From October 2008 to October 2009, nonresidential construction spending slumped 11%, with the steep declines among many building categories: warehouses, -46%; lodging (hotels and resorts), -45%; retail, -41%; and offices, -28%. Institutional categories looked strong by comparison: preK-12 education, -7%; health care, -6%; and higher education, +1%. Manufacturing construction was down 6%.

Vacancies, Defaults Hurt Commercial Loans

Developer-financed construction has been plagued by rising vacancy and default rates. Those conditions make banks understandably leery of lending for new projects, particularly with bank examiners warning them to reduce exposure to commercial real estate loans.

Many hospitals and universities had ambitious multi-year expansion and modernization plans that they had to suspend when their endowments and capital campaigns were clobbered in the stock and bond market collapse of late 2008/early 2009. School construction budgets are reeling from the drop in property and property transfer tax receipts due to multiple factors: falling home values, more delinquencies and abandoned properties, less new construction being added to tax rolls, and fewer transactions.

The overall economy is showing signs of returning slowly to health. Real (that is, net of inflation) gross domestic product (GDP) — the sum of all purchases of goods and services by households, businesses, government and net exports — rose 2.8% in the third quarter, and is likely to keep rising through 2010, though more slowly than is typical after a recession. Consumer spending, residential construction, and federal government purchases, fueled by the stimulus legislation, should boost real GDP. But business investment in equipment and structures, state and local government purchases, and perhaps net exports will remain weak for several more quarters.

A surge in homebuying could spawn at least a modest uptick in retail construction, as demand rises for neighborhood shopping centers, and shuttered department and luxury stores are converted to home-improvement stores. But other developer-financed construction — multi-family, office, warehouse and hotel — will be dragged down by high vacancy rates, low rents and reluctant lenders. Weak economic growth, lackluster consumer spending and cautious investment by businesses mean that hiring will be very slow, there will be little retail expansion, and business travel will remain subdued. These indicators will keep demand depressed for office, warehouse, manufacturing, and lodging construction, while retail will grow but only slightly.

There is hope that universities and hospitals will resume the multi-year campus plans they shelved last winter, now that the stock market has restored many portfolios and bond markets have reopened to qualified borrowers. But these impacts are unlikely to translate into actual construction until the second half of 2010.

State and local government-funded construction will have a tough year. The Center on Budget and Policy Priorities reported on November 19 that the mid-fiscal year budget gap — the amount that must be closed by June 30, 2010 in most states — averaged 6% of the budget. Budget gaps that have already appeared for fiscal 2011 make further cuts inevitable. Construction is often an easier target than current employees or services. Local governments and school districts, which depend heavily on property taxes, will still be absorbing the reductions in assessments that occurred throughout 2009. Even if home sales and house prices both turn positive in 2010, the impact on local budgets will not show up until 2011 or, more likely, 2012.

Federal spending will help, selectively. Base realignment activity will continue at a high level. And more “stimulus” funds will flow to nonresidential building construction in 2010 than in 2009. But these amounts will not be enough to offset the continuing downturns in private or state and local government spending into the plus column.

Ken Simonson is chief economist, Associated General Contractors of America. He can be reached at 703/387-5313 or by e-mail at simonsonk@agc.org.