Director - Building Products
BRG Group North America
While there are still trouble areas in the economy (unemployment, rising foreclosure market and a softening of the non-residential construction market), the overall indicators tell us the recession has run its course. We believe market has bottomed and is turning.
BRG forecasts indicate an upturn in the third and fourth quarters of 2009 with an overall sustainable growth now projected for 2010 in the new residential construction and repair/remodeling markets. The green construction market is expected to continue to gain in momentum. While certain sectors of the non-residential construction market will benefit from the 2009 economic stimulus package, other sectors within the non-residential construction market are expected to retract through 2010 (retail construction, hospitality construction, general office building and amusement/recreation construction spending).
1. U.S. GDP Developments
In the fourth quarter of 2008, the U.S. GDP decreased by 0.7%, followed by a growth of 1.5% in the second quarter. In the second half of 2008, the economy started to deteriorate. The third quarter showed a decrease of 2.7% with the fourth quarter down 5.3% resulting in a total economic growth of 1.1% for the year.The decrease in real GDP in the second semester primarily reflected negative contributions from private investments, non-residential fixed investments, personal consumption expenditures, residential fixed investment and exports.
While the bailout spending from 2008 kept the economy from collapsing further, it is generally believed the recession would continue for the first two quarters of 2009 before bottoming out. In the first quarter of 2009, the GDP slipped an additional 6.4%. At the end of the second quarter, the GDP growth was at -1.0% indicating the recession may have run its course.
2. Unemployment
In 2008 a total of 2.6 million jobs were lost nationwide. At the end of 2008, the unemployment rate rose to 7.2% representing 11.1 million people that were officially unemployed. According to the U.S. Department of Labor, at the end of July 2009, the unemployment rate climbed to 9.4%, and is expected to grow to 10.1% by the end of the year. While this remains high, BRG believes the unemployment rate will start to come down in 2010 as the overall economy starts to gain momentum.3. U.S. Prime Rate And 30-Year Fixed Mortgage Interest Rates
The U.S. prime rate was at 6% at the beginning of 2008. During the year, the Federal Reserve cut the prime rate four times in an effort to stimulate the faltering economy. At the end of 2008 the prime rate was at 3.25%. On August 12, 2009, the Federal Open Market Committee (FOMC) voted to maintain the prime rate at its current level of 3.25%.At the beginning of 2008, 30-year fixed mortgage interest rates were at 5.25%. They dipped as low as 4.78% by May of 2008, then jumped to 5.8% in June until finally settling at 5.35% at the end of the year. Despite initial concerns the long-term fixed mortgage rate would increase because of inflationary pressures, as of the end of August, the rate hovered around 5.14%. While this is up from the May 2008 time frame, long-term mortgage rates remained historically low, which is helping to sustain a high level of affordability in the home-purchase market.
4. Construction Trends
a) New Residential ConstructionThe U.S. Commerce Department reported housing starts in 2008 fell to the lowest level since record keeping began. Housing starts fell 33% in 2008 to 904,000. The anemic housing starts in December were indicative that the recession would continue through 2009.
At the end of July 2009, ground-breaking for new U.S. single-family homes rose for a fifth straight month, keeping hopes for an economic recovery alive. According to the Commerce Department, construction starts for single-family dwellings, the worst-hit part of the housing market, rose 1.7% from June to an annual rate of 490,000 units - the highest since October. Compared to 2008, however, the most recent housing market starts were down 37%, indicating how sharply the market has corrected.
b) Existing Home Sales
Existing home sales - including single-family, town houses, condominiums and other multi-family dwellings - rose 7.2% to a seasonally adjusted rate of 5.24 million units in July 2009. This is up 5% if compared to the same time in 2008.
According to the National Association of Realtors (NAR), the inventory of homes for sale in the United States was at 3.6 million at the beginning of 2009 and has gradually risen to 4.1 million by the end of July 2009 - approximately 500,000 units below the peak of 4.6 million units seen in July of 2008. The NAR says that current inventory levels represent approximately 9.4 months of supply. July 2009 was the third consecutive month in which the inventory of homes has declined. This is down from the peak inventory of 11-1/2 months recorded in April 2008.
As of the end of August 2009, there were 2.3 million homes that have been in default, have been auctioned off or have been reprocessed. July 2009 foreclosure rates jumped 7% from June and are up 32% if compared to the same time period in 2008. According to RealtyTrac, one in every 355 homes with a loan in the United States is in foreclosure filing.
California, Arizona, Florida, Utah, Idaho, Georgia, Illinois, Colorado and Oregon were the states with the highest overall foreclosure rates. The continued rising rate of foreclosed homes is an economic warning signal that cannot go unheeded.
As homes become foreclosed, they add to the existing home inventory and reduce the probability of contractors to start new construction in that area. Additionally, foreclosed homes tend to undermine the valuation of other homes for sale in the neighborhood. Banks and mortgages are unloading repossessed homes at fire sale prices. This ultimately affects the resale value of all of the homes in the immediate neighborhood.
One recent study indicated that a foreclosed home in your neighborhood can result in the overall value of homes in that neighborhood decreasing by up to 25%.
d) U.S. Repair/Remodeling Market
The Repair/Remodeling market generally emulates the market direction of new residential construction. However, there are three key differences:
Since 1982 the largest R&R contraction was -8% and the largest annual growth was 22%.
