A tale of two segments

12 March 2008

As miserable as residential construction has been, it is taking a turn for the worse. Not only are starts and sales falling, but inventories are rising and stand at their highest levels in 20 years. In such a situation, lowering interest can only have a limited effect; for the market to recover, prices must fall to clear inventory. Global Insight believes that the median home price will fall 2.7% in 2007 and a further 9.5% in 2008. Real price declines are even larger as builders in particular incorporate non-price incentives to move properties. If prices fall as we expect, inventories will return to more manageable levels and nonresidential investment will rebound in the second half of 2008.

Nevertheless, on an annual basis, the damage in the first half will well exceed the recovery in the second. Housing starts will barely register a million units in the first quarter of 2008, and residential construction spending will contract 17% in 2007 and a further 18% in 2008 before growing around 6% in 2009.

Slow down?

The decline in residential construction must have an impact on the nonresidential sector, but not all segments of nonresidential are sensitive to housing, and those that are affected see a lag before the impact. Accordingly, nonresidential construction should grow nearly 11% in 2007, but slow significantly to 1.4% in 2008. The distribution of growth within the nonresidential sector will be the story.

Retail construction will feel the housing pinch the most acutely. Not only does the reduced pace of homebuilding directly impact the demand for the new retail space that invariably follows, but falling home prices will limit the funds available for the home equity extractions that fueled consumer spending over the past three years. Indeed, Global Insight expects that while personal incomes will see healthy growth, the savings rate will also increase, reducing consumer spending growth to less than income growth for the first time since 2002. Lower levels of residential construction combined with a lower propensity of consumers to spend suggest that retail construction will contract about 2% in 2008, and more than 6% in 2009.

The bellwether office segment will slow significantly, but is not expected to see a major decline. Global Insight expects a slowing of employment growth, particularly in financial services. However, we do not expect a recession, and other office sensitive employment, such as business services and information services will grow sufficiently to offset financial employment losses. On balance, office construction will see virtually no growth until late in 2009.

By contrast, the construction of new manufacturing facilities is expected to see substantial improvement. The low and declining value of the dollar is making US manufactured products more price competitive, particularly compared to Canadian and Western European producers. The automotive sector may be subdued in the near term given the turmoil amongst some of the key domestic producers. However, the broad manufacturing sector will likely see construction growth in the double digits over the rest of the decade. Fabricated metal products and computer equipment manufacturing are set for the greatest improvements given the worldwide demand for investment goods and the US traditional role as innovator and quality producer of these components.

Public sector construction spending will exhibit steady, if unexciting, growth. Global Insight expects solid income growth and no recession, which will provide states and localities with the fiscal ability to continue investment in new schools, roads and other public structures.

On the whole, total US construction will decline 4% in 2007 and a further 7% in 2008 before recovering with 5% growth in 2009. The near term will be dominated by a residential contraction, reinforced by a nonresidential slowdown in late 2008. In 2009, the residential turnaround will offset the lagged impact on nonresidential construction, but not until late 2009 and 2010 do we see the US construction sector again firing on all cylinders.

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