Mortgage Fallout

Dec 1, 2007 12:00 PM, By Beck Ireland, Staff Writer

Concerns over the mortgage crisis in the single-family housing market and its potential impact on non-residential construction weigh heavily on 2008 economic outlook

Over the past two years, the seesaw that is the construction industry economy was kept level by a thriving non-residential sector. Industry analysis performed in 2006 predicted that in 2007 a red-hot non-residential sector with double-digit gains would again balance the overall construction economy, allowing time for a much-needed correction in the inventory of the overbuilt single-family housing market. Hopes for an impending turnaround in single-family housing, however, were dashed as news of the crisis in the sub-prime mortgage broke mid-year. As a result, last year's predictions of moderate overall increases in the construction industry economy proved woefully incorrect. “Every time we think we've hit bottom, another shoe drops,” says Kermit Baker, chief economist, The American Institute of Architects (AIA), Washington, D.C. “It's increasingly possible the housing recession could bloom into a full economic downturn.”

Despite recent Federal Reserve Board action to cut interest rates and a federal program to freeze sub-prime mortgage rates, most industry forecasters have integrated the consequences of tighter lending standards and increased foreclosures, delinquencies, and bankruptcies into their revised 2007 forecasts. In fact, some economists predict the bad apple that is the sub-prime mortgage crisis will continue to spoil the rest of the barrel well into 2008. However, some projections for next year reveal a lesser degree of doom and gloom, forecasting a softer landing for the general economy, a minimal slowdown in non-residential markets, and, finally, a recovery period for the residential sector after it bottoms out in 2008.

The corrections

Before any economists could complete their forecasts for 2008, projections for 2007 had to be amended to reflect current concerns, such as the Federal Reserve Board's dilemma between inflation and recession, fraud in the sub-prime mortgage market, a weakening dollar, unprecedented prices per barrel for oil, job loss, and a decline in consumer confidence. As a result, projections for 2007 took a nosedive, with single-family housing having the fastest descent.

In a correction to its 2007 forecast, McGraw-Hill Construction, New York, changed a modest 4.8% decline in the dollar volume of single-family housing starts to a whopping 25.1% decline. Almost entirely a result of this decline in single-family housing, the total dollar volume of overall construction starts was corrected from a 0.6% decrease to an 8.2% decrease. For 2008, the firm is expecting a further 3.1% decline in single-family housing starts, which, combined with a 1.6% decline in non-residential, gives 2008 the second dollar decline — at 2% — in the market since 1991 (click here to see Table 1) .

“The stable construction cycle has hit a speed bump,” says Robert Murray, vice president, Economic Affairs, McGraw-Hill Construction. “We are seeing a turndown in activity, not just in construction starts but in spending as well.”

Still, there's a chance for a soft-landing scenario for the economy in 2008, according to Murray. Although the single-family housing market is in a collapse, other markets are showing growth. “The Cinderella at the ball is single-family housing,” he says. “As a result of the credit crunch — the biggest threat to the construction industry going into 2008 — there will be a dampening of the commercial sector, but you'll keep your viable projects. In non-residential building, we seem to have learned the lessons from the past.”

Jim Haughey, chief economist, Reed Construction Data, Norcross, Ga., admits the sub-prime mortgage crisis delivered a jolt to construction and real estate, but his firm is claiming that the ramifications, which have been limited to the residential economy, are mostly over. “Economic support for construction is good but not great,” Haughey says. “Moving forward, there will be lingering effects in real estate and residential construction, but not much for commercial or institutional. The only segment that's shrinking is the new residential sector.”

Haughey's firm corrected its 2007 prediction of a 1.8% decrease in residential spending (not including the remodeling sector) to a huge 20.4% drop in residential construction spending. However, because of its faith in the health of the non-residential sector, the company was able to minimize the correction to its prediction of a 5.9% increase in U.S. total construction spending in 2007 to a modest 1.2% decrease (click here to see Table 2). Reed Construction Data's forecast is predicting a 7.3% increase in U.S. total construction spending for 2008, with new housing construction back in the black with a 2.1% increase.

A 6% decrease in single-family construction put-in-place was recently changed to a 28% drop by FMI Corp., Raleigh, N.C. This led to a change in its 2007 total construction forecast from a 2.2% increase to a 4.8% decrease. For 2008, the company is predicting a mere 1.0% decline in single-family housing, a 5.2% increase in total non-residential, and a 1.9% increase in total construction (click here to see Table 3). “We are probably on the optimistic side of the forecasting business, but we don't see current events impacting the economy, which should continue to be strong,” says Heather Jones, construction economist, FMI Corp. “If we are wrong on that, we are wrong on everything else.”

According to Skokie, Ill.-based Portland Cement Association's (PCA) prognosis, FMI's forecast is well off the mark. Ed Sullivan, staff vice president and chief economist, PCA, warns that the sub-prime mortgage crisis has bled through to the real sectors of the economy and will have a long period of adjustment. “The threat to the economy is not a housing issue,” he says. “It's a credit issue — an issue of how we financed housing and consumer spending.”

Speaking at the PCA Economic Forecast in October, Sullivan corrected PCA's 2007 construction forecast from an initial 1.8% decrease to a 3.9% decline and is projecting a further 3.7% change downward for 2008 (click here to see Table 4). “We had expected the non-residential market to keep the momentum, but that's no longer the case,” Sullivan says.