The next shoe just dropped

Although nonresidential building held up longer than residential activity in the current recession, the nonresidential downturn now has started and is expected to continue into 2010. The timing of the rise and fall of these two construction categories differs. Nonresidential building began to increase strongly at the beginning of 2006, just as residential activity was sagging, and double-digit growth continued in seven of the next 10 quarters, partially offsetting the drag on GDP created by the residential downturn. But nonresidential building hit the skids in the fourth quarter of 2008 with an annualized decrease of 5.9 percent. Now, looking forward, analysts see no bottom in sight for nonresidential spending during the current year.

Although nonresidential building held up longer than residential activity in the current recession, the nonresidential downturn now has started and is expected to continue into 2010. The timing of the rise and decline of these two construction categories differs. The boom in spending on residential building, measured as an inflation-adjusted component of Gross Domestic Product (GDP), peaked in the fourth quarter of 2005.

Residential spending declined for the next 12 consecutive quarters, the longest sustained housing decrease in the postwar period. Nonresidential building began to increase strongly at the beginning of 2006, just as residential activity started to sag. Double-digit growth continued in seven of the next 10 quarters, propping up the economy and partially offsetting the drag on GDP created by the residential downturn. But nonresidential building hit the skids in the fourth quarter with an annualized decrease of 5.9 percent.

Now, looking forward, analysts see no bottom in sight for nonresidential spending during the current year. Double-digit quarterly decreases are expected through 2009. This contraction in nonresidential construction comes on the heels of an expansion greater in magnitude than that recorded by residential building during the recent housing boom.

Residential spending grew by 25 percent between 2003 and 2006, while nonresidential spending increased by 36 percent between 2006 and mid-2008. Nonresidential building includes a diverse mix of structures, including office and retail space, warehouses, health care facilities, manufacturing plants, and even such facilities as golf courses.

But just as residential building has been hit by a weak economy, nonresidential construction is now feeling the effects of reduced demand for office space and facilities of all types. Moreover, tighter credit standards, originally linked to residential mortgage problems, are now affecting nonresidential financing.

According to surveys of bank loan officers by the Federal Reserve Board of Governors, four out of five banks report tighter standards for commercial real estate loans. Nonresidential building has posted many instances of sustained downturns, the most recent being the six consecutive quarters beginning with the fourth quarter of 2001, after the attacks of September 11. As long as financial markets are tight and securitization barely exists, it is unlikely that nonresidential building will show strong signs of life.