Commercial Construction To Decline

Before you build a big commercial building, you generally have to hire an architect. Big office buildings are generally not built from off-the-shelf plans. Thus the amount of new work that architects are getting is a very good indicator of how commercial construction will be doing 9 to 12 months from now.

The graph below (from http://www.calculatedriskblog.com/) shows that the American Institute of Architects (AIA) billing index has been below 50 (indicating contraction) every month since January 2008. This month it fell again by five points to 37.7. This is still a bit better than the record low set back in January, but it is not a good sign.

If one has a very long-term perspective, it is a good thing. With vacancies rising in just about every type of commercial real estate, the last thing the market needs is new supply. Defaults on commercial mortgages are shaping up as one of the biggest headaches for banks this year. This is particularly true for the mid size banks ($1 to $10 billion in assets), which tend to be much more exposed to commercial mortgages than they were to residential mortgages. It also means more out of work construction workers, with federal stimulus spending providing only a partial offset.

The AIA expects that overall spending on commercial real estate construction will fall 16% in 2009 and a further 12% decline is expected for 2010. This year the worst hit area is expected to be hotels with a decline of 26%, followed by a further 17% decline next year. Given that revenue per available room has been consistently off by about 20% on a year-over-year basis due to both lower occupancy rates and lower room rates, the major hotel firms like Marriott (MAR) and Starwood (HOT) have decided that now is not the best time to be building yet more hotels.

Surprisingly, Industrial construction spending (factories and warehouses) is expected to hold up very well this year, dipping less than 1%. Not what one would expect when Capacity Utilization is at post-WWII lows. However, next year the AIA expects a 28% plunge in that sort of spending.

So far in this downturn, commercial real estate construction has held up very well and has helped support the economy from being even weaker. That is going to change going forward. It is not a big enough part of the economy to prevent a recession, as was shown last year, nor is it big enough to prevent a recovery. However, it is one more factor in why the recovery, when it comes, is likely to be very sluggish.

Subscribe by RSS Subscribe by Email