In early 2010, the surety industry finds itself feeling like coastal residents in the Southeastern United States do when monitoring a Category 5 hurricane in the Atlantic Ocean.
So far, other than some brief thunderstorms, the weather has been relatively calm. But there is a lot of trepidation about where the storm will hit. Will it still be a Category 5 or reduced to a tropical storm when it reaches land, and if so, how long it will last and how much damage it will cause?
The Eye of the Storm
According to Associated General Contractors (AGC) of America's economist, Ken Simonson, the macroeconomic outlook for the non-residential construction industry is not encouraging. There will be some bright spots generated by either public spending or private investment that is driven by demographics, such as healthcare, or policy, such as energy.
But there will be heavy competitive pressure for the available work, due to sharp declines in other segments.
According to Simonson, the primary economic influences that are fueling the impending storm are:
- The municipal bond market is now working, but bank lending has not returned. Banks have primarily used the bailout funding to shore up capital, instead of lending purposes.
Regulators are heavily scrutinizing loan portfolios and forcing reserve increases.
Lenders are requiring upwards of 40 percent equity from the owner, before they will finance a project.
- Vacancy rates for offices, retail and hotels continue to rise.
- Cash flow for new properties is not adequate, on a pro forma basis, at the new vacancy rate levels.
- Developers and owners are unable to attract investors or lenders.
- Banks are re-underwriting existing construction loans.
If the cash flow is no longer satisfactory for the property in the revised pro forma, the bank is requiring an additional equity injection from the owner or is pulling the loan.
- Tax revenue short falls at the state and local government levels will drive deeper spending cuts.
- Significant portion of the stimulus funding has gone to balance budgets, instead of construction spending.
- No job growth-the unemployment rate reached 9.5 percent in September, up from 6 percent a year ago. Without job growth, consumer spending will not grow, which will continue to put pressure on retail spending and tax revenues.
As a result, private non-residential construction declined by 10 percent in 2009. Retail, office and hotel renumeration will suffer far deeper cuts, ranging from 25 to 45 percent. Residential spending will decline by 27 percent. Public construction spending will post a 3 percent increase in 2009, as roughly $20 billion of stimulus funded highway projects will impact the 2009 figures.
In spite of the stimulus funding that will boost public construction activity, non-residential construction spending is expected to decline another 5 percent in 2010. Residential construction is actually expected to increase by 5 percent in 2010, due to a rebound in single-family housing. McGraw-Hill Construction is projecting an 11 percent increase in total construction starts in 2010, as they predict a 30 percent increase in single-family units. Multi-family construction will continue to decline, as a result of financing issues and over supply caused by unsold homes entering the rental market.
| Table 1: Expected Change in Construction Spending, 2009 |
| Power is expected to show a 9 percent increase in 2009 and continue at about that same pace in 2010. This is mostly driven by retrofitting current plants to produce cleaner energy, wind farm development and transmission lines. |
| Manufacturing will actually show a 30 percent increase in 2009, as companies close facilities and consolidate plants. This will drive some "onetime" expenditures, so this market will likely decline by 5 to 10 percent in 2010. |
| Highway spending will be up 3 percent over 2008 and likely up another 3 percent in 2010. |
| Sewer/Water is actually expected to show a 1 percent decline in 2009, due to regulatory hold ups and the Buy American Act. However, this market should post at least |
