Local Outlook

Housing Crisis Hangover Heralds Sluggish Market

by Craig Barner

Construction has enjoyed a lot of merrymaking over the past half-decade and beyond, but now the hangover has started.

“I think we’re going to see a decline across markets,” says Jeffrey Hagerman, president of Indianapolis-based contracting firm GDH LLC. “We’re already seeing indicators of that.”

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Projections from McGraw-Hill Construction, of which Midwest Construction is a unit, suggest 2008 will be the second consecutive year of declining starts in the four states where the magazine circulates. The forecast calls for $55.2 billion in starts in 2008, down 2% from $56.4 billion, the preliminary estimate for 2007.

If the 2007 estimate holds up, it would represent a 9.5% decline from the 2006’s $62.3 billion in starts likely the most construction ever to take place in the region.

Guarded pessimism is warranted due to the subprime lending crisis, a major factor impacting construction and overall economic forecasts because of tightening lending requirements and the possibility of recession. The estimated $1 trillion in subprime debt nationwide is causing fallout that includes declining single-family home sales and home building.

“If you factor in housing starts, those are weighing down some markets,” says Rick Blair, manager of business development in Chicago of New York-based contractor Turner Construction Co.

In fact, each of the major metropolitan regions where Midwest Construction circulates experienced declines in residential starts through third-quarter 2007 compared to the period the previous year: Milwaukee, -33%, to $545 million; Indianapolis, -29%, to $1.47 billion; Chicago, -17%, to $7.11 billion; and St. Louis, -12%, to $2.0 billion.

“Historically, the commercial markets have followed the residential markets by 12 to 18 months,” Hagerman adds. “We know where the residential markets are today. We’re starting to see that effect on (commercial) opportunities this year and into 2008.”

But gloom is cautious due to the strong nonresidential construction market.

“So far we haven’t seen a whole lot of decline in the nonresidential market,” says Ron Glaser, vice president of preconstruction in St. Louis for Kansas City, Mo.-based Walton Construction Co.

During the same period of falling residential construction, three markets had increases in nonresidential commercial activity: Indianapolis, +12%, to $1.47 billion; Chicago, +5%, to $5.70 billion; and St. Louis, also +5%, to $1.46 billion. Though Milwaukee had a big decline (-49%, to $504 million), the Wisconsin city would have had a less steep drop and possibly an increase had not the $2.3 billion Oak Creek Generating Station south of Milwaukee started in 2006 to inflate starts that year.

As a result of the nonresidential segment, some contractors say that backlogs are up, hires are being made and even fees are increasing each a sign of a strong market.

Thomas Boldt, chief executive officer of the Appleton, Wis.-based contractor The Boldt Co., says backlogs are up 10% at the firm compared to the same period a year ago, though the figure derives from work nationwide, not just in the Midwest.

Nevertheless, enthusiasm is tempered. Also darkening the market are prospects for $100-a-barrel oil, questions about consumer confidence in the face of massive foreclosures, high energy costs and lower real wages.

In addition to these negative indicators, uncertainty surrounds about the future direction of the nation because of instability in the Middle East, federal deficit and other factors.

“Concerns about the economy might increase in the 2009-10 area because you’ll be post-election,” Boldt adds.

Downbeat Signs

Several other national indicators are negative or mixed:

• The producer price index for finished goods went up 1.1% in September, the latest figure available, and 4.4% over the past 12 months, according to the Bureau of Labor Statistics. Meanwhile, the PPI for “inputs to construction industries” a measure that includes materials going into projects plus items consumed during construction, notably diesel fuel rose 0.2% and 3.3%, respectively.

• Nonfarm payroll employment rose 110,000 in September and averaged 136,000 every month since last year, the Bureau of Labor statistics says.

Meantime, construction employment fell 14,000 in September and averaged a112,000 drop every month since last year. But mimicking the starts situation, the data is brighter for nonresidential construction categories. Employment has averaged a monthly increase of 42,000 since September 2006.

“We expect to hire,” adds Turner’s Blair. “The number of good, qualified people does not match up with the demand.”

• Though they have leveled, costs in the free-trade era for construction materials continue to climb in part because of world demand, especially in Asia and parts of the Middle East. The PPI for materials and components was 193.3 in September, up 2.3 points from 191.0 in September 2006. The uptick is milder than 14-point rise between September 2005 (177.0) and the ensuing September.

“The price increases are leveling, and a few are decreasing,” says GDH’s Hagerman. “The net effect is somewhat of a leveling.”

Regionally, there are also mixed or negative trends:

• The American Institute of Architects’ Architecture Billings Index in September was 49.5 in the Midwest, with the score below 50 indicating a decrease in billings. The Midwest was the only region nationwide below 50.

“While there is plenty of nonresidential construction activity in the pipeline over the coming months, the demand for new projects is tapering off a bit,” says Kermit Baker, the economist who released the data.

• The University of Illinois Flash Index in October fell for the fourth consecutive month to 104.1, indicating the economy in the Land of Lincoln, the most populous Midwest state, is growing but at a slower-than-usual rate. A reading of 100 marks the division between economic growth and decline.

The data indicate that sales tax and corporate tax receipts were down in October compared with the period a year ago, but personal income tax receipts increased, according to J. Fred Giertz, the Illinois economist who released the data.

• Finally, the U.S. Small Business Confidence Index in the third quarter was the lowest in the Midwest (39.66), according to the Buffalo Grove, Ill.-based Small Business Research Board. The index was below the national average (43) and had declined from the previous quarter (42.33).

Small-business owners in the Midwest had deteriorating assessments from the previous quarter about the economy improving and revenue increasing, indices show. But they were slightly more optimistic this quarter about hiring.

Up Institutions, Badger Construction

On the upside, some hopeful signs give reason for optimism.

For instance, institutional building comprising health care, education and other is projected to see a 4.6% in the Midwest, to $11.5 billion, due in part to increased tax revenue in some states from the economic expansion earlier in the decade.

“Chicago is strong in higher education because of the large number of institutions here,” adds Turner’s Blair. Others cited K-12 education, corporate interiors and offices in some markets for expansion.

The forecast also suggests Wisconsin will go counter to trends by seeing an increase in starts, +11.6%, to $9.3 billion in 2008. In addition to the Oak Creek project, other major projects under way include the $810 million reconstruction of the Marquette Interchange, the $494 million Columbia St. Mary’s Hospital project and $240 million Potawatomi Bingo Casino expansion.

Political pressure is likely to increase funding for public works to prevent disasters like falling bridges, exploding steam pipes and busted levees. Indeed, infrastructure starts are projected to increase in each of the four states in 2008: Illinois, +23%, to $5.7 billion; Indiana, +19.2%, to $2.7 billion; Wisconsin, +14%, to $2.0 billion; and Missouri, +$4.1%, to $2.4 billion.

Finally, the popularity of sustainable construction and design is rising like Iowa corn in July.

SIDEBAR 1

Midwest Projection*
(starts in millions of dollars)

Residential construction and nonresidential construction are expected to be down in the Midwest in 2008, but infrastructure and institutional are projected to see gains.

SIDEBAR 2

Declining Starts
(third quarter each year; in billions)

The data show that construction starts are falling in Midwest cities, precipitously in some metropolitan areas.

SIDEBAR 3

Three and One
(starts in millions of dollars)

Three of the states where Midwest Construction circulates are expected to see declines. Only Wisconsin is projected to see an expansion in starts.

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