2009 National Outlook: How Low Can it Go?

By Bruce Buckley

Given the weak economy, there’s little doubt that construction activity is set to take a dive in 2009. It’s just a matter of how fast and how far.

Although construction starts saw mixed results in 2008 as some sectors rose and others fell, few will be immune heading into next year, economists predict.

McGraw-Hill Construction, the parent of this magazine, estimates that construction starts tumbled to $555.5 billion in 2008—a 12% drop from the $634.4 billion of 2007. Steady declines will continue through 2009, dropping another 7% to $514.6 billion, says Robert Murray, vice president of economic affairs at McGraw-Hill Construction.

For 2009, Murray says a 7% drop is a best-case scenario. His forecast assumes that the varied government stimulus packages aimed at jump-starting the economy and unfreezing the credit markets will be successful. Still, considerable drops are expected even if government intervention succeeds.

“By whatever broad measure of the industry that you look at, it’s clearly in retrenchment,” Murray says.

Some agree with that assessment. Market consultants FMI of Raleigh, N.C., are predicting that construction put-in-place will drop 4% in 2009. Ken Simonson, chief economist at AGC of America, which is based in Arlington, Va., expects the value of construction put-in-place to drop between 1% and 7% in 2009. Like Murray, Simonson says the economy will see some recovery thanks to existing and possible future government stimulus.

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“So many things have been thrown at the wall that something will stick,” he says. “Banks will be more willing to lend to customers and the state and local governments will be able to issue bonds again.”

A wildcard in all predictions is the housing market. Housing suffered the biggest decline of all sectors in 2008, with McGraw-Hill Construction estimating that single-family housing starts fell 36% to $128.8 billion and multifamily fell 30% to $44 billion.

But the worst could be over, Murray says. Although single-family housing starts have been in consistent free-fall since 2005, declines could ease considerably in the coming year. Dropping from a peak of 1.626 million units in 2005 to 937,000 units in 2007, starts fell an additional 38% in 2008 to 582,000 units. McGraw-Hill Construction is forecasting a relatively modest decline of 4% in 2009 to 560,000 units.

A souring market for condos prompted the multifamily housing sector to take a dive in 2008, dropping 30% to $44 billion. Although many developers are shifting interest toward apartment projects, Murray says that sector is forecast to see another 6% decline to $41.4 billion.

Ed Sullivan, chief economist at the Portland Cement Association in Skokie, Ill., says the bottom isn’t in sight yet. He forecasts that the value of construction put-in-place in the residential sector will drop 17.9% in 2009, after a 27.6% drop in 2008.

“When you see 1.2 million jobs lost [in 2008] and 1.8 million in 2009, I don’t care what the prices of homes are, they won’t move,” Sullivan says. “If credit conditions are tight and people are losing jobs, you won’t have rapid enough sales recovery to burn off existing inventory. As a result, builders are going to continue to cut back. Even though they are at really low levels now, they will cut back again.”

The tight credit markets will continue to erode commercial sector starts, which McGraw-Hill Construction says fell an estimated 10% in 2008 to $89.8 billion—levels seen at the beginning of the decade. Retail projects are seeing some of the biggest declines, echoing the downturn of the housing sector.

Murray says that bankruptcies by major retailers, such as Linen’s N Things, Sharper Image and CompUSA, will add to the decline in the coming year. Murray forecasts another 12% decline in 2009 to $79 billion.

Next year, the office market could take the biggest hit in the commercial sector with an 18% drop in new-start square footage predicted, Murray says.

The booming hotel market will finally pull back as well. Simonson expects lodging, the fastest-growing sector in recent years, to see a swift market correction. AGC estimates that construction put-in-place on lodging rose 58% in 2007 to $29 billion and closed out 2008 with a 25% to 30% increase. In 2009, he sees it dropping by 20%. Similarly, FMI is forecasting a 24% decline—the largest percentage drop of any sector.

After four years of steady increases, institutional building starts could flatten. The sector increased by 7% in 2008 to $124.4 billion, but could drop slightly to $121 billion in 2009 as financial pressures force public agencies to defer projects in the near term, Murray says.

