The latest Construction Spending report (for June) sheds light on four developments that will affect the course of the recovery.
The key one is the turnaround in single-family home construction, which increased for the first time in 40 months. Residential construction has been a significant drag on economic growth since the first quarter of 2006, mainly because of the collapse in single-family housing. During the first half of this year, residential construction spending chopped 1.1 percentage points off GDP growth. But going forward, perhaps as soon as the third quarter, it will start adding to growth because of the pickup in single-family home construction.
The second development is the collapse in the market for multi-family homes (i.e., the rental market). Multi-family construction spending tumbled 7% in both May and June. This market is being hit on two fronts. Tight credit and overbuilding are hammering multi-family housing construction. As a result, new construction has nearly ground to a halt. The rental market is also being hurt by falling house prices, which is swaying renters into become homeowners. As a result, rental vacancy rates are going up. Indeed, the national average jumped to 10.6% in the second quarter—a record high (data start in 1956).
The third development is the worsening downturn in private nonresidential construction. Until recently, an unsustainable surge in spending on pipelines and refineries had pumped up these numbers. However, in June, spending on pipelines and refineries slipped, and April's and May's estimates were revised down substantially. Going forward, spending on refineries will plunge because current spending levels are unsustainable.
A number of other nonresidential construction categories will also plunge—or plunge further—because of mounting problems on several fronts. These include:
- Overbuilding, as too many hotels, retail stores and malls, and higher education buildings went up during the expansion.
- The securitization market for commercial real estate loans is still frozen.
- Banks are not lending, so loans coming due cannot being rolled over.
- Delinquency rates for commercial real estate loans, as a result, are rising.
- The price bubble, which was as large as the one in housing, burst in late 2007, a little over a year after housing prices peaked. Commercial real estate prices are now plummeting.
- Vacancy rates are rising.
The outlook for private nonresidential construction over the next year is grim. Real spending levels on buildings will decline at double-digit rates in both 2009 and 2010. By late 2010, after most of the building excesses are eliminated and the U.S. economy is on a more solid footing, this sector will start to turn around.
The fourth development is the recent surge in public construction spending, which increased for the fourth straight month. The spending gains in June were across the board. But spending on highways and streets increased only 0.2% and has been flat since the beginning of the year, indicating that the stimulus bill is having a marginal impact on infrastructure spending. (The lion's share of infrastructure spending associated with the stimulus package will take place in 2010 and 2011.)
On balance, the drop in private nonresidential and multi-family housing construction will outweigh the gains from infrastructure and single-family home construction. As such, construction spending will be a drag on GDP growth through the first quarter of 2010.
by Patrick Newport