industry experts earlier this year during an audio conference sponsored by the AGC.
Strong economic growth is likely to keep many construction materials' inventories tight and prices high in the near future, according to Jason Schenker, Chief Economist, Wachovia, who also participated in the audio conference.
Schenker said market analysts are seeing indicators of strong growth in U.S. gross domestic product (GDP) and worldwide GDP. "What does this mean?" he asked. "In the near term, it means greater upside risks for commodity markets, especially markets with tight inventories," like metal markets.
Nickel stainless is among materials commanding the highest prices on the market today, said Bob Garino, Economist, Institute of Scrap Recycling Industries (ISRI), who also participated on the panel. "Nickel is the one market that has outperformed all other LME metals," Garino said. "Stainless production continues to set the pace, and U.S. mills continue to struggle with high prices and soft orders."
He added that prices are so high that consumers are looking for substitutes for nickel-containing stainless. "People looking to alternatives, and once consumers get used to that and find performance is good enough, it's going to be tough for the market to switch back," he said.
Global steel markets, paced by Chinese production, are supplying plenty of steel, Garino said. "Last year, more than 1.3 billion short tons were produced globally," he said. "This year global production is expected to increase by 5 percent or more, another 70 million tons looking for homes." Overall market sentiment has cooled regarding finished steel demand for flat rolled products and scrap prices response, and market analysts have developed a more conservative third quarter outlook, according to Garino.
Asphalt prices, which are tied to the price of crude oil, will also remain high by historic standards for the near future, added the AGC's Simonson.
On the other end of the pricing spectrum, the market for gypsum, used widely in both home construction and non-residential buildings, is likely to remain very weak. Prices have begun to fall and are likely to remain down, according to Simonson, based on the lagging construction market in the U.S.
Schenker added that PVC and other products tied to oil and natural gas are also likely to experience climbing, if not surging, prices. "As long as oil remains high and long as natural gas prices trend upward, it's hard to imagine significant price alleviation on PVC," he said. "PVC prices are driven by natural gas, and there is some softening in demand from residential demand, but there is much nonresidential and non-construction demand so we'll continue to see high prices."
Given the economic outlook, the analysts agreed that markets for many materials used in the construction industry will remain tight, leading to higher prices. "These markets are about supply and demand," said Garino. "When supply is tight and growth continues and that means risks are to the upside. There are some very expensive raw materials out there."
The AGC's Simonson says he expects growth to continue in the nonresidential sector. "In the year ahead, I expect some pullback in office, retail and hotel construction, but more growth in energy, power and hospital work," he says. "Highway construction is also vulnerable unless Congress and the states add more revenue to fund highway programs. And accelerating costs of labor and materials will again be tough for contractors, private owners and public agencies doing construction."
The author is associate editor of Construction & Demolition Recycling and can be contacted at email@example.com.