Simonson agrees that institutional work will cool off considerably despite demand. While the demographics for hospital care remain healthy, owners are being cautious.

“They’ve been looking positive, but we’re starting to hear about health-care systems putting plans on hold,” he says. “It’s looking shaky.”

Higher education has also been booming with construction put-in-place rising 13% in 2007 and 15% in 2008, Simonson estimates. However, the troubled stock market is forcing many donors to close their wallets.

“We have a record population in colleges now and enrollment will stay at a high level, but to the extent that those schools depend on endowments or capital campaigns, the turmoil in the stock markets has taken a toll on their asset base,” he says.

Government restraint is also expected to hamper public works activity. While many economists predict that the incoming Obama administration will likely favor pumping federal assistance into infrastructure, it may not be enough.

With consumers cutting back on gas consumption and car purchases, many states are seeing a big drop in tax revenues. Florida transportation officials predict the state would face a $4 billion budget deficit in 2009. Virginia announced $3.7 billion in cuts for fiscal 2009, while Maryland officials will delay $1.1 billion in upcoming projects.

“There’s an argument that if a stimulus package for infrastructure passes, it will help billions of dollars in projects that are on the shelf and ready to go,” Sullivan says. “It still takes time, though. That money will go out over a long period of time, not right away.”

Plus the security of some state funding is uncertain, says William Buechner, vice president of economics and research at American Road and Transportation Builders Association in Washington, D.C.

“States could start to look at pots to dip into to balance their budgets,” he adds. “During the last recession, we saw a number of states borrow money from their highway program or simply transfer money out. That’s a concern.”

The public works sector dipped 5% in 2008 to $114.8 billion and could fall another 5% in 2009, Murray says. Next year, Murray forecasts that even with the potential for government stimulus that would boost infrastructure, highways and bridges starts could slide 4% in 2009 to $50 billion.

ARTBA is slightly more optimistic, predicting that construction spending on highways and bridges will be flat or possibly rise by about 1.5%.

Despite increasing ridership reported by many mass transit systems nationwide, Murray says that sector could decline by 5% in 2009 to $3.8 billion. However, large transit contract awards in Colorado, Oregon and Nevada as well as $1.5 billion awarded so far for the Second Avenue subway line in New York City should bolster the sector and keep it growing in 2009, Buechner says.

Oil refinery work helped boost the manufacturing sector in 2008 by 69%, but a tight credit market and diminished capacity utilization of those plants could undo many of the recent gains. Murray forecasts that the sector will drop 32% in 2009 to $20.3 billion.

The electric utility market has seen wild swings in activity in recent years, but continues at a high level from a historical perspective, Murray says. The sector surged 55% to a near-record $24 billion in 2008 and could drop 30% in 2009 to $16.8 billion. At that level, starts by dollar value would still be the fourth largest of the decade.

But others see more staying power in the sector. FMI is predicting that power will see the largest percentage gains of any sector in 2009, rising by 10%.

Simonson also sees no pullback in demand for power projects in the coming years.

“There’s tremendous work on power plants and many more will get approvals,” he says. “Plus we’re seeing transmission lines and wind farms. The power category is a winner.”

A likely upside to the down economy is materials prices. Dramatic increases in materials costs have contributed heavily to construction activity in recent years, but Murray says “probably the worst is over.” Between December 2007 and September 2008, construction materials overall rose 13%, led by 36% increases in iron and steel products along with a 13% rise in copper and copper alloy. While such drastic increases may subside in 2009, Murray says their effects will still be felt.

“The problem is dealing with the price increases that have already taken place,” he adds.

Sullivan says several factors could lead to improved pricing in 2009, including an ebb in global demand as building slows as well as improved freight rates that should come with lower oil prices.

“Freight rates track well with the price of oil,” he says. “That could impact materials.”

Just as declining construction activity could help materials prices to drop, so could it affect pricing for contractors. Simonson says contractors are likely to see markets get more competitive.

“Contractors everywhere need to brace themselves for far more bidders on jobs and for a lot of hesitancy by owners to turn the light to green on project starts,” he says.