Nonresidential Building Trendlines Point Up, but Traction Is Tough In Face of Fiscal Uncertainty
The strong rebound reported in CRE development may represent light at the end of the tunnel for the U.S. nonresidential construction sector after several dark years, or it may just be a flicker that fades in the face of flagging confidence among investors and builders in recent months.
A report issued by Fitch Ratings is optimistic, concluding that increasing demand for commercial space coupled with almost no new supply in recent years has fueled stronger activity in 2012. Meanwhile, spending on commercial construction projects put in place jumped 23.1% to $143.2 million through the first half of the year from the same period in 2011, according to U.S. Census figures analyzed in a report by Fitch Director Robert G. Rulla.
Congressional approval in June of a new $105 billion federal highway bill will enable state and local governments to plan new longer term projects with more certainty, another potential boost for the nonresidential sector, Fitch said.
The benefits of the new highway bill are not likely to accrue until 2013 and the sector is by no means out of the woods. Public construction will remain flat through the end of the year before growing 2% in 2013, and highway/street spending will remain under pressure through at least the end of the year, according to Fitch.
Other factors that could level off growth in new commercial construction activity before year end include slow U.S. economic growth, lingering problems in key European economies and ongoing issues with developer access to construction financing.
While the latest Federal Reserve survey suggests that banks are easing lending standards, that view isn't unanimous. Another survey indicated that standards remain tight, with little evidence that CRE credit availability has improved meaningfully. Fitch believes financing will remain constrained as cautious institutions continue to be picky about financing development projects.
For better or worse, developers aren't proceeding with the confidence that marked earlier recoveries. The Construction Confidence Index (CCI) compiled by the Associated Builders and Contractors (ABC), measuring sales prospects, staffing levels and profit in the U.S. nonresidential construction industry, reflected declines in all three areas during the second quarter. The setback reversed much of the progress made in the first quarter, although the index values remain above 50, indicating that construction spending is still poised to expand, albeit at a slower pace.
Construction sales expectations fell from 68.3 in the first quarter to 62.3 at midyear. Profit margins fell from 57.9 to 53.5 and staffing levels declined from 64.3 to 59.8.
ABC Chief Economist Anirban Basu said the nonresidential construction industry continues to struggle to establish sustained momentum despite data indicating that the nation is now in its fourth year of economic expansion. Construction spending levels have barely managed to edge higher in recent months.
Contractor attitudes won't likely improve until positive economic data emerges and the federal government resolves fiscal issues that in a worst case could plunge the nation back into recession in 2013, Basu said.
"Nonresidential construction firms have become unnerved by the possibility of the nation falling off a fiscal cliff due to a number of tax increases and spending cuts that take effect at the end of the year," Basu said. "This would limit private nonresidential construction, which is among the nation’s most cyclical industries."
Recession would also further hammer already weak federal, state and local government finances, likely leading to further declines in public spending, Basu said.
Among the most interesting findings in the CCI is that the proportion of contractors expecting substantial deterioration in business performance has risen from just 2% during the first quarter to nearly 13% in the second quarter.
Construction employment declined in 31 states between July 2011 and July 2012 and in 28 states in the past month, according to an analysis of U.S. Labor Department data by the Associated General Contractors of America. The drying up of public construction funding offset employment gains in homebuilding and nonresidential construction.
"Public construction cuts in particular are taking their toll on construction employment in many parts of the country," said Ken Simonson, the association’s chief economist. "With economic growth remaining sluggish, there is a chance construction employment will begin to slip in even more places."
Worse, if economic growth slows as businesses worry about future tax uncertainty, private demand for construction is likely to lag, the AGC said.