The economic momentum that gathered steam during the early part of 2010 has ebbed. This was expected as growth transitioned from stimulus- and inventory-fueled to core fundamentals such as consumer spending, investment and net exports. The economic recovery scenario can best be described as a synchronized recovery — reflecting the self-sustaining momentum and the interplay of marginal increases in demand, prompting job gains and feeding consumer, business and bank optimism — leading to further marginal gains in demand. The scenario reflects a gradually building private sector momentum — something essential given the winding down of the stimulus.
Homebuilders are unlikely to significantly accelerate construction activity until two critical conditions are met, including: 1) low levels in inventory of unsold new homes reflecting no higher than a five-month supply, and 2) stable or rising home prices. Both conditions are likely to be required to ensure an adequate ROI for homebuilders to spur an increase in building activity. Lacking either condition, a substantive recovery in home building will not materialize.
Given this, analysis of the residential sector becomes very simple. A significant improvement in residential construction cannot begin until the foreclosure crisis is over. This is not expected to materialize until 2012.
The overall number of mortgage resets are expected to decline in 2011. To some, this could imply a reduction in foreclosures next year. Unfortunately, the type of mortgages that are due for reset are extremely toxic. This suggests a greater default rate and, as a result, foreclosure levels that are likely to match 2010 record levels.
The Portland Cement Association (PCA) expects a generally flat single family housing starts scenario will unfold for 2011. In 2009, single family starts totaled 440,000 units, rising to an estimated 476,000 units in 2010. PCA expects 2011 housing starts will reach 492,000 units. As labor market conditions slowly improve, lending standards gradually ease, foreclosures begin to subside and new home prices stabilize, initially tepid gains are expected to materialize. Housing starts are expected to reach 690,000 units in 2012.
Nonresidential construction is not expected to recover soon. Large declines that characterized 2009 have materialized in 2010. Further, smaller declines against weak 2010 levels are expected to characterize 2011. No substantive recovery is expected in 2012.
Several issues confront a recovery in nonresidential expected ROIs and construction activity including depressed occupancy and usage rates, soft leasing rates, declining commercial asset prices and tight lending standards. The speed at which the healing process begins will be largely dictated by the strength in the labor market recovery. In light of PCA’s more modest economic growth scenario, job creation is not expected to be as robust as previously expected — slowing a recovery in nonresidential construction.
PCA’s nonresidential outlook suggests a prolonged recovery process. The timing of the nonresidential recovery (2013) reflects the process in which a recovery materializes — referred to as the “transmission mechanism”. Given sustained job creation and a lowering of vacancy rates, the leasing rates will first stabilize and then improve. Only when both conditions are present, namely declining vacancy rates and improving leasing rates, will expected increases in NOI (Net Operating Income) materialize — igniting new interest in commercial construction activity. Unfortunately, the process will take quite some time to unfold. In addition, the commercial real estate market is plagued with refinancing issues.