2011: A Year of Change - for Better and Worse
By Ken Simonson
Chief Economist, AGC of America
Now that the overall economy has been expanding for nearly two years, contractors increasingly wonder, “When will things change for me?” The answer is, “Soon, but not necessarily in a direction you’ll like.”
On balance, change would be welcome. Construction spending in December and in 2010 as a whole hit 10-year lows, as measured by the U.S. Census Bureau’s data on value of construction put in place. Seasonally adjusted construction employment in January was at the lowest level since 1996, but the spending and job losses are no longer universal. While total construction employment fell by 2% in 2010, 14 states and the District of Columbia saw gains.
The Census Bureau issues a press release each month that reports on spending for 16 nonresidential categories. (The Census website has details on more than 100 subcategories.) Seven of the 16 increased from December 2009 to December 2010, although total nonresidential construction dropped by 6%. Nonresidential and residential building and specialty trade contractors continued to shed workers, but heavy and civil engineering construction firms added employees.
Unfortunately, most of the gains were due to three federal spending programs that are now at a peak and may soon drop sharply. “Stimulus” funds under the American Recovery and Reinvestment Act of 2009 boosted spending in 2010 on highways, other transportation (passenger rail, transit, ports and airports), water and wastewater treatment plants, and federal buildings. The federal government has also put a lot of money into restoring New Orleans and other coastal areas and protecting them from future hurricane damage. A third source of federal funds has been military base projects in support of the recommendations of the Defense Base Closure and Realignment (BRAC) Commission of 2005. Most of these categories have provided more employment to heavy and civil engineering construction than to building construction, which explains the difference in employment change.
Not only are these one-time sources of funds largely spent, but traditional federal funding for transportation and water infrastructure appears to be headed down as Congress tries to cut the deficit. Meanwhile, state and local budgets will be under even greater strain than in 2009 and 2010. Even though tax receipts have begun climbing in most states, the pickup is not enough to offset the end of federal stimulus funds. The problem may be most acute for local governments and school districts, which rely heavily on property tax receipts. Ongoing declines in house prices and high vacancy rates for commercial properties mean the tax base has shrunk. Owners who are delinquent on mortgages may also be falling behind on property tax payments. Spending on primary and secondary school construction sank 17% in 2010 and will likely continue declining in 2011 and 2012.
The positive side of change will come in private construction, most notably multifamily rental housing. Private employment rose every month from March 2010 through January 2011 and seems likely to accelerate during the rest of this year. That will enable more people to move away from their parents or an unwanted roommate and rent a place of their own. The end of the BRAC process will mean thousands of families moving to the vicinity of bases that in many cases are in rural areas without a surplus of housing, adding further to the demand for new rental housing.
Warehouse, manufacturing and hospital construction also appear to be headed up. The rise in exports, imports and domestic sales—especially Internet sales—is creating demand for storage and distribution space. While there is plenty of space for lease, it is pretty cheap to tilt up four walls on a new warehouse that contains the most modern storage and retrieval equipment and is sited to minimize logistics costs, a consideration that becomes more important with rising freight rates and diesel prices. Warehouse construction tumbled 29% in 2010 but turned up late in the year and appears to be headed higher.
In mid-February, Intel announced it would spend $5 billion to build a new fabrication plant in Arizona. Not only was this the largest factory announcement since the recession, but Intel’s decision to build in the U.S. may serve as a strong signal to other manufacturers. In any case, several other companies have recently announced large new or retooled factories. After a 25% slump in 2010, manufacturing construction should rise substantially in 2011 and 2012.
Hospitals and universities were busy until the financial market collapse of late 2008 deflated their endowments and their chances for a capital campaign. Now that the stock market has revived and the private activity bond market has re-opened for qualified issuers, hospitals have begun unfurling the plans they rolled up three years ago. Private colleges are also beginning to resume construction, but state and local institutions—which account for three-fourths of all higher education construction—are not likely to have the wherewithal unless they can rely on private donations or endowments.
One other category that appears poised for at least a modest rebound is hotel construction. Room and occupancy rates, and their product revenue per available room, or RevPAR, climbed at close to double-digit rates since last spring. That should give many hoteliers the confidence to refurbish and gradually expand or build new hotels. But the pickup in 2011 is not likely to be enough to overcome the 44% plunge in spending that occurred in 2010.
The biggest gain among spending categories in 2010 occurred in power construction, which climbed 13% and finished the year as the largest nonresidential segment. Power construction includes retrofits to coal-fired plants to reduce emissions or change the fuel source to natural gas or biomass; new gas-fired plants; wind, solar, geothermal and hydropower projects; and transmission lines to bring power from where it is generated to where it is consumed. All of these project types appear likely to remain strong in 2011 and probably beyond. If nuclear plants get the go-ahead, which could happen late this year, power construction will surge even more in 2012.
Three other big private construction categories—single-family, retail and office—remain among the most troubled. Single-family construction benefited from the homebuyer tax credit that was part of the stimulus law, but spending dropped as soon as the credit expired in April 2010. Home buying is likely to come back later this year, but the timing and extent of the recovery are not yet visible. Retail is plagued by high vacancy rates and less consumer appetite for shopping, at least in brick-and-mortar stores. Office employment is rising but it will be another year or more before most of the “shadow” space is absorbed in suites where companies laid off workers but remained in place.
Putting all the pluses and minuses together, it appears nonresidential construction spending will rise no more than 5% over 2010 levels, while residential spending might grow 5 to 10%, yielding a gain in total spending of 3 to 7%. That will be a big improvement over the past four years but not enough to keep every contractor afloat.