From 1997 to 2007 expenditures in R&R never decreased on a four-quarter basis compared to the same quarter in the previous year. However, expenditures have been contracting since the fourth quarter of 2007 and are projected to decrease for the remainder of 2009. Total R&R expenditures are expected to be $155 billion in 2009.
However, the Remodeling Market Index (RMI) from the National Association of Home Builders for all current remodeling activities across all regions of the United States is up and indicates cautious optimism that the worst is behind us and better times lie ahead.
In the second quarter of the year, the RMI’s “current market conditions” indicator grew to 38.1 up from 34.5 in the first quarter. While remodelers remain cautious, they report business is looking a little less challenging after several quarters of a retracting market. Conditions indicate the market is at the beginning of a recovery phase.
Kitchen repair/remodeling represents approximately 9.9% of the total of residential repair/remodeling expenditures, while bathroom remodeling represents approximately 6.5% of the total R&R expenditures. Kitchen and bath additions represent 2% of the total residential repair/remodeling expenditures, while the replacement of plumbing pipe, plumbing fixtures and HVAC equipment represented 7.5% of the total R&R expenditures.
The American Institute of Architect’s Consensus Construction Forecast reported non-residential construction is expected to drop by 16% in 2009. Forecasts for 2010 indicate the non-residential construction market will continue to soften with an overall market correction of 12% expected.
Retail construction is expected to be down 28% in 2009. New hotel construction is projected to be down by 26% and general office building construction is expected to be down 22% in 2009. Amusement and recreation related construction is expected to drop 21% in 2009.
The institutional and governmental markets will fare better as the Obama Stimulus funding becomes available for public schools, health care and governmental facilities.
While the Architectures Billings Index (a leading economic indicator of expected non-residential construction expenditures) is up 9.8 points from its lowest point in January 2008, at 43.1, it remains in negative territory (below 50) indicating a continued contraction for architectural design services for the non-residential construction market. All U.S. regions remained below 50 in July 2009.
f) U.S. Green Construction Market – the bright spot in the non-residential construction market
Once seen as an emerging trend, the green non-residential construction market has become a growing part of today’s construction market. Green non-residential construction put in place in 2006 was valued at $13.4 billion. Since then, the value of sustainable construction has increased to $49 billion in 2008 and is expected to reach $140 billion by 2013. In a recent study by CoStar, green buildings (sustainable construction) that sold for $171 more per square foot can command a rent premium of $11.25 per square foot and have a 3.8% overall higher occupancy rate than non-green buildings.
As a comparison, Energy Star-rated buildings sell for $61 more per square foot, command a rent premium of $2.38 per square foot and have a 3.6% higher occupancy rate than non-Energy Star-rated buildings.
With this type of money to be earned, it is not surprising that contractors have embraced the Green Construction market.
5. Consumer Spending
According to the U.S. Department of Commerce, consumer spending edged up 0.2% in July, largely driven by the government’s “Cash for Clunkers” program that fuelled demand for autos. This is the second increase of consumer spending in two months. Incomes, however, remained flat.Consumers are correctly worried about the high unemployment rate in the United States and the continued correction of the housing valuations. While general consensus is that the U.S. market is turning, consumers will remain mostly on the sidelines until they have an indication that the market recovery will be sustainable. BRG believes the current uptick in the market is because the housing market is correcting and because distribution is starting to replenish their inventories.
While consumers remain cautious, we believe they will stay in a “wait and see” mode until late in the fourth quarter of 2009, and will fully believe in the recovery around February of 2010.
In Summary
The U.S. GDP - while still in negative territory - is showing signs of a turning economy. New residential starts rose for the fifth consecutive month. Existing home sales are up 5% over the same period last year. Green Construction is expected to triple to $140 billion in the next five years and non-residential construction for schools, health care facilities and governmental facilities is expected to benefit from the Obama Economic Stimulus spending.The U.S. Prime Rate and the rate for 30-year fixed mortgages are still in historical low levels, making the purchase of homes more affordable for the average American.
On the negative side, unemployment is on the rise. Repair/remodeling expenditures are down, as are expenditures for the hospitality, retail and general office building markets.
The foreclosure market continues to accelerate, especially in the states that experienced the highest construction development during the overheated construction phase. With banks scaling back their mortgages to clients with less than stellar credit ratings, the foreclosure tide should soon start to ebb.
The U.S. economy is showing signs that it is working its way through the oversupply in homes. While the foreclosure market is bringing overly inflated home values back into realistic levels, the prime rate and the 30-year fixed mortgage rates have remained at historically low levels, making homes more affordable than in recent years. As we have seen, the inventory of existing homes for sale has dropped in the last three consecutive months and the rate of existing home sales are up 5% compared to the same period last year.
Taking all of the indicators into consideration, BRG believes the market has bottomed and has entered into the long anticipated recovery period. The market should experience a stronger third quarter with an even stronger fourth quarter of 2009 mainly driven by a correcting housing market and by the replenishing of inventories by distribution. The overall sustainable growth period is expected to take hold in the first quarter of 2010 as consumers regain their confidence in the market and voice their confidence through increased consumer spending.
